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The Leverage Strategy

Discussion in 'Investing Strategies' started by Chris C, 20th Apr, 2010.

  1. Chris C

    Chris C Well-Known Member

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    I have started a new thread to discuss using leverage when it comes to investing.

    This has been brought about by some comments I made to Wealth Creator privately that he wanted to speak about publically, and I decided to split it off from another thread rather than hijack GG's post, which was about the following:

    ========

    To which Wealth Creator responded:

     
  2. Chris C

    Chris C Well-Known Member

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    So why would you personally chose this strategy? based on what?

    Very much so, and as I get older I'm finding myself becoming more and more cynical, and less and less willing to even offer critique of people's theories. I'm just finding all too often people just want to believe what they want to believe - they don't want to be objective about it or enter into discussions.

    Yet I digress and it appears that I am once again engaged in the leverage (better known as debt) discussion on InvestEd... there seems to be a voice inside me that says it would be neglect of me to not at least respond.

    :cool:

    I hate that voice!

    :D

    I can do the arithmetic and fully understand your logic (it used to be the same logic I used a couple of years ago)... you can even check my earlier Invested post if you like.

    But what this assumption back then, and still does not factor now is for, what happens when inflation goes negative (aka deflation)? Then what?

    :eek:

    Once again, I really urge you to think hard about if your investing strategy can be applied to every single person in Australia?

    As in what happens to your method if we ALL heavily leverage ourselves into 4 or 5 residential investment properties? Does it still work?

    Do we all still come out wealthy?

    If it doesn't work? Why doesn't it work?

    I mentioned a few threads worth reading in your original introduction thread, I still HIGHLY recommend you read them (it would definitely save me a lot of time in me not having to go over the same ground).

    I'm not saying you have to agree with me about the future, but you should at least understand the other economic variables that come in to play when prices are being set - and there are lots.

    http://www.invested.com.au/85/no-housing-bubble-37335/
    http://www.invested.com.au/6/housing-disaster-looms-if-rates-rise-36923/
    http://www.invested.com.au/96/worlds-biggest-debtor-nations-37522/
    http://www.invested.com.au/6/australias-property-bubble-its-here-37494/

    Unfortunately I don't respect your opinion at all, I have yet to see a reason I should respect it. I respect your right to have an opinion, but that doesn't obliged me to value it.

    I don't mean to come across as a bigot, but I just believe that opinions aren't created equal. Warren Buffett's opinion moves markets, mine is just generally ridiculed on InvestEd...

    :D

    As I mentioned in one of my responses in one of the above threads, I often determine my level of respect for an opinion based on what the opinion factors for.

    So in most cases I determine if an opinion is worth listening to based not just on what they talk about, but what they don't talk about, and whether they acknowledge they are making assumptions in their projections or whether they even recognise they are making an assumption in their projections.

    ... but ultimately, not all opinions are created equal - the the ability to screen out the ones that are just noise will take you a long way.

    LOL - I assume we have same goal (financial free) and we have the same time frame (as fast as possible).

    Though I my entire point is that strategy does matter, and a poor strategy could doom someone into never reaching the goal.
     
  3. wealth_creator

    wealth_creator Member

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    I'm sorry mate, but I know I'm right and you won't change that.
    I've had this discussion with many poor folk over the years and it's getting a little stale for me.

    If we ALL invested in a couple of houses then prices would be even higher and even more 'guaranteed' so yes, I think it's a great idea but try telling that to 95% of the population who does not own a single investment property.. Why do you think this is?

    I'll tell you why this is.
    I'm an Author of an investment book you may have read before. And I've dabbled in mentoring.
    People are very standoff-ish when it comes to investing. And I discovered then that people just aren't interested in being rich, plain n simple. They only know how to work for money.


    The reason most do not invest is because most poor folk are out on the weekends looking at purchasing bad finance at the car yard for their 100% guaranteed depreciating 'asset' and will repeat the process next week shopping with the magic card at Harvey Norman, repeating until retirement age, or should I say the age they physically cannot bring themselves to work for money any longer then wonder where it all went wrong and ask 'why isn't the Government giving me more money?'

    Good luck with your 'investing' ;) Might be safer to just hide under a rock while the world explodes like it was supposed to throughout the last 50 years, hey?

    I'm not interested in speaking with you again.
    Thank you.
     
  4. Waimate01

    Waimate01 Well-Known Member

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    > But what happens if that property purchased for $500k with 10% deposit (only used
    > around $70,000 of our $1mil to remain very safe but at least doing something
    > increased by 7%p/a over twenty years?

    Wealth_Creator, that's the sort of message that lead so many people to destruction with things like Storm Financial. Yes, Storm involved misfeasance on the part of the advisors, but what really wiped out retirees was the leverage (which many of them didn't realise they were getting into).

    To state the obvious (which oddly enough seems to need stating), leverage is an "amplifier". It amplifies gains *and* it amplifies losses.

    An unleveraged investment of $1000 that returns (say) 20% turns into $1200 - great but not fantastic.

    If the wind blows with the same strength but from the wrong direction, it turns into $800 - bad but not disasterous.

    Leveraged to 80%, that $1000 turns into either $2000 (fantastic) or $0 (disasterous) depending on the wind direction.

    Now here's the thing: when you're 25 years old with hardly a razoo to your name, you may as well leverage because you've got a long time to recover if things go bad, and you haven't got much to lose. It's a sensible risk.

    But when you're 55 years old with a comfortable retirement fund you've worked your whole life to build, you would be certifiably insane to dial-up the risk/return ratio and go leverage yourself to any sort of substantial level.

    Think of it another way: you're 25 years old and full of piss and vinegar and out for a night on the town with $100 in your pocket. By all means go to the casino and put it on black (er, I mean red. No, black). But if you're a 55 year old retiree with $1m in savings, do *not* go to the casino and put the mil on either red *or* black.

    Leveraging may be good for younger people and/or people trying to make it big, but too much of it is frequently an inadvisable risk for people who have already made it medium.
     
  5. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I really believe that a leveraged strategy is the only real way for anyone (other than perhaps those earning megabucks but living a pauper's lifestyle), to increase their wealth to any significant degree.

    However, along with that comes some strong words of caution. Just because I think you have to leverage - doesn't mean that you can play the same old game just using borrowed money. Leverage changes the game dramatically.

    I note in some recent articles on margin lending and the new guidelines for financial planners that the advice generally seems to be "with leverage you need to take a long term view of your investments". Financial advisors would say that wouldn't they.

    Unfortunately, the majority of investors are not going to be actively monitoring their portfolios, beyond perhaps trusting that their advisor is going to do their annual checkup and perhaps rebalance. Leverage is a dangerous tool in these cases - and there doesn't always seem to be a clear strategy in place for dealing with the situation where leverage is causing far more harm than good.

    A leveraged position can destroy wealth just as easily as it builds wealth, and risk management is a critical element not typically discussed in glossy brochures about the fantastic returns leverage offers.

    I believe that if you use leverage, it is critical that a risk management plan be in place - a strategy for dealing with adverse conditions based on your goals and situation.

    Buy and hold is a valid strategy, but in a falling or sideways market where returns are lower than the cost of finance, you need to be aware that your returns will be negative (or more negative than they otherwise would be), so if you plan to hold through the down period, you need to be able to both fund any cost shortfalls and have the time and patience to wait for things to recover. Losing your nerve near the bottom of the market (or facing a major margin call), is the worst possible situation - you either hold or you don't ... you don't change strategy half way through.

