Turning Equity Into Income: The Property-to-Shares Transition Strategy

As mentioned in last week’s post, today we’re looking at how you can convert your equity-rich property portfolio, into a share portfolio providing a good level of cashflow to fund a life of freedom.

It’s my view there are far too many Aussies in this situation – clinging onto their properties due to fear of shares, or just not knowing how to make the switch.  Last week was all about why the sharemarket is such a great income generator, without the costs or hassles associated with property ownership.

Well, this is the how-to post!  By the end, you’ll have a clear plan for selling down your property assets and building a diversified share portfolio, while living off your equity at the same time.  OK, let’s get started!

 

Disclaimer

The property-to-shares transition plan outlined here can be adapted to different portfolios and tweaked to suit your own needs.  Also, don’t run out and do this just because you read it on a blog.  Carefully consider your own situation before making any decisions.

This is for thought-provoking purposes, and I hope you find it useful.  Our own transition from property to shares is a similar game-plan to what’s described here.  There are no perfect ways to do this, so if you have another plan you prefer, by all means go for it.  This is simply the approach we’re taking and it feels right for our situation.

Other approaches tend to rely on getting further bank loans, or keeping the properties for as long as possible, eventually living off rental income and cash.  Neither of those were doable or even attractive strategies for us, so we made our own!

Also, I have to acknowledge there is only room for one hypothetical portfolio in this exercise, due to space and time limitations.  And of course, I have to make a bunch of assumptions here which are necessary for the example.  I’m sure you understand!  So if you don’t like the numbers/assumptions, feel free to use your own.  Numbers used are very rough estimates, rather than in dollars and cents.  The concept is more important than the detail.

 

The big picture

So, the overall goal is to move all of your savings from property shares.  But what’s the best way to go about that?

The first thought that probably pops into your head is, “should I sell all my properties at once, or do it steadily over time?”

Great questions, to which there is no right answer.  You could definitely do it all at once.  But personally we’re not.  Here’s why I don’t think it’s a good idea…

—  Selling multiple properties in the same financial year means lots of capital gains to declare and a huge tax bill.  Spreading out the sales in different years results in much lower capital gains tax (CGT), leaving more money in your pocket.

—  Having large amounts of cash to invest all at once is far more stressful than smaller amounts.  Especially so if you’re new to the sharemarket and not yet confident in building your portfolio.  Investing steadily over time is far less stressful, and it gives you time to gain experience and confidence before putting large amounts of money in the market.

—  Selling your properties all at once may mean selling in weak markets.  By spreading sales out over time, it gives you the option of offloading properties in stronger markets or those which have just had a big run of price growth.

—  The effects of averaging.  By steadily moving from property to shares, you reduce the risk of a bad outcome.  You’re more likely to receive the average performance of each asset class over the years.  If selling all at once, you might sell a property just before a strong run of growth and buy shares before a down period.  This way you’ll end up with a less positive outcome.  The averaging approach ensures a less extreme outcome and is much easier to cope with psychologically.  Bottom line: it reduces risk and regret.

 

How much do you need?

OK, so maybe you agree – the steady sell-down approach makes sense.  But for this to work, how big does your property portfolio have to be?

This all depends.  Not on how many properties you own, but how much they’re worth, and the debt against them.  What matters is the overall equity in your portfolio.

For simplicity, I’m ignoring home equity/ownership today.  Because maybe you’re renting.  Maybe you’re mortgage-free.  It doesn’t matter.  The easiest way to work through this is to look at your yearly living expenses.  Forgive me for wanting to make such a complex topic simple!

Covering our annual expenses is really the goal here.  By my rough estimates, I think a good figure to use is 30 times spending.  If you have investment equity which is at least 30 times your annual spending, this can work.  Less than that, and you’re probably cutting it too fine, unless you’re more flexible or have plenty of safety nets on standby.

This 30x figure should leave you with enough after-tax proceeds to build a diversified share portfolio and eventually live off about 4% of the portfolio each year.  To be conservative, I’m also going to ignore franking credits, which boost dividend income much higher than 4% in Australia.  What does this all look like?  I’ll show you.

 

Our wanna-be retirees

Let’s say we’ve got a couple who spends around $50k per year.  And they have a property portfolio worth $4m, with mortgage debt of $2.5m.  So, the couple has $1.5m in equity – 30 times their annual spending.

