Tough times require tough but thoughtful action

REUTERS

Repossessed: In difficult times many of those who have invested in property have allowed the banks to take them back.

You may have heard the expression “you cannot eat your equity”.

In analysing this saying and stressing the importance of cash flow, I can give an experience from my own life.

First we must understand the two terms. Equity is the difference between the market value of an investment, less the value of debt and expenses, rendering income.

Cash flow is primarily derived from our labours and short-term savings that can be used to fund everyday expenses. Equity generates income from an investment when debt is sufficiently reduced.

My story started 10 years ago when I realised that there would not be enough provision in my old age. Saving and investing in property (building equity) became an all-consuming purpose.

All my income and savings (cash flow) was invested in properties for rent (investment). Each time I bought well there would be equity arising in a very short period and the value of the equity would supply my income.

However, to ensure that there is enough income at retirement one has to ensure that debt reduces quickly and that one will reduce the debt and costs by re-investing the income derived.

Some readers may already see the problem that may arise when some of the income is not used to boost one’s cash flow. I did not protect my cash flow and continued to generate income from my labours for investment, never accepting that the fruit of my labours may not always be sufficient.

This is a common problem as none of us makes sufficient provision for a downturn in the economy.

The depth of the recession seriously reduced our incomes and most would not have been able to secure sufficient cash flow to ride out the storm. That happened to me.

Many colleagues who ended up in this position gave up. They stopped paying the bonds and used the rental income to boost their cash flow. The properties were repossessed and they were worse off. I could not do this, age was against me. I will share some of the lessons learnt and the plans instigated.

The first plan, going to banks, failed dismally. Banks will not forward money in times like these against property nor would they even accept property as surety against a loan or overdraft.

Again, I realised that banks are only your friend in good times.

Some of the properties had 80 percent of market value in equity and yet they were not willing to accept property that they were so keen to fund four short years earlier. We cannot rely on banks and yet each time we try.

Many feel that when the bank won’t help, the properties will have to be repossessed. This is linear thinking and difficult situations require lateral thinking.

Let’s look at some of the options available. Even though we are looking at property, the same solutions will apply to other investments:

l Review: Analyse each investment and compare the values to each other.

l Hold: Decide which investments are worth the most for future goals and hold on to these.

l Sell: Decide which are the worst and shed them. This is often precarious as the worst one is possibly the home you live in, as it was possibly bought with emotion, not investment principles, in mind. Even so, this one will probably unlock the most flow and should be considered first despite the upset it may cause.

l Refinance: Offer the property with the best equity value and have it refinanced. Even if we fund to a 50 percent loan level (which you can probably get from banks despite their attitudes) we will be able to unlock 30 percent of the equity to supplement our cash flow.

l Sell equity: If the portfolio is worthwhile one can offer it to someone who is in the same position you are in and invite them to join as investor in exchange for capital.

I combined all of the above and appear to be able to ride out the storm by: selling my home; selling 40 percent equity to a friend my age with the same retirement problem; and refinancing the most valuable property to a 50 percent level.

l Financial planner Deon Hattingh is at deon@makingsense.co.za