    For shares, I do believe in leverage, but I also strongly believe that when the broader market starts to de-leverage (like what happened during the GFC), you also need to de-leverage your position. Unless your leveraged position is so small to be practically useless, you face a catastrophic loss of capital trying to ride out a strongly falling market with a leveraged position.

    You need to have a plan for what you will do in this situation, and you need to have the courage and conviction to follow through on it. At the beginning of the GFC when it was obvious that things were going pear-shaped, I did execute my plan, but only half-way. That indecision cost me close to $500,000 ... but if I hadn't done any of it, I would have been completely wiped out.

    Real estate is a little different. The transaction costs of buying and selling are very high, so a deleveraging strategy is much more difficult to implement. Because of the typically very high levels of leverage involved in real estate, the costs of finance are typically very high - and along with the other expenses inherent with owning real estate, maintaining cashflow is far more critical.

    Real estate tends to react fairly slowly to broader economic conditions. You should be able to see problems coming with a fair bit of warning - rising unemployment, oversupply, rising costs, etc.

    I think the critical part of owning real estate is having a plan for dealing with the inevitable cashflow issues (like interest rates going up by 3%+, unexpected maintenance, extended vacancy, etc). Loss of capital isn't typically such a problem, since the market doesn't tend to react as viciously as the share market does to issues. I think if the economic conditions were to change such that real estate was likely to fall in value over an extended period - we would see it coming and have the ability to adjust our strategy to suit.

    In either case, having a plan is critical. Buy-hold-and-pray is not going to be a winning strategy in anything other than a raging bull market (but thhe wins will only last as long as the market stays positive).

    Leverage to the max and hope for the best is an easy way to lose a lot of money. If the capital losses don't get you, the holding costs invariably will. If you can't reliably make profits above and beyond what you can get from something like UBank - then why would you bother? You really must have a plan for dealing with the downsides.

    One thing I will note about discussing strategies with other people.

    It is all well and good to talk about a highly leverage strategy or making fantastic returns, when the amount of capital on the line is fairly trivial. I'm not overly impressed with your 50%+ returns when you only have $50K at risk. If you lose the lot or end up with a debt and no assets, you can always pay it back from your salary. Everyone needs to start somewhere - but having small amounts invested tends to change the risk profile and the perceived importance of risk management.

    Try adding one or two zeros to the end and then tell me your strategy. Even if you can only get $50K into the market, it's still a worthwhile exercise for testing your strategy. Add two zeros to the end of your investment portfolio and then tell me how you plan to manage it all. I bet your response will be very different.

    If your goal is to just own a couple of properties or have a modest share portfolio - you can typically fund the costs using your salary (this is where negative gearing comes into play). That's fine if that's all you want to be doing - provided you also have a plan for dealing with an unforseen loss of income (insurance, buffers, etc).

    But if your goals are to build a much larger portfolio, the strategy needs to be much different.

    One other comment about timing. A retire-at-65 strategy involving a handful of shares and perhaps a couple of houses ... is very different to a retire-as-soon-as-possible strategy where you need to fund a particular level of lifestyle for 40+ years.
     
  6. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I don't have a problem with the idea of a 65 year old buying investment property, provided that the risks are adequately managed. I'm not talking about putting all of their money into IPs, I'm talking about using some of the surplus cashflow they have available (assuming they do have some and it is reliable), to buy and hold an asset for the next 20 years (assuming they are generally healthy and will live at least that long!).

    20 years is a long time - we can go through several market cycles in that time. If a retiree is in a position to be able to add to their portfolio without placing their retirement income and lifestyle at risk, then why not buy real estate using some borrowed money?

    Of course, it won't make sense for most retirees who will struggle to live on what they have. But if the circumstances are right, sure, why not borrow to invest at that age?

    Blanket statements don't tend to serve anyone well. There is a reason why disclaimers and warnings on PDSes and such (and my signature block) say that you need to take your specific circumstances and goals into account. Everyone is different, and just because most people shouldn't use leverage at that age, doesn't mean that nobody should.

    I also don't like statements like "when you're 25 years old with hardly a razoo to your name, you may as well leverage because you've got a long time to recover if things go bad, and you haven't got much to lose. It's a sensible risk".

    No it's not a sensible risk. If you can't even save a razoo, how on earth are you going to manage the risks of holding a leveraged portfolio of property and/or shares?

    I'm a strong believer in education (hence this website) and I'm also a strong believer in learning some basic financial literacy before you start taking risks. Understanding the nature of risk and how to manage it is critical and something that I think 98% of the population doesn't really get.
     
  7. Waimate01

    Waimate01 Well-Known Member

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    If you run your own business have profits of 1 or 2 mil per year, believe it or not it is entirely possible to increase your wealth and not live anything the least resembling a pauper's lifestyle.

    Your comment is correct if 'megabucks' means a hundred grand or so.
     
  8. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Of course.

    It was a sarcastic comment - most people tend to fit into the law of expansion of lifestyle: lifestyle expands to consume 110% of available income. The more you earn, the more you spend maintaining your lifestyle.

    A very small percentage of our population own a business with multimillion dollar profits - they are the exception, not the rule.

    ... but that was kind of my point. It is likely that only business owners (and select few others) with high levels of surplus income will be in a position to be able to set aside enough cash each year to be able to invest any meaningful amount without leverage.
     
  9. Chris C

    Chris C Well-Known Member

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    I think we should do the more amicable thing and let time decide whether you are right or not.

    :)

    The whole reason I tried to PM you rather than publicly have this discussion is because of this very situation. I didn't want you in insinuate that I'm trying to make you look wrong, that's the last thing I want to do, I just wanted you to consider the possibility that there's more to it and that there is a chance to learn more.

    You are on a forum now where everyone wants to be here and has a passion for investing as great as yours.

    Well you're not talking to "poor folk" anymore.

    So try to enter the discussion with an open mind - rather than certain convictions. Who knows we all might learn something from each other (it's the reason I joined these forums and I'm extremely thankful for it).

    If we all leveraged ourselves into 4 investment properties each all we would have in Australia would be a housing oversupply because the only reasons "investment property" get to keep the word "investment" in the name is because they produce a rental income when we tenant them out, but if we all have 4 or 5 properties each then no one needs investment properties to live in therefore the properties wouldn't produce an income to cover the loan. (I have spoken about this at great length below)

    My simple point is, the leveraged property investment strategy isn't scalable, so the idea we can all run out leverage ourselves up the eyeballs and be "guaranteed" to come out better off is false.

    My second point would be that whilst one individual borrowing to invest has little to no effect on market prices, if the majority start borrowing to invest you have what is called credit growth, in the sense that credit (debt) has been used to make the purchase, this pushes prices upwards because it's an injection of money into the system, via the selected asset class, but this has flow on effects to the rest of the economy, but inevitably all debts must be paid, which ultimately means that the artificially high prices must eventually fall along with the economy. It's simple monetary economics...


    Probably a combination they can't afford to hold an investment that losses them money, and the fact that they don't want the commitment.

    The average Australian investment property loses quite a bit of money a year for the owner, these loses are only justified due to the consensus that you'll be able to sell it for more than you paid for it, which makes the assumption that housing credit levels will continue to rise into the future (of course most investors don't calculate for this risk because they don't understand the dynamics of monetary economics).