We’ll assume they own 5 properties in total, in a couple of capital cities (doesn’t matter where).  Each property was purchased for $500k and is now worth $800k.  No debt has been paid off, so there is $500k of debt owing on each.  Coincidence I know.  Just go with it!

Not unreasonable for a couple who continually saved, bought properties and did quite well over the last 7-10 years.  But as you might remember from this post, it’s unlikely they’re getting any positive income at all from a portfolio like this.  Why?

This capital city portfolio likely has a rental yield of say 4%.  After all costs, this would be around 2.5% (or lower).  So on a $4m portfolio, this means net rental income of $100k.  With debt of $2.5m at an interest rate of 4%, this is an interest bill of $100k per year.  The net result is, it’s neutral cashflow – the portfolio pays for itself, but no positive income.

I think the above is a pretty reasonable scenario.  We’ll assume a few things from here, for the sake of simplicity, your sanity as the reader, and mine as the writer!

That rents increase steadily over the next ten or so years, but so do all property costs.  That all loans remain interest-only.  And that interest rates move up slowly over the next ten years.  These factors offset each other, meaning the portfolio stays in this neutral cashflow position throughout the exercise.

You might think this sounds silly, but I actually think it’s quite realistic, if a bit conservative.  And besides, the more things we try to account for and the more precise we aim to be, the less likely we are to grasp the bigger picture.  Again, feel free to adjust and make your own assumptions.

I’m also assuming that property prices will grow at 3% per annum, and that shares provide a total return of 8% per annum (4% dividends, plus 4% growth).  If you don’t agree with this base-case, stay with me, because the concept is what’s important.  Alright, let’s get this party started!

 

How to convert this equity into an income stream

We have a couple of goals here.  Sell down this property portfolio over time.  Steadily build a share portfolio large enough to generate the income which can fund the couple’s spending.  And, at the same time, provide enough cash each year so this couple doesn’t have to work during the whole process.

Phew!  So where do we start?

Well, firstly, our couple needs to have a decent cushion in the bank.  And if they’re responsible adults, they should already have this sorted, given they have a large property portfolio and a lot of debt.  So we’ll assume they have at least $50k of cash.  If not, it wouldn’t take a 2-person household long to save this amount – maybe a year or so.  This is a sensible level of minimum cushion in this scenario.

At this stage, they’d put the first property on the market.  Ideally, they’d do this mid year, so that the property is under contract during a new financial year.  And at that time, they’d also leave work, minimising the amount of income and capital gains earned during the new financial year.

The cash from the sale (and their existing cash) can sit in an offset account, saving them a bit of interest.  Here’s the picture…

 

Property #1 sold.  Just declared Financial Independence!

Here are the estimates for the first property sale.

Sale price – $800,000.
Debt owing – $500,000.  (same as purchase cost)
Total selling costs – $25,000.  (approx. 3% for agent fees, advertising, marketing, conveyancing, bank charges etc.)
Proceeds – $275,000.

How much tax do they have to pay?  Well, they would’ve spent 5% ($25,000) initial up front costs in acquiring the property – stamp duty, conveyancing, bank charges etc.  So if the profit is $275,000, they only have to declare $250,000 as long term capital gains.

Because they’ve held the asset longer than 12 months, they only need to pay tax on half of this capital gain.  So the taxable capital gain is $125,000.  Owned jointly, they would pay tax on $62,500 each.

Assuming they earn no other income that year (because they’ve stopped work and the property portfolio is cashflow neutral), the tax owing on $62,500 of income is currently about $11,800.  Combined, they’d need to pay around $23,600 in tax on this property sale.

Total after-tax proceeds from sale – $251,400.

OK, we’ve now got a ton of cash parked in the offset account.  Party time!  Round-the-world cruise anyone?

Not for us, we’ve got work to do!  Besides, our couple’s net worth is down $50,000.  This is the short-term pain required with this plan.  But the reward is real freedom, immediately.  From experience, I can say, the hit to net worth from selling costs and tax, are completely worth it!

The numbers on the spreadsheet don’t look so sexy anymore.  But who the hell cares?  This is your life we’re talking about!  Anyway, where to from here?

 

Sidenote – An alternative plan

This quarter-mill of cash is enough to cover our couple’s spending for 5 whole years.  They could continue on this path – selling one every 5 years or so and forget about investing.  With property prices likely to increase over time, the proceeds from each sale would be higher than the last.  This means the money could even last 30 years or longer.

