Navra and Margin Loans

Hi, I've been listening to the Cocktail Party audio with great interest (thanks to the combined effort of Steve, Sim and Nigel!).

What I don't get is Steve said if people were managing their margin loans correctly they would have been using the first 10% of the Navra distribution to cover their interest costs and then re-investing the extra 5% to lower the LVR. Doesn't this defeat the purpose of being in the Navra fund by using the distributions to cover the holding costs of negatively geared property, (which is what the fund is designed for)?

With margin lending rates up near 10% p.a, once you have covered the interest cost on the margin loan you'd be re-investing the balance and have nothing left over to fund the cash short-fall on your other investments.

Also, Steve is recommending that his clients switch their margin loans to instalment warrants but to do this you need to reduce your LVR to 55%. With the recent market drops I'm curious how many people have high LVR's on their margin loans (65-75% range), and if so do you have other funds available that you plan on using to lower your LVR. If not, are you going to take Steve's advice and make a loss now by selling some of your Navra units to avoid a potentially larger loss if/when you get a margin call?

Hi Oli,

The margin is capitalised, so interest added to the loan each month. You use that money to cover the costs of negative geared property. Anything left over is put back into the fund (in theory). This covers the increase in the LVR.

When using such a strategy, prudent management of distributions is absolutely vital.

Mark

The margin loan is for only half the cost of the capital (at 50%LVR). If distribution is 15% then it only takes 5% of that to pay for the margin loan. If however, you borrowed the other 50% capital (like many do), then paying that interest is outside this equation, and presumably not part of the structure suggested.

The general structure (individual cases vary) is that you use the first 10% of the distributed income to fund negatively geared property, including the cost of borrowings against the equity in the property for the initial Navra investment. The margin loan interest is capitalised. It is then proposed that the remainder of the distributed income be re-invested, and it is this re-investment that keeps the margin loan LVR under control (along with potential capital growth in the unit price).

JustB

And don't forget the deductability of the interest against your income (including the distributions and rent etc).


Cheers,

Barracuda

Thanks for the explanations, I see what Steve was saying now.

As MrDarcy pointed out I wasn't taking into account that the interest on the margin loan is only for 50% because I also borrowed the other 50% against IP's. As JustB mentioned the other portion of the interest is covered anyway in the first 10% of the distribution.

Thanks.

If you are using some of the distribution to pay down against neg. IP's, you are also using most of the rest of the distribution to pay down non deductible debt such as your PPOR!! therefore it leaves little or nothing to reinvest in purchasing additional units, but with the danger of letting the interest capitalise until your LVR blows out as with the recent fall in the unit price. Also your percentage return is calculated based on the closing unit price each quarter times the number of units you hold, so if you had 200,000 units and the closing price was back at $1.16 and the distribution was going to be say 3%. for that quarter, or the relevant percentage, then at a closing unit price of say 92c. and a similar 3% distribution quite obviously that is going to leave you quite a bit shorter in meeting your ability to pay down the IP's neg. and your PPOR. Interest rates are going up, returns are going down based on a diminished unit price and LVR's are increasing. Again, if that is your scenario, there is even less left to reinvest, if any.

There are many scenarios that people have entered into this strategy, one of which was "LIVING ON EQUITY" but it seems unless you have fairly large amounts invested, you are going to be chasing your tail, until unit prices rebound by at least 15%.

As Mark said...
"The margin is capitalised, so interest added to the loan each month. You use that money to cover the costs of negative geared property. Anything left over is put back into the fund (in theory). This covers the increase in the LVR."

Unfortunately in reality land (and not theory) things dont always work out to the formula. If that is the deal then what about paying down your PPOR debt first which is more important than meeting the shortfall in neg. IP's which are tax deductible??

For those lucky few with no PPOR debt and only cash and no margin loan to worry about you are very fortunately, but for all those who invested with the original idea of paying down PPOR debt, then IP's neg. etc. then hopefully some aside for reinvestment - well the current market has just made things a bit ouchy, and certainly one in which capitalising margin loan interest is not a goer.