Happiness is a landlord with 100% occupancy, no arrears, no outstanding repairs or maintenance and no tenants having given notice to terminate their leases.
The lease on the only vacant property has been agreed and only awaits bank approval.
If only it could always be like this.
Saturday, March 31, 2007
Monthly Review - March
My net worth increased by 2.5% in March.
The year to date increase is 9.4%.
This was a surprising result given the volatility experienced in a number of markets in which I have an interest. Here's the breakdown:
1. my holdings of funds were down, but only slightly. Small losses in Vietnam and Hong Kong were offset by gains in European smaller companies, Taiwan and Thailand;
2. my investment in silver was down;
3. my direct holdings of equities were up. This was the source of the surprise. I still hold a few shares left over from the days when I was allowed to invest in listed companies. A couple of these shares made strong price gains in March. The gains here were greater than the losses in #1 and #2 described above;
4. my properties generated net income (rents were higher than expenses) as usual in spite of not having 100% occupancy;
5. my savings for this month were good. Although I had to pay my taxes and for our next holiday these had been fully provided for and had no impact on my savings rate for the month.
The only movements in investments this month were regular monthly contributions to Asian and European smaller companies funds.
I am very pleased with my progress over the first quarter of 2007.
The year to date increase is 9.4%.
This was a surprising result given the volatility experienced in a number of markets in which I have an interest. Here's the breakdown:
1. my holdings of funds were down, but only slightly. Small losses in Vietnam and Hong Kong were offset by gains in European smaller companies, Taiwan and Thailand;
2. my investment in silver was down;
3. my direct holdings of equities were up. This was the source of the surprise. I still hold a few shares left over from the days when I was allowed to invest in listed companies. A couple of these shares made strong price gains in March. The gains here were greater than the losses in #1 and #2 described above;
4. my properties generated net income (rents were higher than expenses) as usual in spite of not having 100% occupancy;
5. my savings for this month were good. Although I had to pay my taxes and for our next holiday these had been fully provided for and had no impact on my savings rate for the month.
The only movements in investments this month were regular monthly contributions to Asian and European smaller companies funds.
I am very pleased with my progress over the first quarter of 2007.
Monday, March 26, 2007
It's a strange (property) world (2)
The previous post looked at the key drivers of demand for residential property. I now turn to the factors that influence supply.
Every piece of land and every property is unique, making the supply side review quite interesting. The main factors are:
1. availability of land: there is a lot of land on which there is no human habitation. In fact there is far more land unused than used on our planet. Quantity of land in general is not a factor affecting supply;
2. availability of land in convenient locations: most people want to live close to someone or something: work, family, friends, the beach etc. When commuting time/distance is taken into account with other factors below, the availability of land and properties in convenient locations means that supply side limitations on quantum play a key role in determining property prices;
3. constraints on land use: there are a variety of constraints on land usage. Some land is physically unsuitable for use as residential land (swamps, mountains). Some land is made less desirable (proximity to certain industries, former rubbish dump etc). Even for the remaining land in convenient locations which is both suitable and desirable, further limitations on usage imposed by town planners and other regulators have the effect of limiting the amount of land available and the uses to which each piece of land can be put. Certain areas will be set aside for parks or other public purposes. There will be restrictions on density of property development. While all these restrictions are well intended, they do play a significant role in restricting the supply of land and property available in many locations.
Since I do not see much prospect of the regulatory constraints changing in a manner which will permit higher density housing in many cities, I feel comfortable that residential property prices (or, more specifically, land values) have the ability to hold up over the longer term even in the face of economic adversity to the economy in general (obviously with the possibility of considerable volatility). Of course, Japan has shown us that the longer term can be very long when it comes to deflating a bubble.
As long as the population and the number of households continue to grow at a rate faster than the supply of new housing in convenient locations, I would expect any price falls to be a case of demand being deferred rather than a long term prospect. Put differently, the supply side of the housing market in many cities has shown itself to be somewhat inelastic which helps to partially explain why prices levels that look expensive in terms of affordability, yield and historical prices show little sign of easing off (and probably will not unless there is a general economic down). Even rising interest rates have failed to have much impact on the rate of house price appreciation in some places (see New Zealand as an extreme example. In spite of interest rates above 9%, house prices are still appreciating).