In all honesty, if the couple was in their late 30s or above, with a decent amount already in Super, they could follow this strategy up until their mid 60s and simply live on their Super after that.  There’d be little tax to pay and zero work along the way.

If your Super doesn’t look large now, it will be multiples of that in 30 years time, even adjusted for inflation.  Plus the pension kicks in as a backup plan if need be too!  This is also a valid approach.

Now, back to our property-to-shares transition strategy!

 

Starting the investment process

So, our couple is sitting on around $250,000 of cash (ignoring their buffer).  They need $50,000 per year to live off, plus invest a decent amount to build their share portfolio for passive income.

Let’s say they work on investing $30,000 per year.  They can invest this up front, or $2,500 per month.  They invest in a basket of diversified, dividend-paying shares such as index funds or LICs, as discussed many times on this blog.

Between their spending and investing, they’d burn through $80,000 of cash each year.  Therefore, their lump of cash would last around 3 years.  But over this time, the average cash balance would be around $125,000 (half way between $250,000 and zero).  Sitting in an offset account, this would likely save them (or provide them) another $15,000 over the period.  Or an extra $5,000 per year.  So our couple can actually invest $35,000 per year.

Over time the interest savings reduce as the money is spent, but you get the idea.  Dividends would start rolling in too, but we’ll assume these are reinvested.

After 3 years the cash will run out.  So here’s where they stand at that point.

Property portfolio – $3.5m. (four remaining, 3% growth per annum)
Mortgage debt – $2m.
Shares – $113.6k. (assumes 8% return)
Investment income – $4.5k per annum, plus franking.

So after 3 years of being retired and enjoying everyday life, our couple’s net worth actually grew a little bit.  From $1.5m to $1.6m.  But they’re out of cash, ignoring their $50k buffer.  This means it’s time to sell another property (obviously you’d start the sale process a little earlier than this).

 

Property #2 sold.  3 years into FI.

Here’s the estimate for the second property sale.  Note: each property is now worth a bit more than before, due to capital growth.

Sale price – $875,000.
Debt owing – $500,000.  (same as purchase cost)
Total selling costs – $25,000.  (approx. 3%)
Proceeds – $350,000.

How much Capital Gains Tax (CGT) is owing this time?  Again, accounting for the initial 5% up-front costs to acquire the property, the profit to declare here is $325,000.

Because they’ve held the asset longer than 12 months, they only need to pay tax on half of this capital gain.  So the taxable capital gain is $162,500.  Owned jointly, they would pay tax on $81,250 each.

Assuming no other income for the year (no work, property portfolio neutral cashflow and tax on dividends is covered by franking credits) the tax owing on $81,250 of income is currently about $18,400.  Combined, they’d need to pay close to $37,000 in CGT this time.  Ouch!

Total proceeds after-tax from sale – $313,000.

 

Investment process continues

This time our couple has over $300,000 of cash to allocate.  Assuming 2% or so inflation, they now spend around $53,000 per year.  Even if inflation ends up being higher than this, it’s not hard at all to contain your living costs as I looked at here.  If anything, I think allowing 2% for inflation is generous, as most spending can be adjusted or optimised as prices rise.

The lump sum will sit in the offset initially saving them $12,000 annual interest, reducing over the three years.  Over the three years it’s likely to save them close to $20,000 in total.

Assuming $53,000 annual spending, I think they can safely invest $57,000 per year.  Or $4,750 per month.  Between spending and investing, they’ll use $110,000 per year.  This equates to $330,000 in total over three years, roughly equal to their lump sum plus interest saved due to the offset account.

So this lump sum will again last around three years, assuming dividends are being reinvested.  If the numbers are off by a grand or two here and there, either positive or negative, it’s not going to matter overall.  There are much bigger variables at play anyway, which we’ll get into later.  Again focus on the big picture.

It’s now three years later and the cash has run out.  How are they doing?

Property portfolio – $2.85m. (three remaining, 3% growth per annum)
Mortgage debt – $1.5m.
Shares – $336k. (assumes 8% return)
Investment income – $13.5k per annum, plus franking.

Alright, we’re now 6 years into early retirement, and our couple is still alive!  Their property portfolio is smaller, while the share portfolio has grown nicely.  And they’ve had enough cash to pay the bills, while kicking their feet up and doing whatever it is FI folks people get up to!

