Just wondering on my FIRE plan

[Major Tom]

Hello MM Community

I relish the idea of removing myself from paid salary and wondering if FIRE is at all feasible. Need a heads up and non-biased, objective view on my situation please.

Below is my breakdown and I am currently working full time as a software developer. Thinking about stopping entirely and embracing a FIRE life change including  potentially potential moving overseas for a while or part of the year. I like/frequently travel to SE Asia where it is feasible to engage in lower cost of living arbitrage. I am free to come back to Sydney (Australia) as I choose.

I live frugally and although I have mortgage debt the interest on these is manageable (fixing portion of loans with 5 year terms, interest only etc.). I may sell IP # 2 in 5 years time and pay down debt. I don’t intend to sell IP # 1 as it is a good investment,  highly rentable and I would be having to pay capital gains tax once it is sold.
(Both properties have always been rented, well maintained and I have spent renovating both of them)

My mortgage / accounts are setup so I am able to offset a portion of the interest using cash (200k) to reduce my monthly mortgage costs *.

Situation single (no children, relationship ended 1 year ago) 
48 male in Sydney live, in family home and have an option to live there as I want.

Breakdown

Investment Property (IP) #1 - Value 1,300,000K
$500,000 Mortage and rental income of 40K per year
Expenses $8,000 per year


Investment Property (IP) #2 - Value 450K
370k Mortgage and rental income of 20K per year
Expenses $4,000 per year

Total mortgage interest cost 38k per year
*Possible to reduce this to 28k per year using the 200k offset

Total rental income (excludes mortgage interest) 48k

Family trust income 7k per year
Dividend income 7k per year

Total yearly living costs $24,000

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Assets

Investment Properties 1.75M

Investments

Cash 200k
Superannuation  200K
Investment Funds, ETFs, Stocks 170k

TOTAL Assets, Investments: 2.32M

Debt

Mortgages 870k

[BicycleB]

I may defer to others more versed in Australian investing and cost systems. Partially unfamiliar, though have been reading other cases with interest and informally studying long term international investment performance (stocks, real estate, bonds).

It's unclear to me whether the "standard" 4% rule of thumb is useful in a real estate heavy allocation like you have. If it were, and the debt structure did not interfere, your 1.5M $AUS portfolio would presumably enable spending of $40,000 $AUS/year less taxes (not familiar with Aussie tax). Taking your $24k spend rate at face value, I presume that FIRE would be plausible.

But I second lhamo's concerns. As an outsider, it seems that returns on the real estate are lower than the "standard" rule of thumb. To me this also implies that there could be a bubble in this asset. There are markets in the US with similar pricing, but most Mustachian landlords avoid owning in them like the plague. Debt presumably increases any risk inherent in the asset class.

For what it's worth, landlords in America frequently have expenses (not principal, not interest - operating expenses, including vacancy costs, capital expenditure, maintenance, tax, property managment, etc) close to 50% of rent. Not all landlords recognize all the expenses until they occur in large surprising lumps. Your expected expenses are far lower than this 50%. Is that consistent with long term complete expense standards in your market?

lhamo addressed this, but - your stated rent less expenses and mortgage interest produces $10,000 per year against stated equity of $880,000. That's a return of less than 1.2% per annum even if your expense estimates are correct. Is that the best return you can find? Are we missing something here?

Supposing that the $10,000 per year is the best option, what is the expected return per year on the other main assets - the $200k of cash, $170k of stocks and the $200k of superannuation? Is the expected return in total less than 24k?

If the cash gets eaten by rental expense variations and vacancy, could you be forced to sell your crown jewel properties at discounted prices in some market downturn?

[mjr]

You're on the way, but you're not there yet.

You've said that you can effectively get 5% on the $200k as an offset, so you should be doing that.

That gives you $34k of income, on which you'll pay $3k of income taxes.

Yes, that's more than your expenses of $24k, but you don't have much of a safety margin. 

You've got too much in real estate - you've got to sell them in one chunk if you need the money and then you'll cop capital gains,  as you know.

[Major Tom]

Thanks for the insights. Particularly highlighting the siginificance of the debt and real estate components in my asset allocation. Also as alluded to by BicycleB there are indeed differences with Australian taxation laws and debt structuring to that in USA.

For simplcicity in writing my case I bundled the mortgage as one debt amount - though the true borrowing for property is 700k, the balance is for the stocks and ETFs 170k.

Also, one correction on the stock, funds, etfs  holdings, the true value is 230k

The costs at 20% on gross rental is realistic and consistent for these properties over the years I have owned them (in fact, this 20% is used by banks/lenders in calculating the debt servicing levels of borrowers who own investment properties).
Lenders in Australia have been more conservative in their lending practices as compared to other parts of the world. The major lenders are regulated and a recent Royal commission has compelled them to be even more careful with their lending practices. My point is the lenders are comfortable with the current gearing of these assets.

