FIRE yet? My conclusion at the end of doing this exercise is….NOT FIRE (yet)

[Major Tom]

Topic Title: FIRE yet? My conclusion at the end of doing this exercise is….NOT FIRE (with current setup) but there are options.


Life Situation: Married couple; I am 47, wife is 44 no dependants. Residence paid off.

Gross Salary/Wages: $92,000 , wife $65,000

Other Ordinary Income: Family trust cash payments $7,000

Qualified Dividends & Long Term Capital Gains: $10,000 (pa approx)

Rental Income, Actual Expenses, and Depreciation:  Rental from two properties $61,000 (gross)

Adjusted Gross Income: $170,000 (pre tax)

Taxes: Tax paid $70,000 after tax income in 2017 was $100,000

Current expenses:
I have two Investment Properties (IP):
IP A - Sydney apartment
mortgage repayments interest pa $22,000, principal pa $9,000
rates, strata and utilities pa $4,800
IP B – Regional house
mortgage repayments interest pa $5,000 principal pa $7,000
Rates and utilities pa $3,200

Assets:
IP A - Sydney apartment
Value $1,100,000
Rent: $41,000 pa

IP B – Regional house
Value $400,000
Rent: $20,000 pa

Managed/Index Funds (Australian and International), direct shares
$200,000

Cash in offset (offsetting investment loan)
$120,00

Superannuation; Managed/Index Funds (accessible in 13 years)
$150,000



Liabilities: two secured Investment loans

IP A – owing $510,000 (currently paying P&I)
IP B – owing $220,000 (currently paying P&I)


Living expenses:

Insurances (health etc.), gym, food and clothing, entertainment, travel

$36,000 per annum


Specific Question(s):
Net Worth = $1,240,000
4% x $1,240,000 = $49,600
Living Expenses plus Property costs (interest and rates/utilities) = $71,000
Based on this and largely because of my loan amounts I am not FIRE yet.

Nevertheless I would like to have some feedback on how well I am on track to FIRE. I have been working full time salary work for 20 years and need a break if not a permanent one soon.
Currently investing in equities and managed/index funds $30,000 per year and paying off loans approximately $30,000 per year (approx.)
That is $60,000 per year working towards FIRE.

Other thoughts:
Sell IP A Sydney Apartment would net me $590,000 and move me to FIRE. (Net Assets would be $1,260,000 x 4% = $50,400 and annual costs $44,200 including IP B) ie without the interest and rates cost of IP A of $26,800)
My wife is completing studies and has recently embarked on a new career (full time work) and intends working for the foreseeable future. I have excluded her intentionally from the calculations.

Another way to look at it is to adopt some BADASSITY and reduce my $36,000 per annum spend…with a some help by MMM

I welcome your thoughts.

[Laura33]

I don't think the standard 4% rule necessarily applies to income properties.  I would separate out that math into two components:

1.  Income properties:  what is the net income from those properties (once you include a set-aside for longer-term repairs/upgrades)?  Looks like you have about $48K in annual expenses*, leaving you @$13K cash flow.  What is your set-aside for longer-term repairs/upgrades?  Even 1% of the home value would be $15K/yr, meaning that long-term, the properties may be cash-flow negative.

But let's ignore that now just to run the math, and assume that your actual net income from those properties is $13K/yr.  What you would do would be to subtract that from your living expenses -- in this case, $36K.  So that means that the properties would cover $13K of your living expenses, and you'd need to find some other income to cover the remaining $23K.

2.  Investment assets.  This is what the 4% rule applies to.  The caveat, though, is that this assumes that your money is invested in the market, so things like cash assets don't count (I'm also not sure what "cash in offset" means).  It looks like you have $350K in investment assets, which would throw off about $14K annually under the 4% rule.  So that means that as is, you need sufficient additional assets to cover another @$9K toward living expenses, or another @$225K.

The other option is, as you note, to sell one or more of the homes -- you have a lot of equity locked up there, especially in house #1; plus selling means you wouldn't have to worry about extra costs associated with things like vacancies or future maintenance that could eat into your profits.  If you take the @$550K net you say you'd get from selling the first home and add it to your $350K in investment assets, that brings you to $900K, or $36K/yr -- not even including any additional income you might still receive from house #2.  Or you could go the other way and use some of that cash to pay off house #2, so you'd be bringing in maybe $12-14K/yr from that home as additional cash flow ($20K/yr rent - utilities & maintenance).** 

Do the math yourself to figure out which option works best for you -- it's just easier to visualize if you think of "property" and "investments" as two separate buckets, so you are evaluating the income/expenses/risks associated with each bucket separately.