Their net worth hasn’t grown much, but that’s OK.  The plan is still working.  Overall, the goal at this point is to enjoy your freedom and generate cashflow from your investments.  Speaking of which, they’re out of cash again, so you know what that means… (again pointing out that you’d start the sale process a little earlier than this).

 

Property #3 sold.  6 years into FI.

Here’s the estimate for the third sale.  Note: each property is now worth a bit more than before, due to capital growth.

Sale price – $950,000.
Debt owing – $500,000.  (same as purchase cost)
Selling costs – $28,000.  (approx. 3%)
Proceeds – $422,000.

After subtracting the initial 5% up-front costs to acquire the property, the total gain to declare this time is around $400,000 (rounding for simplicity).

Again, because they’ve held the asset longer than 12 months, only half of the capital gain is taxable.  So the taxable capital gain is $200,000.  Owned jointly, they pay tax on $100,000 each.

Assuming no other income for the year (no work, property portfolio neutral cashflow and tax on dividends covered by franking credits) the tax owing on $100,000 of income is currently about $25,000.  Combined, they’d need to pay about $50,000 in CGT this time around.  It’s getting a little more painful each time, isn’t it?

Total proceeds after-tax from sale – $350,000 approx.

 

Steadily building…

Our couple has now been free for 6 whole years.  And it’s pretty safe to say, they’re enjoying the hassle-free income from shares and getting comfortable with the process.

From the latest sale, our couple now has $350,000 of cash in the bank.  Due to inflation, they now spend about $56,000 per year.

Again, this chunk of cash sitting in the offset account will initially save them something like $14,000 annual interest, reducing quickly over the next three years as the funds are spent.  It could even be higher, because remember, we assumed slightly increasing rates over ten years.  But to keep it simple and conservative, this is fine.  With an average balance of $150,000 over two years (half way between $350,000 and zero), it’s likely to save them close to $20,000 in interest.

Assuming $56,000 spending, they can invest around $67,000 per year for three years.  Or just under $5,600 per month.  Between spending and investing, they’ll burn through $123,000 per year.

Over three years, this equates to the lump sum, plus the interest savings.  Lots of cash has been pumped into the share portfolio and they’re running low on cash again.  Let’s see what the picture looks like now…

Property portfolio – $2,075,000. (two remaining, 3% growth per annum)
Mortgage debt – $1m.
Shares – $641k. (assumes 8% return)
Investment income – $25.6k per annum, plus franking.

It’s now 9 years later and our couple is getting where they want to go.  We’re still assuming they’ve done absolutely no productive paid work and increased their spending with inflation.  In real life, most FI people find lots of new and fun things to do, some of which they’ll earn an income from.  So it’s not the most realistic example, but let’s continue!  Time to sell another property…

 

Property #4 sold.  9 years into FI.

Here’s the estimate for the fourth property sale.  Note: each property is now worth a bit more than before, due to capital growth.

Sale price – $1,037,500.
Debt owing – $500,000.  (same as purchase cost)
Selling costs – $30,000.  (approx. 3%)
Proceeds – $507,500.

After subtracting the initial 5% up-front costs to acquire the property, the total gain to declare this time is around $482,000 (rounding for simplicity).

Again, because they’ve held the asset longer than 12 months, only half of the capital gain is taxable.  So the taxable capital gain is $241,000.  Owned jointly, they pay tax on $120,500 each.

Assuming no other income for the year (no work, property portfolio neutral cashflow and tax on dividends covered by franking credits) the tax owing on $120,500 of income is around $33,500.  Combined, they’d need to pay around $67,000 in CGT.

Total proceeds after-tax from sale – $440,000 approx.

 

Eyes on the finish line!

Because of inflation, our couple now spends about $60,000 per year.  Right now, they now have $440,000 of funds to allocate over the next three years.

With an average offset balance of about $220,000 over three years (half way between $440,000 and zero), this would save at least $25,000 in total interest.  In reality, just like other years, it saves lots of interest at the start, which reduces as they spend down the cash.

Assuming $60,000 annual spending, they can invest around $95,000 per year for three years.  Or just over $7,900 per month.  To break it down…

Personal spending over three years is $180,000.  Total investments equal $285,000.  This is $465,000 in total – broadly in line with the lump sum plus interest savings.