    If it's a property investment book, and your name isn't Steve McKnight or Jan Somers, then not likely... but I'd love to know what it was called.

    :)

    Nonetheless that's beside the point, you don't need to qualify yourself, I just wanted to hear your rationale for your investing strategy.

    This is a position that the vast majority in life are going to have to accept - not everyone can be "know it alls" like you and I, someone has to do the work.

    :D

    LOL I love the distain for "poor folks" though I largely agree.

    Though with that said, as much as I shake my head at their seemingly obvious and repeated financial blunders I do sympathise with them because the system we live in has been designed to take advantage of their short comings, whether it be their lack of financial intelligence or preying on their emotional and impulsive spending habits with "pay nothing today" finance.

    Who said I'm not investing...

    ;)

    I'm sorry to hear that.

    I have taken the liberty of copying some of my other posts over into this one because I'm really getting tired of going over the same points with different people, or sometimes the same people. Plus it will be nice to finally have a thread where all my titbits (right, wrong or delusional) are all in the same place.

    :)

    They might seem a little out of context but bare with them:

    =======

    In most cases people only want to hear what they want to hear, and most people don't want to think past today.

    Just like a fat person doesn't want to hear someone tell them they are fat. The tragedy is that that for many morbidly obese individuals the wake up call is not looking in the mirror and having an honest look at reality, it is a doctor telling them they need to lose weight, and fast, or they will literally die.

    The same applies to debt fuelled wealth - a debt junkie won't come to the realisation that money doesn't grow on trees (or through debt fuelled capital appreciation of property) until interest payments on their debts become unserviceable and bank won't continue lending to low deposit mortgagee's, but you can rest assured that living in denial of reality for long periods of time has a way of slapping the delusionals very hard.

    It's sort of like financial Darwinism, where the the unfit and unable to apapt to changing conditions don't survive.

    =======

    Well continuing on from above, it will stop when the laws of financial system say stop. This will most likely come in the form of tighter credit and higher interest rates as a result of under performing of credit.

    So take for example the Lehman Brothers collapse, credit markets around the world froze, and overnight loan rates sky-rocketed causing interest rates all around the world to spike higher, and in many cases making credit unavailable.

    This was a direct result of the sub prime mortgage crisis in the US. The fact that the crisis was property based is irrelevant, the important fact is the increased rate of losses on loans. As in, when a bank lends money it expects to get that money back plus a little bit of interest. However, if the original money lent starts to not come back the banks begin to make losses on those loans, and the risk of losses is one of the main variables that goes into calculating interest rates, as in, if you are not sure you will get your money back you are going to ask for a higher interest rate.

    Now what will likely cripple the Australian housing expansion will be a combination of higher credit costs (higher interest rates and higher requirements for deposits) as a result of higher risk. The next phase of higher risk entering the market has probably already begun in the form of sovereign debt problems, with Dubai and Greece being the starting point at this stage.

    If these sovereign debt problems can't manufacture the political will to be solved, it will likely call into question many other highly indebted nations like Portugal, Spain, etc and of course if these countries were unable to prove to the markets they could handle their debt loads then we'd probably find we'd have a real sovereign debt crisis on our hands that would call even some of the bigger economies of Japan, UK and US into question.

    At the end of the day it is difficult to conceive of a future were the risk premium cost on interest rates around the globe aren't higher given the increased risk of sovereign default. These higher interest will also reach out shores, and will put some downward pressure on our property market.

    We are already seeing banks raise rates irrespective of the RBA as well as place higher credit conditions on borrowers, like Westpac which to my understanding have now set a deposit requirement to 13%. This of course will have downward pressure on property prices because the vast majority of Australian property finance their purchase with borrowed money therefore if a bank deems a potential home buyer as unworthy of credit then that results in less demand for housing which forces down prices.

    If this effect is dramatic enough this creates a trend would would increase the risk of lending for borrowing to property based purchase which creates a self fulfilling prophecy.

    That said it wouldn't be the interest rates and tighter finance alone that would cripple housing prices, but also a slower economy given the struggling global economy, leading to higher unemployment rates and defaults.

    The important thing to remember is that at the end of the day all debts must be paid one day, which ultimately will be deflationary for an economy. So it isn't a case of "if" this will happen it's more a case of "when" it will happen as debt loads can't expand relative to income forever.

    This is why the laws of finance will eventually decide the fate of the Australian property market.


    =======

    This theory, whilst preached often, is completely flawed when you think about it rationally, because at the end of the day for someone to justify owning an IP you need someone to rent it, which means that renter much not have their own PPOR or IPs.

    So this "retirement strategy" isn't scalable, therefore the "majority" shouldn't pursue this strategy, otherwise we'll all end up in a situation like the US where everyone invests in property, creating an oversupply, such that the financing costs (debt) use to buy/development the IP can't be serviced forcing investors into default. Obviously if it's done on a large enough scale you get a US style drama/recession.

    I think the key point to focus on at the end of the day is that property doesn't produce anything. They don't become more efficient over time, or innovate themselves. Property is just bricks and mortar. There will always be demand for them, but they are a store of wealth not a path to riches.

    =======

    If prices keep going up it will be because people have increased the size of mortgages they are willing to take on to buy properties, which will increase holding cost which will reduce net yield, which will ultimately cripple cashflow (assuming that wages and rental growth don't grow ATLEAST as fast as the rate of capital growth - which they virtually never do), forcing IP owners to sell off equity to cover the short fall (of course they will have planned to still sell at profit), but of course if all IP owners are constrained by this financial reality at the same time this will greatly increase the number of sellers, with only few buyer being able to obtain credit to afford to buy due to very high prices, which would create a situation of lots of sellers and few buyers, prices would fall dramatically via a deflation spiral back to rational and profitable levels.

    Of course I don't believe that prices will go excessively higher than present levels, as things can't grow exponentially, everything operates in balance. Things can get out of balance, and stay out of balance for quite extended periods, but ultimately everything finds its way back to equilibrium.

    =======

    You're always right until you are wrong.

    The toughest thing to do is stand by your convictions when everyone is saying you are wrong, and you're saying but the game hasn't finished yet...

    That said it is always wise to keep the voice in the back of you head on repeat asking "have I missed anything? What don't I know that I don't know?"


    =======

    I think all opinions/reports should be taken with a grain of salt, including demographia's - though I definitely think their reports highlight some interesting perspectives.

    At the end of the day almost all opinions and reports are unreliable to a degree in that the data is either poorly collected and makes lots of assumptions or the interpretation of the data is used to sell an agenda. The opinions of banks, RBA, media, real estate, fund managers, financial advisors, government, etc are all equally unreliable because they almost always have vested interests.

    So all opinions should be taken with a grain of salt and we should all strive to educate ourselves in being able to read the available data and its discrepancies rather than relying in the opinion of others.

    =======

    I'm never one to advocate that land and houses hold no value - I personally think they hold great intrinsic value.

    However when people use debt to purchase land or housing a calculation of ROI needs to be made to justify the debt. However in recent years/decades this calculation of ROI hasn't been based on the underlying "value" that these assets provide rather are dependant on capital appreciation which is inflation dependant and therefore doesn't really qualify as being a "return".

    Most people that are advocates of strong property growth are focussed on short term price drivers. I prefer to look at longer term marco realities and don't see as bright a future.