The above conclusions apply to cities where there are restrictions on the ability of a city to continue to expand or which have the ability to expand but only at the price of a disproportionate increase in the inconvenience factor. London and Sydney come to mind as examples.
Every piece of land and every property is unique, making the supply side review quite interesting. The main factors are:
1. availability of land: there is a lot of land on which there is no human habitation. In fact there is far more land unused than used on our planet. Quantity of land in general is not a factor affecting supply;
2. availability of land in convenient locations: most people want to live close to someone or something: work, family, friends, the beach etc. When commuting time/distance is taken into account with other factors below, the availability of land and properties in convenient locations means that supply side limitations on quantum play a key role in determining property prices;
3. constraints on land use: there are a variety of constraints on land usage. Some land is physically unsuitable for use as residential land (swamps, mountains). Some land is made less desirable (proximity to certain industries, former rubbish dump etc). Even for the remaining land in convenient locations which is both suitable and desirable, further limitations on usage imposed by town planners and other regulators have the effect of limiting the amount of land available and the uses to which each piece of land can be put. Certain areas will be set aside for parks or other public purposes. There will be restrictions on density of property development. While all these restrictions are well intended, they do play a significant role in restricting the supply of land and property available in many locations.
Since I do not see much prospect of the regulatory constraints changing in a manner which will permit higher density housing in many cities, I feel comfortable that residential property prices (or, more specifically, land values) have the ability to hold up over the longer term even in the face of economic adversity to the economy in general (obviously with the possibility of considerable volatility). Of course, Japan has shown us that the longer term can be very long when it comes to deflating a bubble.
As long as the population and the number of households continue to grow at a rate faster than the supply of new housing in convenient locations, I would expect any price falls to be a case of demand being deferred rather than a long term prospect. Put differently, the supply side of the housing market in many cities has shown itself to be somewhat inelastic which helps to partially explain why prices levels that look expensive in terms of affordability, yield and historical prices show little sign of easing off (and probably will not unless there is a general economic down). Even rising interest rates have failed to have much impact on the rate of house price appreciation in some places (see New Zealand as an extreme example. In spite of interest rates above 9%, house prices are still appreciating).
The above conclusions apply to cities where there are restrictions on the ability of a city to continue to expand or which have the ability to expand but only at the price of a disproportionate increase in the inconvenience factor. London and Sydney come to mind as examples.
Saturday, March 24, 2007
It's a strange (property) world (1)
In some parts of the world we are currently seeing signs of very weak or falling downward property prices. Parts of the United States can be used as examples. The very long down trend in Japanese real estate prices also comes to mind.
In other places we are seeing property prices continue to march upwards in spite of prices looking expensive when measured against incomes, rental yields and historic prices. London and Australia illustrate this situation.
So why do property prices keep going up when they have already reached levels where (i) younger and less affluent people are struggling to afford either a down payment or to service a mortgage and (ii) yields are significantly below bank deposit rates (note: this is not the case in Hong Kong)?
As with most economic questions, the answer is supply and demand.
This post looks at the demand part of the equation. There appear to be four factors driving demand for residential property:
1. population: populations in these cities are growing. More people means that more accommodation is needed to house them;
2. declining household size: not only are populations growing, but the size of the average household is falling. This means that even if the population remained static in absolute terms, the total number of housing units needed would continue to rise;
3. investment demand: the demand for investment property by (in particular) middle class families has been a noticeable feature of the last decade or so. I have no data to refer to, but looking at all the books, web sites, TV shows and other materials devoted to property investment I would guess that a meaningful percentage of the demand for residential property purchases is driven by investors. This does not change the number of people living in a city but it does add to the demand;
4. liquidity: the ease of obtaining a mortgage (even one that is of questionable affordability) is also a factor. The current problems faced by sub-prime lenders in the US give a good indication of how lax lending standards have become in some markets (and what happens when things go wrong).
Factors #1 and #2 are long term demographic trends. In spite of aging populations in some countries, I do not expect these to change anytime soon. Factors #3 and #4 can be a bit more fickle, but even if investment demand goes away (or reverses itself with investors being net sellers), it is a fairly safe bet that it will come back. The only question is when. It took Hong Kong about six years for the market to bottom out after the 1997 peak. Japanese investors had to wait about sixteen years from the top of the bubble to be told that property prices had at last shown a statistical increase. Other markets have recovered from slumps after much shorter periods. I have not heard of anyway to reliably predict the bottom of a market slump, but based on my (limited) experience, anytime you can by a property with a reasonable deposit (30% is typical in Hong Kong) and have the payments on a P+I mortgage being less than the rental return, it is a good time to buy.