*$16K of this is principal repayment, which doesn't necessarily count as a "cost" in the same way, since it's just moving your money from one asset to another.  However, we are looking at cash flow here, and from that perspective, it does count.

**Big caveat that I don't know anything about your tax system, so I don't know whether you'd actually realize that $550K, whether paying off the mortgage might lose you valuable tax deductions, etc.

[Major Tom]

Thank you Laura33 for your insights.

You have shed another light on this as well as introduced some important insight.

For the record, "cash in offset" meaning; in Australia we have offset account set up with financing on properties. An offset is a separate account against a home loan, it literally offsets the interest payments. So if you have a 100k loan and 90k in the offset against that loan you only pay 10k in interest. It is popular as one can park all income, spare cash in this account and use cash when needed for anything (without tainting the tax deductibility of the loan being offset).

**Big caveat - interesting point you raise , fortunately I have structured the first property with 550k equity in a favourable way. If I intend to sell it,  I have a maximum of roughly 8 years to sell it without incurring any capital gains tax. This is an incentive is to eventually sell but holding for some of that time so I can realise more gain. Without going into too much detail on our tax system but since I lived in it first then rented it,  the tax treatment is different to a a property that has always been rented.

The other property if sold would incur capital gains tax (as it has always been a rental property).

[marty998]

Thank you Laura33 for your insights.

You have shed another light on this as well as introduced some important insight.

For the record, "cash in offset" meaning; in Australia we have offset account set up with financing on properties. An offset is a separate account against a home loan, it literally offsets the interest payments. So if you have a 100k loan and 90k in the offset against that loan you only pay 10k in interest. It is popular as one can park all income, spare cash in this account and use cash when needed for anything (without tainting the tax deductibility of the loan being offset).

**Big caveat - interesting point you raise , fortunately I have structured the first property with 550k equity in a favourable way. If I intend to sell it,  I have a maximum of roughly 8 years to sell it without incurring any capital gains tax. This is an incentive is to eventually sell but holding for some of that time so I can realise more gain. Without going into too much detail on our tax system but since I lived in it first then rented it,  the tax treatment is different to a a property that has always been rented.

The other property if sold would incur capital gains tax (as it has always been a rental property).

I assume you mean you pay interest on the net $10k loan, not $10k in interest.

The rule is 6 years, not 8. And you've got a residence that you are living in that you have fully paid off. Since you (and your spouse collectively) can only have one PPOR at a time, I think you are mistaken here, and you will be liable for CGT on IP1 for the proportion of time that it has been an IP. I'd suggest you get yourself some tax advice on this one :)

Agents fees to sell a $1m property might come out to be about $20k as well.

[Major Tom]

Thank Marty998
Yes correct I meant the interest on the 10k is payable.

Since I initially bought and lived in the property the 6 years applies from when I began collecting rent. I intend to trigger another 6 years. This won’t start again until 2 years time. Within 2 years time we will move back into the IP. Once it is rented out again the 6 year count starts again. That is the advice I have received.

You may be aware off company from the UK that has began trading recently in Australia and take no commission instead they receive a flat fee, approx 6.5k to Auction a property regardless of the selling price (I am not mentioning the name but give you a clue with the name of company containing the word for a colour that begins with ‘p’ 😉)

[Major Tom]

Apropos to the above. The PPOR is in my wife’s name and my registered address is at the family home.

[marty998]

Yep, I agree with the below - you can re-trigger the 6 year rule by moving back in.

However you will be fully liable for CGT on the property you are currently living in.

[Ben Kurtz]

Expensive residential real estate in big cities (especially when owned one unit at a time) is rarely a cash-flow winner. It is possible to come out ahead due to value appreciation, but then your cash flow is very lumpy! By contrast, in smaller cities and regional areas the cash flow tends to be better -- but people tend to take a less bullish view on the chances of value appreciation. That's just the pattern I've observed in many markets around the world.

To FIRE and live on investments you need to plan your cash flows with some care so you can avoid having to sell assets when you didn't expect to (or want to) or transact more than you really need to in order to pay the bills on time. It can be quite different from your working years / accumulation phase, when you live off part of your wages and your biggest goal for your savings is long-term growth, without much concern for liquidity or cash flow from your investment portfolio.