    Of course this means that I'd be perfectly willing to accept that property prices could continue to grow quite significantly in the short term, though I thoroughly believe that in the longer term the trend in a real sense will be downwards trending towards their underlying "value" which is today's prices minus the volumes of speculative money that is currently hoarded in Australian property.

    But at the end of the day the house is still a house, and land is still land. So in this sense they are great preservation of wealth vehicles - unless you are using debt to finance their purchase in which case these assets need to yield revenues that offset the holding costs - which more don't (negatively geared property).


    ========

    This is a BIG point, and I totally agree this bubble is unlike to pop while rates are low, which is why I actually think this property recovery might actually have some legs in it (for the time being).

    However I think the next "affordability crisis" (I love the way they call it that - PR spin at its best) the difference will be a much slower economy, lower levels of inflation (ie meaning weaker capital growth), tighter lending standards, higher taxes (not just because of government debt but lower labour participation rates with increased retirements), household workers working fewer hours and of course the big kicker - unemployment.

    At the end of the day most households can buckle down and cut back on a few luxury items to make the mortgage payment when rates go up a bit, however if you lose your job, your stuffed.

    I think the best case scenario for property going forward will be relatively flat property prices maybe trending "slightly" upwards, which makes them a dud investment given that most people's IPs are still negatively geared (also known in business as making a loss) at historically low interest rates, so imagine when rates go up!

    =======


    There may well be some short term supply issues (though I'm pretty sure they are heavily overstated by those with vested interests) nonetheless the above statement makes some assumptions that probably won't hold true if there are tough times ahead (which I'm obviously predicting there to be).

    Firstly immigration; in aggregate, if unemployment is rising it's unlikely the government will push for higher levels of immigration like it has been of late given that immigration will only exacerbate the unemployment problem and the welfare burden on the system.

    Secondly, the notion that supply shortages increase prices would normally hold true but in a financial crisis were interest rates go up and credit tightens the ability to demand is not determined by those that need a house rather is determined by those who the banks will lend to, given that the vast majority of Australian property is not paid for with cash but is bought on finance.

    Now for most it is hard to envisaged Australian banks going back to requiring 20% deposits and charging double figure interest rates, but IF the world lapses into another financial crisis (this time spurred by sovereign defaults) then this is the likely outcome, which will send foreclosure rates through the roof, creating a situation of over supply coupled with constrained demand.

    So whilst I agree on a short term purely Australian focus view of the market right now things look good, but I think once you look past Australia the reality is much bleaker, and we as a nation are definitely not decoupled from anything or anyone, and therefore have no immunity to international problems!

    =======

    I'm not saying that property prices can't go higher from here, or that prices will crash by 40%, I'm saying that eventually the penny will drop and people will become rational about property prices, and that like any investment it should make a cashflow profit because the capital gains in majority are just a reflection of inflation.

    The only thing stopping a price correction is Average Australian's nieve enchantment with bricks and mortar and their belief that they will deliver them to riches, but rising interest rates, unemployment and a contracting broad money supply with change that tune.

    =======
    Well Australian credit growth in aggregate is still positive and has been through this entire episode, mind you it was only supported by continued real estate credit growth. And whilst it's no where near what it has been in recent years, it's not negative so deflation equally isn't an issue for Australia and with a more stable economic environment rates this low would quickly prove to cause inflation.

    After all you don't want too many people finding a new sense of confidence around their irrational exuberance such that they run out and start repeating the same mistakes that cause the crisis in the first place. So I think they can justify in their position on moving early on future inflationary problems.

    For more information review the RBA's monthly credit aggregate reports.

    ========

    However central banks can't do much other manipulate broad interest rates... clearly the issue is real estate based lending which has been growing quite solidly throughout the crisis whilst business lending has fallen off a cliff which is the complete reverse of what we want to be encouraging right now. I think it's time the government moved away from FHOGs to entrepreneurial grants for business innovation and job creation. FHOGs and FHOGB's give the public the wrong idea about buying a house, where as the government should really be promoting entrepreneurship, innovation and productivity growth - that's what really drives the economy, and as a flow on effect will drive housing prices too.

    Of course this isn't the place of the RBA, unless they want to allow them to regulate credit flow and start moving the way of the Chinese central bank and start a credit rationing to move finance to the productive and socially beneficial sectors of the economy, which I would argue would mean less money going into real estate and property. For the record I'm all for adopting the Chinese model of rigid monetary regulation - it would cut a lot of crap out the system.

    =======

    The problem with property is the lack of liquidity, so even if you foresee the needle that will pop the bubble, you'd have to see it many months in advance to be able to get out before some nasty falls start impacting sales price.

    I'm reading that many areas where property bubbles have burst that the average time on market can be in excess of 6 months+.

    So whilst I'd agree that Australia property bubble might not necessarily pop in the short run, you still have to have quiet a bit of belief in both Australia and the world to think the bubble is guaranteed to have at least another 10%+ in it to cover transactional costs and ROE, and a lot of self belief to think that you will see the needle coming and head for the exit before everyone else.

    =======

    There are always alternatives to buying a house, yet people that keep pushing the "housing shortage" argument seem to imply it with a sense that people MUST buy or live on the streets, therefore prices are supported.

    For me personally, I'm 25 now, and I'd say at least 70% of people my age that I associate with still live at home, with less than 2% having purchased their own home. Why do we live at home? it's not because of mum's cooking... it's because it's just too bloody expensive to live out of home unless you NEED to live out of home.

    I personally have live out of home on a couple of different occasions, but at the end of the day I always draw the same conclusion, I "want" to live out of home, I don't "need" to live out of home, and the small number of benefits of living out of home don't justify the very large cost.

    And in our debt ladened society I think the penny is finally dropping for most that we need to forego our wants and focus on our needs if we are planning to effectively build wealth for our futures.

    =======

    Todd your argument is the popularly held one in Australia at the moment, and it is probably one of the large reasons why prices are continuing grow. So I can't say I disagree with your logic in the present market.

    However I think many of the popularly held beliefs I come undone when looking forward into the future by assuming that the way things have been will certainly be the way they are in the future.

    I'm not saying that the bull run in Australian property won't continue in the short, potentially even medium, term. However actions have consequences, and financial realities will inevitably come home to roost (ie debts inevitably need to be repaid, and credit growth can't be exponential without inflation). When this reality is realised we will be left with a credit bubble that needs to either contract or be inflated away, but ultimately the "wealth" people had perceived to have built up will be shown to be what it is, "just credit based inflation".

    ======

    Once again, just because recent trends (the last couple of decades) suggest that the number of people per household will decline, doesn't mean that will continue to be the trend of the future.

    If credit growth is stifled or contracts, quite the opposite will happen out of necessity and prudence. But once again this centres on my belief that financial reality dictates decision for many people, which infers it doesn't matter if people would "prefer" to live in their own place, they can't afford to, therefore they need to share.

    ======

    I completely understand your micro economic arguments, and I don't disagree that our population will grow and there may well be a housing shortage, but my arguments about property prices falling has got very little to do with micro economic variables (not that I haven't considered them).

    I can't help but feel that so many of the advocates for property price growth completely ignore (or are unaware of) the macro economic variables, and in some case I can't help but question whether they have a even have an understanding of "money" and "financial laws".