So, three years later and they’re out of cash again.  But they’ve been rapidly building their share portfolio in the meantime.  Let’s take stock of the situation.

Property portfolio – $1,135,000.  (one remaining, 3% growth per annum)
Mortgage debt – $500,000.
Shares – $1,135,000.  (assumes 8% return)
Investment income – $45.4k per annum, plus franking.

Wow, we’re now 12 years into this thing.  Our couple hasn’t lifted a finger.  They’ve got one property left, and a share portfolio which is now spitting out a decent amount of income.  Alright, let’s sell the final property!

 

The last hurrah!  Property #5 sold.  12 years into FI.

Here’s the estimate for the final sale.  Note: each property is now worth a bit more than before, due to capital growth.

Sale price – $1,135,000.
Debt owing – $500,000.  (same as purchase cost)
Selling costs – $35,000.  (approx. 3%)
Proceeds – $601,000.

After subtracting the initial 5% up-front costs to acquire the property, the total gain to declare this time is around $576,000.

Again, because they’ve held the asset longer than 12 months, only half of the capital gain is taxable.  So the taxable capital gain is $288,000.  Owned jointly, they pay tax on $144,000 each.

Assuming no other income for the year (no work, property portfolio neutral cashflow and tax on dividends covered by franking credits) the tax owing on $144,000 of income is about $43,700.  Combined, they’d need to pay around $87,500 in CGT.

Total proceeds after-tax from sale – $513,500.

 

Finishing touches

With a little inflation, our couple is now spending around $63,000 per year.  This time they have over $500,000 of funds to tip into the market!  Let’s say they continue to drip feed it in, as that’s what they’re most comfortable with (like many people).

They might not have an offset account anymore (if they’re renters), so perhaps they put it into a high interest savings account before it gets invested, and earn a measly 2%.

If, over three years, they spend $195,000 in total, this means they have close to $320,000 to invest.  But it’d be more than this, due to the interest from their savings account.  With the average balance being around $250,000 or so over three years, a 2% yielding savings account would earn around $15,000 in total interest.

This means over three years there’d be $335,000 to invest.  A little over $110,000 per year, or $9,300 per month.  At the end of the period, their portfolio will look like this…

Shares – $1,800,000.  (assumes 8% return)
Investment income – $72,000 per annum, plus franking.
Annual spending – $67,000 approx.
Cash buffer – $50,000.  (from the start, untouched).

 

We did it!

Well, that took longer than expected!  Our couple has now been pottering around and enjoying life for the last 15 years!

Some of you might look at these figures and think it’s a bit too close for comfort.  But remember I’ve been pretty realistic, if not conservative.  Here’s what we assumed…

—  Long term sharemarket returns have been around 6.5% after inflation since 1900.  I’ve used 5.5% to 6% here.  (8% total return, less 2% to 2.5% inflation.)

—  Our couple doesn’t earn a single dollar over this 15 year period.  What we know about early retirees is that basically every single one goes on to do productive and enjoyable things which end up earning some sort of cash.  From experiencing FI myself, and talking to others in the same boat, I can tell you it’s crazy to assume you’ll never getting paid doing something ever again!

—  Spending rises over time roughly with inflation.  Our own spending hasn’t gone up for 10 years.  In fact, it’s gone down almost every year.  A well-run household naturally finds new ways to save and become more efficient over time, making inflation mostly optional.

—  The remaining properties continue to generate zero positive cashflow throughout the whole period.  Remember, we started from neutral cashflow, so it’s likely they’d generate at least some positive income after the first 5-7 years or so.

—  Property prices to grow at 3% per annum.  This is much lower than in recent decades, and perhaps in line with household incomes over the coming decade.  How many investors are still banking on 5%, 6% or 7% long term compound growth?!

—  Our couple hasn’t looked at diverting money to super to save paying so much CGT.  This would mean less money in their personal portfolio, but more in super and a higher net worth overall.  To overcome this, they could sell down a little of their portfolio each year, until they can access the now-higher super balance.

—  We’ve ignored the possibility of investing in higher yielding options to generate more yearly income sooner.  These include higher yield shares or funds, real estate investment trusts (REITs), or peer-to-peer lending.  This would come at the expense of growth, but our couple might be okay with that.