Apart from the strong capital gains in Sydney recent years, the yield of the properties for the market is within expectations.
Should I face vacancies, expenses relating to these properties I would partially sell liquid assets (shares etc) first and then I would sell IP # 2. I have a clear expecation of selling this within 5-7 years in any case.
 
The property market has turned and there may well be a bubble in the Australian property market though as a rule of thumb Sydney property doubles in value every 10 years. Of course these returns may not continue and investment decisions should not be made on these expectations.

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One option I have is to extinguish/offset the interest only loan on IP # 2 using the 200k which would change the mortgage interest costs to roughly 30k.

This would mean net rental of 18k (net of all costs)

Return on shares, funds, etfs  5% x 230k is $11500

I also receive annually $7000 in cash from a family trust.

These components when added exceed 24k.

Superannuation is only available to me at age 60, using future value calculator on a conservative measure with no more contributions this would be worth 350k by the time I am 60.

As mjr states - on my way and close but perhaps not enough for a comfortable safety margin.

[MrThatsDifferent]

I’m not sure how you can work this out without your expenses now and your expenses when you FIRE?

[former player]

For simplcicity in writing my case I bundled the mortgage as one debt amount - though the true borrowing for property is 700k, the balance is for the stocks and ETFs 170k.

Do I understand this right, that you have taken on 170k in debt in order to invest it in the stock market?

That is risky.  And even if you are making the figures work for you at the moment it has to be considered an active investing policy rather than the "index funds and forget it" which is the principle of the MMM way. 

[Major Tom]

The 170k borrowing is mainly actively managed individual stocks.
Admittedly it may be a challenge for some, though it can work in the current low interest rate environment.

[marty998]

It may be worth considering selling both IPs after you stop working.

Best thing to do would be to stop working on 30 June 2020, sell the properties on 1 July 2020, and don't have any other income for the 2021 financial year. This would absolutely minimise any CGT payable.

You could live off some of the cash proceeds for a year, then recommence your investing on 1 July 2021 by buying shares (ETFs or LICs), which are a better outcome than property in terms of income, along with getting franking credits. Your CGT on the properties would finally become payable in March/April 2022 depending on how late your accountant lodges your tax return.

You would need to sell them prior to moving to SE Asia (if you go there permanently), because the CGT discount is not available to non-residents on TARP (Taxable Australian Real Property).

How big is the unrealised gain on the IP1?


 

[SwordGuy]

It's unclear to me whether the "standard" 4% rule of thumb is useful in a real estate heavy allocation like you have.

The 4% rule has ABSOLUTELY NOTHING to do with real estate investing.  Nothing.   It ONLY has to do with a  stock/bond/cash (and maybe gold??) portfolio and then only in specific ratios to each other.   It has nothing to do with any other kind of asset.

For what it's worth, landlords in America frequently have expenses (not principal, not interest - operating expenses, including vacancy costs, capital expenditure, maintenance, tax, property managment, etc) close to 50% of rent. Not all landlords recognize all the expenses until they occur in large surprising lumps. Your expected expenses are far lower than this 50%. Is that consistent with long term complete expense standards in your market?

Absolutely correct.   What is the NOI, the Net Operating Income, with all income and expenses and set asides?

lhamo addressed this, but - your stated rent less expenses and mortgage interest produces $10,000 per year against stated equity of $880,000. That's a return of less than 1.2% per annum even if your expense estimates are correct. Is that the best return you can find? Are we missing something here?

A US stock/bond portfolio should be able to shed 4% of $800,000 (assuming $80,000 in sales costs), or $32,000.   

Plus all your eggs wouldn't be in one building. 

[Major Tom]

It may be worth considering selling both IPs after you stop working.

Best thing to do would be to stop working on 30 June 2020, sell the properties on 1 July 2020, and don't have any other income for the 2021 financial year. This would absolutely minimise any CGT payable.

You could live off some of the cash proceeds for a year, then recommence your investing on 1 July 2021 by buying shares (ETFs or LICs), which are a better outcome than property in terms of income, along with getting franking credits. Your CGT on the properties would finally become payable in March/April 2022 depending on how late your accountant lodges your tax return.

You would need to sell them prior to moving to SE Asia (if you go there permanently), because the CGT discount is not available to non-residents on TARP (Taxable Australian Real Property).

How big is the unrealised gain on the IP1?

Thanks. The unrealised gain on IP#1 is 800k.
I will be exempt from CGT on IP#1 as i originally lived in it as my PPR. I subsequently had it leased- coming up to 6 years in March 2020. I intend to move back prior to March 2020 for a little while then lease it out again.

IP#2 will attract 50% CGT at sale.