    To be honest I'd say less than 1% of people I meet really have a good grasp of Monetary Economics and just how much of an impact they have on the economy, yet the majority of people still have firm, confident to the point of righteous opinions on the future "prices" of houses despite a complete lack of understanding about the monetary system and the "money" with which those houses are priced.

    In my day to day life personally pass judgement of people "having a lack of understanding" not by what they talk about, but what they don't talk about in their arguments.

    I'm more than happy for someone to say housing prices will go up due to a "housing shortage" and "population boom" as long as their argument accommodates variables such as:

    * What would happen if bank's lending criteria tightened?
    * What would happened if they loosened?
    * What implications does reduced credit growth (or potential credit contraction) have on the economy and house prices?
    * Which sectors of the economic have credit growth and which are contracting? and why?
    * Are price set by supply and demand? or money supply? or both?
    * What is the Australian money supply doing?
    * What's the difference between the currency levels? M3? and broad money supply?
    * How can broad money supply have a growth rate higher than currency? Can this be sustained?
    * What implications do commercial bank's reserve requirements have on the economy?
    * Do we have reserve requirements in Australia?
    * Does the RBA control reserve requirements? If the RBA doesn't then who?
    * What are mortgage approval rates are likely to do to housing prices?
    * What long term multiplier effects do government subsidies like FHOGs have on the economy?
    * Under what circumstances do high levels of debt hinder future growth?
    * Why can't debt levels grow forever?
    * What is debt?
    * Why is Australia's funding shortage an issue?
    * Why do the bank's interest rate move around irrespective of the RBA?
    * What is the RBA? What does it control?
    * Why are US bond yields rising?
    * Why are the rising US bond yields important to Australian interest rates?
    * What implications do bond yield prices have on the prospects for the potential of a double dip recession?
    * Why has quantitative easing in the US, UK and Europe not resulted in inflation?
    * Why are central banks printing money as the solution to the problem?
    * Why is debt essentially the same as real money in the economy?
    * And why does paying down debt contract the economy?
    * Is deflation a good or bad thing? or neither?
    * Is inflation a good or bad thing? or neither?
    * What is inflation caused by? rising demand? or increasing money supply?
    * Is house price growth a symptom of rising demand or growing money supply?
    * What is included in the RBA inflation figure?
    * What is NOT included in the RBA inflation figure?
    * What impact do threats like Greece, Dubai, California default have on Australia?
    * What impacts do these have on bond yields?
    * What impact to government deficits have on the economy in the short and long term?
    * What multiplier effect does government spending empirically have on an economy.
    * What affect does higher taxation have on an economy?
    * Does the US government bailouts solve the banking insolvency problem?
    * Why does the AUD strengthen against the USD?
    * Is a stronger AUD good or bad? or neither?
    * Which side of the carry trade is Australia on?
    * What do long term current account deficits cause?
    * Why does China own lots of US treasuries?
    * What are the debt levels of Australian households, businesses and governments and how do these stack up with other nations?
    * Under what circumstances do house prices fall? Is it only in situations of falling demand? over supply? or does money supply have an influence?
    * What are the different schools of economic thought?
    * Which school of thought do most western economies operate under today?
    * Why can't government spending compensate for falling private demand in cases like Greece?


    ... meh I'll stop there. There are hundreds of questions I could pose that all have impacts of Australian housing prices beyond the microeconomic problem of a "housing shortage", and of course if someone has a firm and rational position on all the above question and still says Australian property is going up then obviously we just differ in interpretation of the data.

    But of course the vast majority of Australians couldn't answer half, let alone the majority of the questions above - yet I'd argue all of them have not only a significant impact on housing prices, but many of them have a BIGGER impact that the short term micro economic variables of supply and demand in the property market.

    Ultimately if I sense someone doesn't understand the macro economics of the issue then I tend to either suggest they broaden their information source beyond popular media or just smile and walk away (depending on how much I care about the person and how much time I'm willing to waste/invest).

    ======

    Also I think over the next two decades we will have the added problem of under funded retirees many of whom will be force to move in with their children if the government is burdened by massive debts which will limit its ability to provide welfare support via pensions.

    I know I have already spoken at length with my mother, who is only 50 years old, about her needing to move in with one of us kids, because unfortunately at this stage it would seem that she just doesn't have enough savings, super, equity or earning capacity to be fully self sufficient when she retires, and I know she's not alone.

    Once again I need to make the caveat, that I'm assuming that today's level of welfare will not be available to the retirees of the future, based once again on the financial laws of to offer welfare to one requires taxation of another, and with the growing ratio of retirees to taxable workers, in addition to the already highly indebted system will mean it's unlikely that levels of welfare to retirees will be able to be sustained given that Australian are already heavily taxed.

    =======

    Yes but even these defaults have implications on all areas, because if banks have to write down bad loans due to FHO's defaulting, then this will leave banks underfunded, and reduce their lending ability to all mortgage applicants, which will reduced mortgage approvals and induces tighter credit restrictions which will limit both the number of buyers and the amount those buyers can borrow (and spend), which pushes prices down.

    So it's not a case of isolated problems, there are flow on effects, and of course if these "isolated problems" are big enough you get deflation expectations which creates a downward spiral which can be VERY difficult to stop.

    Even now it's hard to tell if all the stimulus and support the US government and FED have offered the banks, home buyers, etc has done enough to reverse expectations. If the latest data is anything to go by it would seem that the US housing market is about to embark on the next leg down, but I have little doubt that the government and FED will step in and support it, but they can't offer unlimited support without other issues arising.

    =======

    Actually the cost of the materials doesn't go up at all, it's the value of the money that goes down against that material (fiat currency being debased by inflation). A cow is still a cow, bread is still just bread, and houses are still houses. They don't change - the money does.

    The price only went up because the money supply grows, which causes inflation, but kicker about whether you are making "real" returns is how you calculate inflation. If you take the RBA at their word and say there is 2 - 3% each year then we are all making a killing with our house prices growing and stock portfolios rallying.

    Of course if you look a little deeper into what is included, and more importantly, what is EXCLUDED from the RBA's inflation figure - you might not feel as wealthy given the real cost of living (for things like milk, bread and houses) tends to go up much faster than the quoted RBA's inflation figure.

    Now I assume most of you were already aware of the obvious, in that that "inflation" (a symptom of a growing money supply) and prices are linked, but the question you really want to answer is what is causing this inflation? and is this cause sustainable?

    =======

    Also just for giggles I decided to whip out trusty excel and see if I could see some correlation between margin lending credit levels and stock market prices over the last 10 years, here are the results using the RBA's credit aggregates vs the XAO index:

    [​IMG]
    [​IMG]

    Looks reasonably similar to me, who knows, maybe there is something to this amount of debt in the system and prices thing.

    I'll leave those that are interested to mock up their own excel sheets to see if they can find a correlation to household debt levels and housing prices...

    ========


    here is definitely an issue with government - though I wouldn't call government charges a bubble as they are not determined by supply and demand - though I would call government itself a bubble.

    Government (like in most western countries) has it's fingers in way too many pies, and is just far to big/inefficient/ineffective to be justified in taxing the amount of economic resources it does.

    But this is part of the end game of large bubble under a Keynesian system, ie the government steps in to bail out the bankrupt private sector, but in turn it bankrupts itself, forcing it be downsized just like everyone else.

    At the end of the day all levels of society, individuals, households, businesses and government are all beholden to the realities of financial laws - in that debts must be paid, ie long term consumption cannot exceed production.