—  We assumed there will be no future income tax cuts, which are likely to occur in the next 5 years or so.  And highly likely over the next 10 years.  So we’ve forced our couple to pay increasing amounts of capital gains tax.  In reality, tax brackets are bound to be adjusted in the future to reverse bracket creep and result in lower tax than above.

—  I’ve ignored franking credit refunds.  Every year our couple invests in shares, they’ll be paying basically no tax, and instead will receive franking credit refunds.  Reinvesting this extra cash every year would make an increasing difference as the years roll on.  What’s more, franking credits are unlikely to be touched by government for at least the next 6-8 years.

—  We’ve assumed you live on 4% of your portfolio each year (whether through dividends or selling shares, or both).  But remember, when the share portfolio is built, it’s 10-15 years after you first left work!  So our couple is likely to be 45 or 50 years old by then, meaning accessing super isn’t far away.  This means they can (if desired) spend more than 4% from their portfolio, since super and even the pension (if needed) will be available before too long.  There’s more cushion in this plan than there first appears!

—  It’s also possible to park cash in a higher yielding place than an offset account.  We did this personally, with peer-to-peer lending.  Obviously, this comes with extra risk versus cash in the bank.  But we had a good experience with this approach, putting a six-figure sum from a property sale into our RateSetter account.  Interest rates were around 7%+ at the time, to lend for 3 years, and no tax to pay due to zero personal tax rates.  As the repayments rolled in each month from borrowers, the money was automatically sucked out and sent to our bank account.  From here we paid our bills and invested in shares each month.  There were no hassles and we found it to be a convenient and reliable way to spend down a lump of cash.    Rates are a little lower these days, but maybe worth considering.  More details here.

 

Dealing with imprecision

Why don’t I have downloadable spreadsheets for you and pretty colourful graphs for this stuff?  Because the world doesn’t run on Excel!  There’s no way your scenario is going to work out like above.

But it won’t really matter, because after you step off the hamster wheel and declare your Financial Independence, you’ll wind down for a bit and then begin looking for new challenges.

So, it’s far better to get the overall picture right, than trying to nail down precise figures down to two decimal places.  Too many people get lost in spreadsheet land, thinking there’s a ‘right’ answer.  There’s not.

Get the basic plan sorted, and be prepared to adjust things as you go.  Remember to be adaptable.  This is about accepting the risk to get your life back much sooner.  From the other side, I can tell you it’s totally worth it.

Our plans didn’t work out like we expected.  Not even close.  Some things turned out better, others not so good.  Lucky I wasn’t relying on a spreadsheet!  For example, Perth property continued to fall, so our net worth took a hit.  But on the plus-side, we’re both earning some income in a way that’s enjoyable for us.  We didn’t plan that either!

 

What if?

Obviously there are many variables at play here, so this raises questions…

—  Which property do I sell first?
Hard to say.  One option is to sell the property which has the most equity.  This is the one with the highest opportunity cost and that will provide the most funds for personal spending and investment.  Another option is to cash out the asset with the best recent growth.

Or another way of looking at it, keep the assets which have the best outlook (in your view) for the next 5 or so years.  That’s not to say you’ll get it right, but it will at least help you choose.  We pretty much balance both of these ideas to choose which property to sell.

—  What if I’m single?  I’ll have to pay more tax?
Yep, you will.  I only had room for one broad example here, so I chose a couple which is the more common scenario.  On the plus-side, you should have lower expenses, or the ability to more easily adjust your lifestyle or move house, to adjust spending lower if needed.

—  What if I want to keep some properties?
Well, under this example, it won’t work.  You’ll need an even bigger pool of equity to do that.  Maybe closer to 40 times your annual spending.  Right now, these assets are standing in the way of your freedom.  Is it really worth working longer to keep properties?  That’s up to you.  But we decided, no it’s not.

—  What if the sharemarket/property market drops?
If the sharemarket plummets while property doesn’t, it’s worth looking at offloading a property or two sooner than planned.  Why?  To take advantage of building your share portfolio at much lower prices than you otherwise could, while cashing out of property while the market is still okay.  Make your own judgement here.

If property is falling, but shares are up a lot, again you’ll have to make a call.  If it’s all a bit scary at the time, you could always do a little part-time work to stretch out the time between property sales.  And if you’re like most of us who retire early, you’ll end up doing that anyway, for the sake of enjoyment and satisfaction.  I was as shocked as anyone to find that out!