In other places we are seeing property prices continue to march upwards in spite of prices looking expensive when measured against incomes, rental yields and historic prices. London and Australia illustrate this situation.
So why do property prices keep going up when they have already reached levels where (i) younger and less affluent people are struggling to afford either a down payment or to service a mortgage and (ii) yields are significantly below bank deposit rates (note: this is not the case in Hong Kong)?
As with most economic questions, the answer is supply and demand.
This post looks at the demand part of the equation. There appear to be four factors driving demand for residential property:
1. population: populations in these cities are growing. More people means that more accommodation is needed to house them;
2. declining household size: not only are populations growing, but the size of the average household is falling. This means that even if the population remained static in absolute terms, the total number of housing units needed would continue to rise;
3. investment demand: the demand for investment property by (in particular) middle class families has been a noticeable feature of the last decade or so. I have no data to refer to, but looking at all the books, web sites, TV shows and other materials devoted to property investment I would guess that a meaningful percentage of the demand for residential property purchases is driven by investors. This does not change the number of people living in a city but it does add to the demand;
4. liquidity: the ease of obtaining a mortgage (even one that is of questionable affordability) is also a factor. The current problems faced by sub-prime lenders in the US give a good indication of how lax lending standards have become in some markets (and what happens when things go wrong).
Factors #1 and #2 are long term demographic trends. In spite of aging populations in some countries, I do not expect these to change anytime soon. Factors #3 and #4 can be a bit more fickle, but even if investment demand goes away (or reverses itself with investors being net sellers), it is a fairly safe bet that it will come back. The only question is when. It took Hong Kong about six years for the market to bottom out after the 1997 peak. Japanese investors had to wait about sixteen years from the top of the bubble to be told that property prices had at last shown a statistical increase. Other markets have recovered from slumps after much shorter periods. I have not heard of anyway to reliably predict the bottom of a market slump, but based on my (limited) experience, anytime you can by a property with a reasonable deposit (30% is typical in Hong Kong) and have the payments on a P+I mortgage being less than the rental return, it is a good time to buy.
Friday, March 23, 2007
Frustration with Funds (2)
I have previously written about the problems Hong Kong investors have with accessing funds which have no load and low MER (management expense ratios). The situation is improving and I summarise my current understanding as follows:
1. many fund houses will only offer actively managed funds. MERs are typically in the 2-3% range. While this is very high by US standards and has a material negative effect on returns, in part it is justified by the relatively small fund sizes;
2. most fund houses still try and charge 5-5.5% front end load. This can usually be negotiated down to 2% and "specials" of 1.5% have been seen. This is still outrageously high. I've managed to get one reasonably good fund house down to either 1% or 0.5% but it took a while to get there;
3. most of the overseas ETFs and no load index funds I have looked at are either not available to Hong Kong residents or the returns are subject to a withholding tax of up to 30%. As much as I hate paying the front end load and the high MER, because of the withholding tax issue, I think I am marginally better off over the longer term paying the load and MER than going with an overseas no load index fund. This conclusion is not an absolute one - the result depends on what the actual return on the funds is and does vary a bit with the actual MER, the actual load and the time period of the investment;
4. there is a small range of ETFs listed on the Hong Kong stock market. Of these, only the ones which track the Hange Seng Index (TraHK), the FTSE/Xinhua A50 Index, the Hang Seng China Enterprises Index and the BSE Sensitivity Index have enough liquidity for me to feel comfortable investing in. I hold TraHK, but do not hold either of the two China related funds or the India fund. The latter is one that I only recently became aware of. There are also ETFs which track other China indices, the MSCI Korea Index, the MSCI Taiwan Index, a Hong Kong bond index and a pan Asia bond index. However, these ETFs have either no or inadequate trading volume making them inaccessible. Lyxor (part of the SocGen group) has announced that it intends to list other ETFs in the near future and, if there is enough trading volume, I look forward to that;
5. there is one hedge fund available: the AHL Managed Futures Fund. This has no load but a high MER (including profit share). I do not hold this fund. Based on past performance, a decision to invest would have done reasonably well;
6. there are some REITs listed in Hong Kong, but I am not allowed to invest in these.