    That's why getting rich quick off a negatively geared, buy and hold property strategy doesn't work in the long run, unless you are aware you are just speculating, in which case to make a profit you need to time the market, and your gain can only be achieved in aggregate with someone else's loss. Granted this winner vs loser prospect isn't apparent in the short run, and only becomes obvious when you look at a credit fuelled trading bubble over the long run.

    Also the losses aren't necessarily born by one individual, as in that an individual who bought a deflating asset may be leveraged beyond their capacity to pay in which case they go bankrupt and pass the loss onto the lender (often a bank), and if enough people do this it will collapse the banking institution that lent the money which will mean loses for stock holders, and if the government bails them out the loss will be transferred to tax payers, who may refuse to pay the taxes at which point the central banks print money which transfers the loss via currency debasement (aka inflation) to anyone who is holding the currency - but ultimately the loss needs to be realised.

    When it comes to speculative trading someone needs to lose, because nothing is being produced by trading, which is why it is such a problem for countries if everyone in an economy is resting on their lorals in that they are making a fortune from the credit fuelled growth of their housing or stock portfolios, and in this illusion of wealth they decide they can reduce how much work they need to do to sustain their lifestyle, but nievely do not account for the change in credit based money supply.

    Of course when this credit based money supply contracts you have what is being experienced in the US and some countries of Europe, and on the flip side you have the Asian sweetshops who have been the creditors in most cases and are now the production centre of the world and as result will no doubt soon see reasonably large currency appreciation given most western countries have cornered themselves into position where they will have to debase or deflate theirs.

    ========

    That's one way to do it, but this falls back under the category of being a speculating trader, in that if you take on more leverage than the average amount of leverage in the economy (assuming the average credit growth is positive) then yes it is likely you will be better off given that the leveraged gains you will make will be greater than the inflation within the economy, given that when people take on leverage this cause credit growth which causes inflation.

    But of course this logic comes crashing down if average credit growth within the economy (holding the monetary base equal) turns negative, because then what will happen is you will have deflation within the economy given the contracting broad money supply. Thus the reason why people say debt is bad during a deflation spiral...

    So if you want to be a good trader within a credit bubble you want to have as much leverage as possible on the upswing, but none on the downswing.

    ========

    If housing "prices" can come down, so can rents and wages, because once again rents and wages are not assigned prices based on price history, they are assigned prices based on monetary economics (money supply).

    However before you say, "but wages almost never come down", that may be true, but the repercussion of wages not falling is rising unemployment because workers refuse to take pay cuts to make the businesses they are working for profitable again, and if unemployment spikes high enough and stay high for long enough periods wages do eventually fall because people can only stay unemployed for so long. You will see this in countries like the US, Spain, Greece, etc

    With rents it is the same thing, rent may be sticky in the short run, but if vacancy rates spike and stay high inevitably rents fall. This is often more frequent and obvious in commercial real estate markets, but the same principle applies to the residential rental market as well.

    =======

    Traditionally yes, price fluctuations tend to be small, but that is generally because changes in broad money supply also tend to be small.

    However, quite often throughout history these price changes can be rapid in either direction (hyperinflation events or crippling deflationary depressions), to imply that prices only move in "small" increments ignores how the system really works in that when things are stable so is the money supply, when there are bubbles, manias, crisises going on changes can be rapid and extreme. We are presently in the later stage.

    Though with this in mind, it's interesting to note the US Federal Reserve only recently exploded their monetary base (of course the quadrupling of the monetary base had little effect on broad money supply because the economy is the middle of a debt deflation spiral)... but in light of events like this, to imply that we are going to revert back to "normal" growth, "normal" levels of inflation, "normal" interest rates, or stable prices is highly unlikely. The ECB and BoE have also opted for similar strategies, and I expect in the not too distant future the RBA will be forced down the same path.

    Now I'm not saying that Australian property will crash tomorrow, or we will hit hyperinflation on Tuesday, my point is simply that these are massive fluctuations in variables that are traditionally very stable and I think it's nieve to expect that there won't be future repercussions of these actions. And to assume that times are anything close to "normal" will be a very dangerous assumption to make over the next few years.

    So I think people need to stop worrying as much about what the latest newspaper headline is telling you about our housing shortage or mineral boom - we need to start focussing on what value of money is likely to do over the next 6, 12, 24, 60 months, both here and overseas.


    =======

    Nuf said.

    :cool:
     
  10. Chris C

    Chris C Well-Known Member

    Joined:
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    Posts:
    1,327
    Location:
    Brisbane, QLD
    Good points Waimate.

    :eek:

    ... I don't know if I'd go as far as calling it "sensible", but I'd agree that it might be a "tolerable" risk.

    :D

    You're 100% right, leverage is the key to substantial wealth.

    I know further down in your post you suggested that leverage is needed because we aren't all business owners, but businesses owner use leverage too! They leverage their employees, in that they "borrow" their employees labour and human capital, and the sell the products that employee produces (hopefully for a profit).

    But the underlying principle of using leverage to generate serious wealth is always the same in the long run - you need amplify (leverage) profitable business investments, not amplify losses.

    I agree, using a buy and hold strategy using leverage in a credit fuelled stock market is asking for trouble, but the same principle applies to a buy and hold strategy in a property portfolio, unless the investment based on 100% finance still has a net profit and also factors in a risk premium for risks like deflation.

    But this isn't REALLY a buy and hold strategy if you have intervened during the down times.

    I know my opinion is not the popular opinion, but from my perspective, a buy and hold strategy should be seen as a "store of wealth" strategy, not a get rich quick strategy.

    Using leverage with a buy and hold strategy and planning to not be active with those investments is a recipe for disaster. However if you are active with your investments, then this (in my books) falls under the category of being a "trader" and making speculations about future directions of market movements - not buying and holding.

    A plan is a good starting point and is normally the catalyst for seeking relevant information, but I liken this situation to that of the hedgehog and the fox parable - the fox knows many things, but the hedgehog knows one big thing.

    Short term traders need to factor for numerous changing variables and to be successful they need to know many things and try to be experts in many fields. Buy and hold investors often make their living from a single job which they are good at and should be looking at investments as a store of wealth for later consumption.

    Both the fox and hedgehog have successful strategies for their circumstances if they stick to what they are good at. I just think there are too many hedgehogs trying to be crafty foxes when they have a great defensive buy and hold strategy available to them.

    They should stick to what they know and work hard at it. That will maximise their return over the long run.

    Unless things like regulatory change occur, or their is another freezing of the credit markets.

    Whilst I agree the market does tend to move a lot slower, there are a number of variables that if changed could cause a rush for the exits (ie changes to taxation - removal of negative gearing or capital gain discount laws).

    This is sort of the thing that really annoys me.

    I know that if things were starting to look bad, virtually everyone on these forums (except the hard liners) would quickly adjust their strategy and would be able to avert major losses, but the average joe blow who isn't as cluey, but who bought in because they originally listened to guys like us, because they know we know more than them, are the ones that ride the market to the floor. *cough*FHOB*cough*

    To me it just seems so wrong that people are placing so much trust in "gurus" selling hopes and dreams yet make glaring omissions in their articles and publications. Honestly when I pick up Money magazine and read some of the nonsensical statements in it makes me cringe.