—  But my properties are ‘A’ grade, and will have more growth than 3% per annum…
That’s great – I hope they do!  But remember, everyone else believes their property is better than average too.  And that can’t be the case!  As I’ve said, adjust the numbers to suit yourself, just try not to be too optimistic.

—  What if ‘X’ or ‘Y’ happens?
I don’t know.  Honestly, I have no clue what’s going to happen.  I’m in the same boat here.  My plan?  Just deal with whatever happens.  If you find this too scary, then don’t do it.  The key element when making plans like this is to be adaptable.

Life is always uncertain – we can’t change that.  So if you don’t like any of the numbers I’ve used, wait until you have much more money to retire.  But realise, you’re trading your life away out of fear and lack of flexibility.

 

Summary

You know the overarching message by now…

Net worth without passive income is almost meaningless.  Make your wealth generate cash and real freedom for you.  Otherwise, what’s it all for?

This post goes hand-in-hand with last week’s article. 

You’ve read the reasons why shares are a far more effective income-producing asset to retire on.  We also covered the most common worries about the sharemarket, and why they’re unfounded.  And now, you’ve got a roadmap for the property-to-shares transition strategy (which you can modify for your own situation).

You’ve seen how equity-rich investors can steadily go from zero passive income, to living on their assets and building a strong cash-generating share portfolio, all at the same time.

We’ve done it in such a way that:  Minimises tax.  Uses realistic and conservative expectations.  Offers flexibility of when and what asset to sell.  And allows a dollar-cost-averaging approach to shares, which reduces stress and helps the investor gain confidence and experience as they build a large portfolio.

So now it’s up to you!  You can stick with what you know, and quite likely remain at work longer than you’d like.  Or you can take a leap of faith, vow that you’ll make it work regardless of what happens, and get your life back!

My goal here, as always, is to help you build a life of freedom, by managing your money efficiently and creating an income stream from investments, letting you spend time doing what matters most to you!  Thanks for reading, and all the best.

 

** Tickets for the Playing with FIRE Sydney Premiere are selling now.  Come watch the movie and hang out with like-minded people on August 14th, including a Q&A session with Aussie bloggers, including myself.  Details here.

20 comments

  1. Very interesting read. I don’t have any IPs of my own, nor do I ever plan on it, but I can see how your strategies make sense.

    For me, I’ve had the benefit of reading a lot about FIRE and general investing before properly starting my own portfolio. Sites like this have given me a lot of pre-knowledge. So I think I’ll stick to spending less than I earn, investing the difference in stocks with a growing income stream, with the occasional borrowing-to-invest sprinkled in here and there.

    I’m genuinely looking forward to seeing a post on your site in 10 years time, saying something along the lines of “that’s it, the last one’s sold!”. Can’t wait to see it all unfold.

    1. Cheers Nick. Sounds pretty sensible to me!

      Haha hope you’re still reading in 10 years time! I’m not locked into anything, but I think I’ll stick around that long 😉

  2. Great story Dave – and very thorough indeed! Although I have to say my favourite part is your comments on dealing with imprecision – as much as I do love fancy charts and excel, I couldn’t agree more with your sentiment here. A great piece of advice. It’s so easy to get bogged down in complex calculations looking for the right answer, but if there’s one thing you can be certain of, it will not play out the way you model.

    I’m enjoying following your own story as you transition to shares – my favourite asset class by far 🙂

    Cheers, Frankie

    1. Thanks very much Frankie!

      Absolutely mate – being flexible is so incredibly important and being prepared to deal with the ‘what ifs’ as they come up. There’s simply no way to account for everything and expecting a smooth ride like the spreadsheet says is pretty silly. Applies to lots of things in life too, not just this example 🙂

  3. Hi Dave
    New reader here but have been enjoying your blog. Thanks for sharing.
    Question- you mentioned that the stamp duty is part of the 5% capital expense and can be subtracted from the capital gains. Is this really the case? I thought stamp duty couldn’t be claimed on? Can you please clarify? Thanks!