1. many fund houses will only offer actively managed funds. MERs are typically in the 2-3% range. While this is very high by US standards and has a material negative effect on returns, in part it is justified by the relatively small fund sizes;
2. most fund houses still try and charge 5-5.5% front end load. This can usually be negotiated down to 2% and "specials" of 1.5% have been seen. This is still outrageously high. I've managed to get one reasonably good fund house down to either 1% or 0.5% but it took a while to get there;
3. most of the overseas ETFs and no load index funds I have looked at are either not available to Hong Kong residents or the returns are subject to a withholding tax of up to 30%. As much as I hate paying the front end load and the high MER, because of the withholding tax issue, I think I am marginally better off over the longer term paying the load and MER than going with an overseas no load index fund. This conclusion is not an absolute one - the result depends on what the actual return on the funds is and does vary a bit with the actual MER, the actual load and the time period of the investment;
4. there is a small range of ETFs listed on the Hong Kong stock market. Of these, only the ones which track the Hange Seng Index (TraHK), the FTSE/Xinhua A50 Index, the Hang Seng China Enterprises Index and the BSE Sensitivity Index have enough liquidity for me to feel comfortable investing in. I hold TraHK, but do not hold either of the two China related funds or the India fund. The latter is one that I only recently became aware of. There are also ETFs which track other China indices, the MSCI Korea Index, the MSCI Taiwan Index, a Hong Kong bond index and a pan Asia bond index. However, these ETFs have either no or inadequate trading volume making them inaccessible. Lyxor (part of the SocGen group) has announced that it intends to list other ETFs in the near future and, if there is enough trading volume, I look forward to that;
5. there is one hedge fund available: the AHL Managed Futures Fund. This has no load but a high MER (including profit share). I do not hold this fund. Based on past performance, a decision to invest would have done reasonably well;
6. there are some REITs listed in Hong Kong, but I am not allowed to invest in these.
Tuesday, March 20, 2007
Book Review: Collapse
I purchased this book wanting to read about what made some civilisations succeed and others fail from a historical perspective. The book met that expectation. What was surprising was the fact that Jared Diamond's work is clearly focused on the interrelation between the environment and the success or failure of each of the civilisations which he considers.
As an academic text, it is an impressive work. As a wake up call on the significance of environmental issues to us today, it had a far greater impact on me than watching "An Inconvenient Truth" (which I also regard highly). The massive amounts of detail given are presented alongside the human story in a manner which makes for compulsive reading rather than the more common problem with lengthy works on technical subjects of dryness. As an example, the story of the establishment and ultimate failure of the Norse settlements in Greenland is precisely attributed to a number of factors (some man made, others not) which conveys the importance of environmental factors in the demise. At the same time Diamond presents a chilling depiction of what the final years of the settlements may have been like.
The book is not all historical. Diamond also considers a number of modern successful societies such as parts of the United States, Australia and Haiti/Dominican Republic. His review of some of the major extraction industries (mining, oil, fishing and forestry) made very interesting reading from both an environmental as well as economic perspective.
The issues raised in the book have a direct relevance to personal finance. Just to take the subject of water as an example, the effects of the environmental changes we are witnessing on the supply of water (both quantity and quality) are explained in a manner which makes it clear that not all sources of water are created equal. Some are more vulnerable that others which has implications for those looking to invest in land (whether for farming, lifestyle or other purposes).
Very highly recommended.
As an academic text, it is an impressive work. As a wake up call on the significance of environmental issues to us today, it had a far greater impact on me than watching "An Inconvenient Truth" (which I also regard highly). The massive amounts of detail given are presented alongside the human story in a manner which makes for compulsive reading rather than the more common problem with lengthy works on technical subjects of dryness. As an example, the story of the establishment and ultimate failure of the Norse settlements in Greenland is precisely attributed to a number of factors (some man made, others not) which conveys the importance of environmental factors in the demise. At the same time Diamond presents a chilling depiction of what the final years of the settlements may have been like.