    Sure people are better off learning about personal finance and investing, but that benefit is quickly overshadowed if armed with basic information they run out and put themselves into debt up the eyeballs because some magazine article said they could retire by 40 without lifting a finger.

    I mean what a nonsensical idea - that we can ALL get rich by being property investors (or any sort of investors for that matter). If we are all living off the proceeds of our investments - who's doing the work to earn those profits? It's not far short of a ponzi sheme for the semi informed investor.

    I know I'll sound like a royal ****** by saying this, and I am making some assumptions about Wealth Creators knowledge, but if you don't understand the basics of monetary economics and international markets, then in my opinion you don't have the right to be claiming to be an expert when selling "books" and "mentoring" yet, because you are only equipped enough to get people in trouble.

    I mean seriously - what chance does the average joe have... but of course it's hard to sell books and pack out seminars about property investing if your message is "fastest way to lose your shirt"...

    :rolleyes:

    Or if you want to take an Elliot Wave perspective 20 years is enough to go through nearly half a supercycle...

    Japan's property and stock market went down for 20 years! Who knows how many decades it will take to get back to the same levels.

    The Dow is at the same level it was 10 years ago!

    My point is people also need to stop looking at the long term as 7 years. Modern finance has been going on for over 300 years... we need to start learning from history or we will continual be doomed to repeat it.

    So if a 20 year old is looking to maximise his wealth for retirement he needs to start thinking about the long term in a 40 or 50 year time frame, and when you start getting information in relation to those time frames, and longer, different patterns and information emerges.

    I agree, a bad investment at 65, is a bad investment at 35.

    Once again, totally agree. Though I'd argue leverage should never be used unless your an expert in the field in which you are investing otherwise it's just speculating.

    They will always be the exception, not the rule.

    In a society where we all focus on being "rich relative to our neighbour" ultimately not everyone can be "rich" because then none of us would be rich relative to our neighbour. So there will always be a wealthy elite - society just needs to accept it.

    So everyone needs to understand that of Australia's $1 trillion of gross domestic it doesn't matter how you divide it up, it has still gotta equal 1 trillion. Leveraging yourself up to your eyeballs to make a loss on an investment property doesn't increase our GDP in a real sense, just the level of inflation, because nothing was really produced other than growth to the money supply, therefore there isn't any extra pie to divide.

    What's unmeaningfulness about investing $10,000 into index based ETF in comparison to $1,000,000 into an indexed based ETF?

    They both get the exact same ROI.

    Trying to keep up with the Jones by taking bigger risks is a recipe to being confined to the poor house.

    If there is a logic that is resonating more deeply within me with each passing year, it's that the path to truth wealth is via providing value. The same way an employee provides more value to an employer to get a pay rise, the same way a business produces a valuable product that customers want to buy, The same way a property investor buys and IP and renovates it to produce higher rent and sale price, the same way a website (like InvestEd) provides a free information and conversation platform for opinionated mugs like me (while you make money from the advertisements). They all have the underlying premise of providing value.

    So at the end of the day if you really want a sure fire way to make it rich, it's all about providing as much value as possible - and it applies to absolutely everything.

    Trading (be it in shares or property) doesn't provide value... it's a zero sum game in the long run (super cycle long run, not 7 years long run). The main way to win in this trading game is to find the assets that are under "valued" and sell them when they are over "valued".

    Great investors that make money from trading (Warren Buffett) just know value when they see it, and probably more importantly, know when there is no underlying value.
     
    Last edited by a moderator: 21st Apr, 2010
  11. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I do differentiate between owning your own home and owning investment properties. I think home ownership is a fantastic forced savings vehicle, and over the typical lifespan of a home owner, they would generally build up a nice amount of equity (from paying down debt, from underlying capital growth, but also from adding value to their property).

    Now, of course, some people will get suckered into buying overvalued property because of the whole Joneses thing - but assuming they haven't over extended themselves or overcapitalised when adding value, then I think in general people do well from home ownership.

    We're not talking about 107% loans with IO payments. We're talking your typical 80% loan with P&I and all spare cash being poured into the loan to minimise interest. This is a very different ball game to what investors will do, and can dramatically change the risk profile compared to your typical investor strategy.

    Now, of course, if you are looking at your graphs of various economic super-cycles and seeing that we are due for a downturn sometime within the next 20-100 years, then I can see how you might get nervous with such a strategy.

    However, I believe the general benefits of owning a home and striving to pay it off will turn out to be far better for most people than any alternative.

    I agree.
     
  12. Chris C

    Chris C Well-Known Member

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    Brisbane, QLD
    The unfortunate thing is that I don't disagree.

    It's a real shame that people need to take on debt to be "forced" to save. It's same lack of financial sense and prudence that produces bubbles.

    With that said, I would add the caveat that there is limited, to no "capital growth" in houses over a super cycle. A house, is a house, is a house. Adding value to the property is a different can of worms.


    I don't disagree, but to require that all property loans have at least a 20% deposit would hammer the number of new loans approvals, and subsequently the property market.

    :)

    It's more that fact that Australia is now, overdue, but I'm happy to concede, just because we are overdue doesn't mean things can't go higher form here.

    I would argue that the average Australian would be better off taking the difference between the cost of renting and living in the home they are rent, and committing this saving into a forced savings scheme like Super and just renting.

    With that said in instances of sustained high levels of inflation it might be better to own your own home than be invested in Super, given the capital gains free tax allowance of owning one's home.
     
  13. Waimate01

    Waimate01 Well-Known Member

    Joined:
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    Posts:
    157
    Location:
    Sydney
    I agree that debt to buy a PPOR is worthwhile, and moderate debt to buy one or two IPs can be ok if you can service the debt and if a 20% decline in property values would not cause undue stress.

    But to those who think the only thing better than debt is more debt, and that debt is the only way to get ahead, I summarise your strategy as follows:

    "Debt is an amplifier that increases both your gains and your losses, so the trick is merely to be smarter than everybody else in the room and arrange your affairs such that you have more gains than losses, thus the amplifier only provides good effects, not bad."

    If only it were that easy. Certainly if it were that easy, we'd see professional fund managers turning in consistently outstanding results. Yet we don't. So for the strategy to work, it assumes that one must be so amazingly brilliant that, in one's spare time, one can do better than teams of professionals around the world.

    Now maybe one or two people are that amazingly brilliant. But the vast, vast majority are not.
     
  14. GregR

    GregR Reid Consultants

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    Location:
    Berwick Vic
    An interesting discussion again started by ChrisC.
    I work with property investors and I work with seniors so it gives me a perspective many don't have.
    I see the results of the advice from grandparents and parents, buy a home, pay it off and never get into debt. Irrespective of superannuation (only started for most in mid 90's) they are now on a pension and it is a tough lifestyle especially for singles.

    People do not save enough and for most will not ever save enough for a comfortable retirement lifestyle (as defined by ASFA). They may own their own home but that's it. With the baby boomers entering the retirement years in the next decade, we will see more and more people going into retirement with debt on their PPOR. Some will use super to pay for this but I do not like the chances of governments allowing lump sum withdrawals to last in the future. Our mix of wages earners to government beneficiaries will skew and super is an obvious vehicle to restrict to an annuity base scheme only.

    Some of those baby boomers will downsize but most will still buy another property, it will be a change of property type and location. I am still not envisaging this factor that will lead to massive sales volumes that will lead to property prices dropping significantly. I can and have seen segments of the market falling, higher priced areas, holiday type areas but I have not seen all the market falling.