    1. Hey FIREwannebe, thanks for reading.

      Stamp duty and other purchasing costs incurred, such as buyers agents fees for example, cannot be claimed as an instant deduction, but they do count as part of your ‘cost base’ and therefore are effectively subtracted from your capital gain. Which makes sense, because it’s real money you spent in acquiring the property. Here’s the ATO example. Hope that helps 🙂

      1. Thanks Dave. Since we’re on the property topic, hoping to get some advice too. Wish I had found your blogs prior to purchasing my property. Anyway, I did, and now regretting it. It’s a BR apartment, and I want to sell it within 1 year. I’m currently planning to live in it and rent a room out. I’m not sure if I should claim the IP portion of it (including paying for a depreciation schedule) and pay 100% CGT later, or not claim and not pay CGT later. Maths was never my strong subject so not sure how I should crunch the numbers to help with my decision.

        1. Oh man, tricky one. There’s simply too many variables to give an answer to that. Either way, given the short timeframe involved, it might not matter too much as it’s unlikely you’ll be making a large taxable gain on it once all costs are accounted for.

    1. Ohhh that’s right – dammit! Can’t believe I forgot that, we just sold one ourselves!

      Cheers Codebeard 🙂

  4. Hi, I liked you story but could you explain your comment in regard to not diverting their money into super to avoid paying large capital gains tax.

    1. People can contribute money to their super each year up to a certain amount and have it taxed at a concessional rate (15%) instead of their personal tax rate. And it’s also possible to bring forward future year’s contributions unless you already have a large super balance. For people in a situation like our hypothetical couple, where they aren’t working, and receive large capital gains every few years, this could reduce tax quite a bit. Details on the ATO site here. Hope that helps Rob!

      1. FYI the bring forward rule only applies to non concessional contributions, and you wouldn’t be able to claim a tax deduction for putting money into super this way. You can however make catch up concessional contributions if you didn’t use your full entitlement the previous year, and this would work for claiming a tax deduction against your income in the year you sold your property.

  5. Very interesting indeed.

    My former neighbours used to have a strategy similar to yours, but adapted slightly to fit their situation. They were keen renovators with a property portfolio much like yours. But what they did instead of just selling was to live in it for a year or so, while renovating the place. This in effect became their PPOR. When they sold, because it was a PPOR, they were exempt from paying capital gains. So they did this, living in a property, renovating, then selling, presumably repeating until they had none left.

    All in all a pretty interesting strategy! Thanks for writing about it.

    1. That’s an interesting idea – I hadn’t considered that. Some stuff I’m reading on the ATO site suggests it may be frowned upon, and seems to have various conflicting points. Pretty good way to do it though – we could probably do that with our Perth ones (provided there ends up being much capital gain to worry about lol).

      1. Great article Dave! What a great and unique thought exercise. The whole way through I was thinking that making each one the PPOR or at least the last couple would make sense (as the tax bill really shoots up).

        I don’t think there would be any ATO issue as 3 years is a pretty good amount of time. Generally once you have claimed the first 100% cgt free having a 2 year plus gap would be safe.

        Might be worth adding it on as an alternative option and run some numbers as it would make a pretty decent difference at a guess. If the property locations work of course but then again, your retired so why not try living in different states for a change (obviously some moving costs would take the shine off).

        1. Thanks Adam – it is a great point. I’ll add it in the list of ‘conservative assumptions’. The couple pays a total of around $250k in capital gains tax thoughout the exercise, so this would make a pretty decent difference to the end shares balance, given some compounding over the years. The oucome would be an extra $10k-$15k in passive income per annum from this approach.

          But I’m still not sure this is entirely allowed. It seems you’re only allowed a partial exemption if the property was initially purchased as an investment. You get an exemption for the time you lived in the property, not an immediate full exemption. It seems too good to be true, and that may well be the case here. See here and here. The ATO also says this which could be quite noteworthy “The main residence exemption is not based on one factor alone, and the weight given to each varies depending on individual circumstances. The length of time you stay there and your intention in occupying it may also be relevant.”

          In other words, if bought and held as an investment for most of the holding period before selling, it seems unlikely you’d get a full CGT exemption. ATO may believe you’re doing it to avoid CGT and may not be allowed. It’s a hard topic, a lot of this stuff isn’t black and white unfortunately.

  6. Why not tweak it a bit by selling the main residence CGT free and moving into one of the investment properties. Avoiding CGT allows for a few more years of living expenses and the capital gains in the new property will be wiped out at death.

    1. That’s a decent option Terry. I think someone suggested hopping from property to property to do this, but I wanted to keep it pretty simple and conservative and avoid extra tricks. We may consider moving into one of ours if we end up with the happy problem of large capital gains in Perth…

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