The book is not all historical. Diamond also considers a number of modern successful societies such as parts of the United States, Australia and Haiti/Dominican Republic. His review of some of the major extraction industries (mining, oil, fishing and forestry) made very interesting reading from both an environmental as well as economic perspective.
The issues raised in the book have a direct relevance to personal finance. Just to take the subject of water as an example, the effects of the environmental changes we are witnessing on the supply of water (both quantity and quality) are explained in a manner which makes it clear that not all sources of water are created equal. Some are more vulnerable that others which has implications for those looking to invest in land (whether for farming, lifestyle or other purposes).
Very highly recommended.
Monday, March 19, 2007
Where to park short term savings?
When I am trying to save up for an investment the money usually builds up in the form of bank deposits and/or money market accounts. I am starting to question whether this is the optimal approach.
My most common savings goal is a deposit for a property purchase. This has been a recurring situation for several years now and I expect it to continue for at least a few more years. This means that I am constantly putting money aside into bank deposits and/or money market accounts.
Cash and bank deposits are lousy investments over the longer term. Given that I am almost constantly building up such investments (before drawing down to spend them) it means that I am averaging a level of cash/deposits which is sub-optimal in terms of portfolio management.
Instead of accumulating the deposit for the next property investment in the form of cash/deposits, I am considering putting the money directly into a low cost index fund. The logic is that the equity investment should, on average, show a significantly higher return than cash/deposits over the medium term. In fact the local Hang Seng Index tracker fund shows a yield which is very similar to large Hong Kong dollar deposits meaning the market only needs to move by more than the transaction costs to show a gain on this strategy.
Of course, there is no such thing as a free lunch. Investing in equities carries volatility risk. If the market moves against me, I will either have to delay the purchase or take the loss. Given that (i) I am in no hurry to acquire the additional properties and (ii) I am underweight equities anyway, this may be a risk that I am prepared to live with.
I would not follow this strategy with money that I could not afford to lose or if the money being set aside was needed for something I must spend it on within a short time period. But with investment properties for which there is no particular sensitivity on timing, it would appear to have potential.
Just a thought.
My most common savings goal is a deposit for a property purchase. This has been a recurring situation for several years now and I expect it to continue for at least a few more years. This means that I am constantly putting money aside into bank deposits and/or money market accounts.
Cash and bank deposits are lousy investments over the longer term. Given that I am almost constantly building up such investments (before drawing down to spend them) it means that I am averaging a level of cash/deposits which is sub-optimal in terms of portfolio management.
Instead of accumulating the deposit for the next property investment in the form of cash/deposits, I am considering putting the money directly into a low cost index fund. The logic is that the equity investment should, on average, show a significantly higher return than cash/deposits over the medium term. In fact the local Hang Seng Index tracker fund shows a yield which is very similar to large Hong Kong dollar deposits meaning the market only needs to move by more than the transaction costs to show a gain on this strategy.
Of course, there is no such thing as a free lunch. Investing in equities carries volatility risk. If the market moves against me, I will either have to delay the purchase or take the loss. Given that (i) I am in no hurry to acquire the additional properties and (ii) I am underweight equities anyway, this may be a risk that I am prepared to live with.
I would not follow this strategy with money that I could not afford to lose or if the money being set aside was needed for something I must spend it on within a short time period. But with investment properties for which there is no particular sensitivity on timing, it would appear to have potential.
Just a thought.
Sunday, March 18, 2007
Forestry as an investment?
Global warming and other environmental problems raise a number of issues for the forestry industry.
Starting with the basics: supply and demand. As far as I can tell from a brief internet search, there is no sign of demand for forestry products abating under environmental pressure and the move to an electronic age. If anything, demand is still increasing with much of the increased demand being led by developing economies. The supply side shows signs of being a similar story to what we have seen with a number of other resources over the last few years - inelastic supply meeting rising demand. Supply and demand would suggest that forestry offers potential as a long term investment.
Regulations make an interesting and complex part of the analysis. The position would appear to be different in different countries. The move to certification programs such as FSC is one issue. The costs seem to be quite nominal and would not appear to have an adverse impact on forestry companies over the longer term. The prospect of increasingly tougher regulations on the cutting and transportation of old growth forests will help the supply side become tighter, although timing and extent remain guesses. The more interesting issue is the regulation of carbon credits. A far as I can tell, some countries have moved to impose a carbon cost on the cutting of forests (even those planted for the express purpose of being harvested) but do not give a credit for the carbon benefits generated by a forest prior to harvesting. Industry lobby groups are trying to address this issue. My guess is that it is only a matter of time before at least some recognition is given to this.