    Comments have been made that property prices will drop an interest rates increase, they haven't yet, or that property prices will drop as lenders tighten credit, lenders have tightened significantly, no longer are there 105% loans, you need an exceptional case to get a 95% lend, CBA has dropped investment loans to 80% LVR, property prices are still increasing.

    Comments have been made of the losses from Storm Financial clients and they are many. There are also many that made millions based on their strategy. I did study what they put in place for clients, leveraging the PPOR using a low or no doc loan and investing in indexed funds and further leveraged these. Double risk without protection but in a rising share market, many made millions. A lot also come unstuck due to the margin calls. The moral is leveraging can work but you need to match risk to return.

    I work on the basis of a finance strategy, using other peoples money to acquire capital growth assets to build wealth over time. Whether you describe it as store wealth or build is semantics to an extent. What property enables you to do is to add value, through renovation or through development. My view it is buying median priced properties in areas people want to rent in. This is the asset protection based on style of property where over a period of 5 to 8 years, it moves to positively geared based on rent increases. Leverage enables you to do this.

    I agree that you do not want to buy an IP that is forever negatively geared, you are just losing cash continually unless you 'know' it will appreciate in capital greater than the cash losses. It is a higher risk than I would pursue. With clients I help work out their goals and time-frame and build a strategy to achieve those. I use property as the investment asset class because lenders will lend on it at higher ratio's up to 90% (I rarely go above 85% LVR) and there are no margin calls.

    We need to do more than buy a home and pay it off and have nothing else left for retirement. There are many people who have invested in property wisely and succeeded and we learn from those who have.
    Greg
     
  15. Vagon

    Vagon Well-Known Member

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    Chris,

    Your point has been lost amid all your posts. Is it simply that debt is risky? The big banks have determined that 80% is a suitable LVR, if you think this is too much debt name an LVR you think is appropriate and preach that.
     
  16. Chris C

    Chris C Well-Known Member

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    My point is increasing credit levels within a society can be dangerous if excessive, because credit growth can't be exponential, therefore contracting credit will catch those who speculated (they like to call it invested) based on future inflationary expectations with their pants down.

    ;)
     
  17. Vagon

    Vagon Well-Known Member

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    Cool, but what level do you determine as "excessive"? And are you talking all levels of debt including AAA?

    I have a few more questions for you:

    On the inflation side of things I think you've mentioned you believe current CPI doesn't capture it well enough. What would you see changed? Is the existing target rate sufficient once your hypothetical changes (if any) are taken into account?
     
  18. bundy1964

    bundy1964 Well-Known Member

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    Problem is professional fund managers tend to underperform the index of the market that they are investing in, they have benifited from capital raising that have only been available to institional investors at discounts to market rates. They have peer pressure which prevents most from looking outside the box, asset allocation rules, market depth problems with large transaction sizes, relativly short trading window and management fees.

    As a 6 figure investor I miss out on the great deals offered the big end of town, I can however do what I choose within the rules of the market, the broker and the bank.
     
  19. Chris C

    Chris C Well-Known Member

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    Well I guess "excessive" is always in the eye of the beholder, but it's important for people to understand that in a stable price system you'd only want money supply to increase by a percentage of population growth and production technical efficiency gains, which for most economies would only be a couple percent a year.

    Any increase over and above this will cause inflation and a debasement of money's purchasing power over time.

    Now it's important to appreciate that the money supply can grow either as a result of credit growth or good old fashioned money printing. Now for the most part Australia's broad money supply growth is driven by credit (debt) expansion not money printing.

    I'm not saying that credit growth is a bad thing either - in an economy where there is population growth it's totally acceptable and in many ways beneficial to have credit growth to keep the money supply stable.

    But the thing about credit growth within an economy is that it can't be exponential, because debt by its nature needs to be paid back, therefore it's illogical to lend someone who has limited future income potential (let's say someone who is 55) a 30 year loan given that they are likely to have no income to service the debt in 10 - 15 years and will be forced to sell the underlying asset to service or repay the loan.

    So in this sense you could argue that "excessive" refers to the point where serviceability becomes exceedingly difficult without selling down underlying assets, which some might argue many property investors find themselves in, with them needing to subsidies loan repayment with personal income as well as "tap" equity from other investment properties which have appreciated in value due to credit based money supply growth (inflation), to finance additional property purchases.

    "Tapping" this equity is quite similar in principle to selling the underlying asset, and for me just indicates the poor investment quality of investment properties once discounting for credit based inflation.

    I think most of the rating agencies debt ratings systems are very broken, and are still yet to be fixed. Nothing highlight this more than GFC, and light is once again been shone on the issue with the mounting sovereign debt crisises.

    From my perspective rating agencies looking at the US have to know that given its debt levels, future budget projections as well its future spending obligations that the country is CERTAIN to go bankrupt in the future if it follows it present policies, and let's no forget the FED has already started printing money (debasing their currency) which only erodes value to bond holders.

    Yet it still gets to keep a AAA rating on 30 year bonds just because it's not under the spotlight today, and probably won't be for a couple more years, but that doesn't change the reality that there is just no way it can maintain it's current obligations and rating agencies projections should reflect this and investors should be rewarded by receiving yields accordingly and pressure should be placed on the US to be more fiscally responsible well before these inevitable problems arise.

    So, no I don't care much for the rating agencies projections. I mean look at the UK - it's got a AAA rating but like the rest of the countries in Europe its CDS are always drifting higher because the markets know what the rating agencies won't admit - the maths doesn't add up.

    You can't spend more than you earn forever, but at the moment none of these governments are planning to change this in the short to medium term, they are only planning to reduce their overspending and I have severe doubts as to whether the bond markets will believe this will be enough to justify their risk.

    Including all the things that average Australians spend most of their money on would be a good start.

    I have posted about this point quite a few times on this forum:

    "the price of food, health, accommodation, petrol, childcare, holiday travel, clothing, and so much more are not even accounted for in the "underlying inflation" figure that is reported"

    Another big problem with the target rate is that it hasn't previously (and still doesn't) factor into the equation presences of asset bubbles.

    That's probably why Glenn Stevens is now out there publicly preaching that people should avoid these asset bubbles as a means to wealth because he realises his central banks target don't help remove volatility in these asset markets, which so obviously have huge implications on the stability of the rest of the economy.

    That said I'm not completely adverse to having a low inflation target (though I do think 3% is too high, especially given that deflation isn't really a major threat to an economy if debt is properly managed within it), but this target over the medium term should factor in as much elements of an economy as possible.

    However in light of all the things that the current underlying inflation figure misses, if you looked back over the last 20 years you'd probably realise that inflation rate was actually well over 5% (excluding the asset bubbles - including them would make that figure worse), and no where near the targeted 2.5%.

    Any other questions?

    :D
     
  20. GG

    GG Active Member

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    What a great thread! :)

    In some way it was sparked by something that i asked

    I feel I need to defend somebody called 'wealth_creator' because he/she was giving an opinion on what I had asked, and that was exactly what I wanted - as many opinions as possible, and then I make up my own mind. And probably make my own mistakes!

    But I'm really grateful to everyone contributing to the thread as it helps people like me to consider these sorts of things.

    I might later try to comment on particular points, but meanwhile, many thanks :)