My suggestion if you desire FIRE in the near future is to spend the time arranging your tax affairs so you can sell the expensive Sydney apartment and roll the gains into other investments which have better cash flow characteristics -- some combination of residential real estate in less expensive areas (pay off the existing one or put a down payment on another one), commercial real estate or investment securities. (On a side note, even growth stocks which don't pay large dividends still have good cash flow characteristics in my book, because it tends to be very easy to sell a few appreciated shares from time to time to meet your needs. But you can't sell 1/50th of your Sydney apartment each year to contribute to spending money and leave the rest invested).

You overall net worth and reported spending habits mean you are already, in theory, FIRE-able on a balance sheet basis -- you have a net worth that ought to generate enough yearly cash flow to sustain your spending habits indefinitely. Actually getting there just a matter of portfolio structure and investment allocation. It sounds like it might take a few years to get that done, given the need to tax-structure by moving house and selling properties in a very careful order, so you ought to keep working while that is still in process, but once that is done you are free to go.

Next, to address the elephant in the room: It sounds like once you've planned out the above you need to sit down and talk with your wife. If she has started a new career and plans to work at it for years to come then the family cash flow needs will be a lot different than if you are living solely off investment income. Moreover, in my observation, perceptions of work and productivity express themselves emotionally in funny ways. If you are visibly idle at a non-socially acceptable age when your wife continues to work, she may grow resentful on an emotional level even if she recognizes intellectually that you brought more money into the family in prior years and your current seeming "idleness" is financed by your prior savings and investments. Moreover, you may or may not be happy and satisfied if you FIRE at your age without some worthwhile pursuit in place of your former job.

From your post, it sounds like you are more keen to run away from your current job than to run towards some dream goal that you've started to nurture. From the sound of it, you might be just as happy switching to a different field or different type of employment than fully retiring from paid work. The good news is, you are done saving: You can take a massive pay-cut (which has the silver lining of cutting your income tax bill), radically shrink your contributions to savings, and (with restructuring the real estate allocation as discussed above to reduce the cash flow drag), let your investment portfolio grow in the background until you finally figure out if you and your wife have a burning desire to pursue a goal that does not involve anyone in the family earning a living wage. If and when you get to that point, you'll be able to jump on that train on a moment's notice, which is a rare and wonderful thing among most people these days.

[Major Tom]

Sage advice, thanks Ben Kurtz.

I have taken note on the timing issue with the sale of the Sydney property with careful tax planning. The regional house’s strength is its yield so I will keep that (apart from CGT payable if sold which I don’t plan on doing), leaving ‘some’ loan offset with a balance of cash.
The sale proceeds will likely go into index funds, managed funds, etfs  and individual stocks (possibly another better yielding property elsewhere as you suggest). I currently participate in the equities market everyday and have a genuine interest in it (something not mentioned in my original post).

I appreciate you also bringing up the often overlooked household and emotional needs. You are absolutely correct in that the wife may resent a ‘layabout' who isn’t working. Something (again) I didn’t mention is any post FIRE plans. I intend to participate in volunteer work (the wife has been a volunteer during university studies). I have contact with different organisations and groups when I choose to pursue this down the track. I also have interests in sport and fitness so this is another hobby to throw myself into. As I am actively buying and selling shares currently this is something I would intend to be doing when I stop paid work, which at least would satisfy my analytical and numeracy side.

I currently work in software implementation and applications administration, there is scope for me to approach a third party that I am currently working with on a project. I am ‘hanging out’ for my 20 years employment in my current role for the benefits that I will be entitled to in April 2019. Having said that, it might be too close to home to continue to work in the same field though…

On the finance side of things in the next couple of years I will re-finance my loans against the 2 properties. This will be done while I am in paid work, I will structure the loans as interest only and also extend lines of credit (against both properties). As this is the cheapest finance I can get. The money won’t necessarily be used at all but there is a level of comfort in having cash at my finger tips for an emergency (discipline required here I know). In the event I sell the Sydney property I will pay of the loans against this property (obviously).

In the coming year(s) I anticipate a combination of monthly paying down debt, top up equities, index funds and actively using my trading accounts. I realise it isn’t too bad situation to be in - whilst having the benefit of being able to go to the beach every day as well :)