A further variable to consider is whether the investment includes ownership of the land or merely the cutting rights.
The above is no more than some preliminary thoughts and speculations. However, if correct, it would be interesting to look into the economics of an investment in the industry. I would also need to verify whether the preliminary analysis above is correct and complete.
Since I am prohibited from buying listed securities (with very limited exceptions) and would not expect to be able to buy a forest, I suspect I am looking at a share in a forestry partnership. By their nature, I would expect to be looking a a long term, illiquid investment with small negative cash flows until harvesting in the distant future. Tax issues would also need to be taken into account. I would expect gearing to be impracticable.
On the surface it sounds as though the attractive supply and demand situation may be negated by other factors, but I will do some research into it.
Starting with the basics: supply and demand. As far as I can tell from a brief internet search, there is no sign of demand for forestry products abating under environmental pressure and the move to an electronic age. If anything, demand is still increasing with much of the increased demand being led by developing economies. The supply side shows signs of being a similar story to what we have seen with a number of other resources over the last few years - inelastic supply meeting rising demand. Supply and demand would suggest that forestry offers potential as a long term investment.
Regulations make an interesting and complex part of the analysis. The position would appear to be different in different countries. The move to certification programs such as FSC is one issue. The costs seem to be quite nominal and would not appear to have an adverse impact on forestry companies over the longer term. The prospect of increasingly tougher regulations on the cutting and transportation of old growth forests will help the supply side become tighter, although timing and extent remain guesses. The more interesting issue is the regulation of carbon credits. A far as I can tell, some countries have moved to impose a carbon cost on the cutting of forests (even those planted for the express purpose of being harvested) but do not give a credit for the carbon benefits generated by a forest prior to harvesting. Industry lobby groups are trying to address this issue. My guess is that it is only a matter of time before at least some recognition is given to this.
A further variable to consider is whether the investment includes ownership of the land or merely the cutting rights.
The above is no more than some preliminary thoughts and speculations. However, if correct, it would be interesting to look into the economics of an investment in the industry. I would also need to verify whether the preliminary analysis above is correct and complete.
Since I am prohibited from buying listed securities (with very limited exceptions) and would not expect to be able to buy a forest, I suspect I am looking at a share in a forestry partnership. By their nature, I would expect to be looking a a long term, illiquid investment with small negative cash flows until harvesting in the distant future. Tax issues would also need to be taken into account. I would expect gearing to be impracticable.
On the surface it sounds as though the attractive supply and demand situation may be negated by other factors, but I will do some research into it.
Friday, March 16, 2007
Buy v Rent
A lot has been written about whether it is better to buy your own home or to rent. Much of what I read on this subject is deficient in terms of objective analysis. Common deficiencies include:
1. focusing on selective statistics: a common example is the fact that home owners have, on average, considerably higher net worth than non-home owners. While superficially appealing, this is not a meaningful comparison. It would be more useful to compare home owners and non-owners of similar age and income groupings and possibly further broken down to account for other factors (such as children);
2. claiming that there is one single factor which is a decisive determinant: as an example it is sometimes claimed that the ability to leverage gives property ownership a decisive advantage;
3. making misleading comparisons: a common example is comparing the average house price at some point in the past with the average house price now. Even if the numbers used are specific to the local real estate market, the comparison is still flawed because (i) the average house has often changed during the time period under consideration (in many places they are bigger and have more facilities), (ii) this often ignores costs necessary to maintain the house's condition and (iii) very few houses are "average" or appreciate at the "average" rate;
4. using arbitrary, unrealistic, overstated or understated numbers: an example is long term maintenance and optional improvements. Advocates of home ownership often ignore or understate these while advocates of renting often overstate them;
5. ignoring relevant costs or benefits: advocates of property ownership often ignore the costs of long term maintenance. Likewise, advocates of renting often ignore the more favourable tax treatment given to owner occupied homes compared to many other investments. I have even seen examples which ignore the cost of renting;
6. making illogical or emotional claims: a common example is that a home is a liability or an expense. The former is nonsense (in almost all cases). The latter is true but then all assets are, from an accounting perspective, simply long term expenses which renders the claim irrelevant and misleading. The question is not whether a house is an expense but which or two alternative expenditures is the best way of meeting your accommodation needs.
