‘Live off equity’: What does it mean in today’s market?

Some investors even went as far as making this equity their main salary, referring to it as ‘free money’.

After several years, most of the market in capital cities across Australian states and territories are experiencing a decline in prices and demand.

If, by any chance, you’re still able to live off the equity on your existing properties, you may count yourself among the lucky ones, according to Right Property Group’s Steve Waters.

“That strategy of living off equity, for me, is probably the most dangerous strategy that there is,” he highlighted.

Risks

Imagine: You have a portfolio worth $1,000,000 and it goes up by 10 per cent annually, or at least $100,000. You can refinance 80 per cent of that and consequently live off that $80,000—buy a new watch, a new car, a new boat or even a new property.

As easy as it sounds, this strategy will only work in two scenarios, as in:

• If your property’s value is always going up, or;
• If you can always access financing.

Both of those are not always possible, according to Mr Waters.

The value of your property can’t always be going up because it is influenced by different socioeconomic factors that drive the movements of the market, hence, the market fluctuations. Meanwhile, your ability to access financing is also not guaranteed as it depends on your serviceability, which is subject to different policies set by the national and local government as well as your chosen lender.

In today’s market, particularly in Sydney and Melbourne, some areas have contracted by as much as 20 per cent. Investors who have drawn down on their equity for a long time are put on a tight spot as the value of their property as well as its equity base are affected negatively.

Mr Waters said: “You still got a mortgage to pay, your debt is always increasing—there's never an endpoint. At no point in time will you have that property as an unencumbered asset, if that's what the ultimate goal is.”

“You've got to get finance to service the debt, and if you're sole income is derived from property, banks just do not like that. It's a vicious circle from there.

“I just don't think it's a safe strategy at all. I'm yet to meet more than half of a dozen of people that do it successfully,” he highlighted.

Essentially, living off your equity is 'fundamentally flawed', the property expert said.

By implementing the said strategy, you become totally dependent on the upward movement of the market as well as your serviceability. With today's property value decline and tighter lending regulations, the strategy could easily work against you.

“You're actually spending your wealth rather than your cash flow. I'd rather spend cash flow and maintain my wealth,” according to Mr Waters.

While investors who have a sizeable portfolio can make this strategy work, he does not recommend it for the long-term, especially if the end goal is to set up for retirement.

Expert advice

While you can definitely achieve comfortable lifestyle and financial freedom by living off your equity, especially if you have multiple properties, you will still have to service the debt on your assets and retain the ability to get a loan throughout your investment journey.

Once you retire with only your equity as your source of income, it will be a lot harder to maintain good serviceability and access financing.

According to Mr Waters, drawing down equity from your properties is essentially a 'watered down version of a reverse mortgage'.

He explained: "That used to be pretty common in the late 90s and the target market were obviously retirees. The bank would come in and give you 20 to 40 per cent of the equity, a set amount per year.”

“From financial institute point of view, reverse mortgages are very hard to come by right now—there are so many hoops to jump through. We still see through and through that the banking system doesn't quite like that strategy either,” the property expert added.

Mr Waters strongly advised investors to actively look for ways to pay down their debts throughout their investment journey. Instead of focusing on equity, they must work hard to control the income and improve their cash flow. The build up of equity will happen in the background.

At the end of the day, property investment is all about finance. If you can’t access financing, you lose the ability to control your wealth. As a result of this inability, you also lose the capacity to maintain the comfortable lifestyle that you want.

"Keep it simple—look after your cash flow and the equity should happen," he concluded.

Tune in to Investing Insights' June episode to find out how the most common property investment strategies will work in today's market.