My own view is that there is no universally correct answer to this question and the best approach is to prepare a detailed spreadsheet comparing the choices on a case by case basis. It is obviously important that the spreadsheet be as comprehensive as possible and reflect all relevant values (of which there are many). My experience is that the analysis is dependent on assumptions or estimates of the following factors:
A. duration: how long a time period you are looking at
B. return: what returns you expect to get on both the property (appreciation) and the alternative (equities, cash etc)
C. rent: what rental you expect to pay
D. interest rates: the interest rates you pay on your mortgage
E. outgoings: what outgoings you expect to pay (including long term maintenance, insurance)
F. transaction costs: commissions, stamp duty, lawyers etc
G. taxes: the impact of taxes on the numbers you come up with
H. will home ownership help or harm your asset diversification
I. the level of gearing you will use for both the house and the alternative investment
One other thing I have learnt through experience is that looking at hypothetical numbers is not that useful. It is important to look at an actual property and to use the numbers for the actual alternative investment that you would make if you rented (as opposed to some theoretical investment).
Given the number of variables, most of which involve making guesses about the distant future, the analysis is very often no better than an educated guess. However, my view is that it is still better to do the analysis than not. Sometimes the results can be surprising. When we brought our first Hong Kong property in 2001, the market was very depressed following the Asian crisis. My very rough calculations at the time showed that buying was better than renting even if I assumed a small annual decrease in the value of the property. I took that as a very strong "buy" signal.
There are also some factors which are harder to quantify or the inclusion/exclusion of which is debatable :
(i) should improvements (as opposed to maintenance) be included in the calculation?
(ii) for the "rent" calculation, what is your alternative investment?
(iii) will the alternative investment be geared?
(iv) what is your risk tolerance?
(v) how much value do you place on the feel good factor of owning your own home?
(vi) how confident are you with your estimates?
(vii) how disciplined a saver are you?
The last point is an interesting one. Concluding that you are better off renting is often justified on the grounds that the money that would otherwise be spent on a deposit, mortgage payments, outgoings etc would be invested in assets that show an expected return higher than the rate of appreciation of the property. This is fine if you actually make those investments. However, if you lack the discipline to do so, all you have done is give yourself an excuse to spend money that you would otherwise be forced to save through the principal component of your mortgage payments.
As a final point, even when I am looking at residential properties for investment purposes, I find it useful to put myself in the position of a potential home owner and consider whether that hypothetical home owner would be better off buying or renting the property I am looking at. I find it helps me to decide if the property is a good investment or not.
1. focusing on selective statistics: a common example is the fact that home owners have, on average, considerably higher net worth than non-home owners. While superficially appealing, this is not a meaningful comparison. It would be more useful to compare home owners and non-owners of similar age and income groupings and possibly further broken down to account for other factors (such as children);
2. claiming that there is one single factor which is a decisive determinant: as an example it is sometimes claimed that the ability to leverage gives property ownership a decisive advantage;
3. making misleading comparisons: a common example is comparing the average house price at some point in the past with the average house price now. Even if the numbers used are specific to the local real estate market, the comparison is still flawed because (i) the average house has often changed during the time period under consideration (in many places they are bigger and have more facilities), (ii) this often ignores costs necessary to maintain the house's condition and (iii) very few houses are "average" or appreciate at the "average" rate;
4. using arbitrary, unrealistic, overstated or understated numbers: an example is long term maintenance and optional improvements. Advocates of home ownership often ignore or understate these while advocates of renting often overstate them;
5. ignoring relevant costs or benefits: advocates of property ownership often ignore the costs of long term maintenance. Likewise, advocates of renting often ignore the more favourable tax treatment given to owner occupied homes compared to many other investments. I have even seen examples which ignore the cost of renting;
6. making illogical or emotional claims: a common example is that a home is a liability or an expense. The former is nonsense (in almost all cases). The latter is true but then all assets are, from an accounting perspective, simply long term expenses which renders the claim irrelevant and misleading. The question is not whether a house is an expense but which or two alternative expenditures is the best way of meeting your accommodation needs.
My own view is that there is no universally correct answer to this question and the best approach is to prepare a detailed spreadsheet comparing the choices on a case by case basis. It is obviously important that the spreadsheet be as comprehensive as possible and reflect all relevant values (of which there are many). My experience is that the analysis is dependent on assumptions or estimates of the following factors:
A. duration: how long a time period you are looking at
B. return: what returns you expect to get on both the property (appreciation) and the alternative (equities, cash etc)
C. rent: what rental you expect to pay
D. interest rates: the interest rates you pay on your mortgage
E. outgoings: what outgoings you expect to pay (including long term maintenance, insurance)
F. transaction costs: commissions, stamp duty, lawyers etc
G. taxes: the impact of taxes on the numbers you come up with
H. will home ownership help or harm your asset diversification
I. the level of gearing you will use for both the house and the alternative investment
One other thing I have learnt through experience is that looking at hypothetical numbers is not that useful. It is important to look at an actual property and to use the numbers for the actual alternative investment that you would make if you rented (as opposed to some theoretical investment).
Given the number of variables, most of which involve making guesses about the distant future, the analysis is very often no better than an educated guess. However, my view is that it is still better to do the analysis than not. Sometimes the results can be surprising. When we brought our first Hong Kong property in 2001, the market was very depressed following the Asian crisis. My very rough calculations at the time showed that buying was better than renting even if I assumed a small annual decrease in the value of the property. I took that as a very strong "buy" signal.
There are also some factors which are harder to quantify or the inclusion/exclusion of which is debatable :
(i) should improvements (as opposed to maintenance) be included in the calculation?
(ii) for the "rent" calculation, what is your alternative investment?
(iii) will the alternative investment be geared?
(iv) what is your risk tolerance?
(v) how much value do you place on the feel good factor of owning your own home?
(vi) how confident are you with your estimates?
(vii) how disciplined a saver are you?
The last point is an interesting one. Concluding that you are better off renting is often justified on the grounds that the money that would otherwise be spent on a deposit, mortgage payments, outgoings etc would be invested in assets that show an expected return higher than the rate of appreciation of the property. This is fine if you actually make those investments. However, if you lack the discipline to do so, all you have done is give yourself an excuse to spend money that you would otherwise be forced to save through the principal component of your mortgage payments.
As a final point, even when I am looking at residential properties for investment purposes, I find it useful to put myself in the position of a potential home owner and consider whether that hypothetical home owner would be better off buying or renting the property I am looking at. I find it helps me to decide if the property is a good investment or not.
Tuesday, March 13, 2007
Asset Allocation - A Random Thought
On the subject of asset allocation I have been wondering if the text book approach of using asset allocation as a tool to manage risk and improve returns without considering the circumstances of the individual is best or whether my asset allocation should reflect (at least in part) my personal retirement plans.
As an example, our retirement plans include a reasonable amount of travel. Europe is certainly one place we would like to visit more often. The problem is that Western Europe is very expensive. Meals, hotels and the like cost a lot more than we would pay for a holiday in Asia or many other places.
In order to hedge against the cost of travel to Europe, I am considering ensuring that an adequate portion of our retirement income is derived from assets denominated in euros or pounds. There have been a few occasions when I have considered buying a property in London but have been deterred by the difficulties in managing a property in another jurisdiction (I have enough problems managing back home where I can rely on relatives to help out if need be) and limited knowledge of the local market. If I rule out direct investment in UK or European property, I am left with allocating a portion of my equity investments to dividend paying European equities. At least some of these dividends would be spent on our European travels.
Similar considerations apply to some other parts of the world that we would like to spend more time in.
This approach to asset allocation is different from the text book approach which focuses on allocation solely for the purposes of reducing risk and increasing returns in a portfolio that exists independently of the circumstances of the individual. Quiet frankly, I am not sure if it matters too much since I would inevitably include equities from a number of countries in my portfolio anyway. However, it did strike me as an interesting question.
As an example, our retirement plans include a reasonable amount of travel. Europe is certainly one place we would like to visit more often. The problem is that Western Europe is very expensive. Meals, hotels and the like cost a lot more than we would pay for a holiday in Asia or many other places.
In order to hedge against the cost of travel to Europe, I am considering ensuring that an adequate portion of our retirement income is derived from assets denominated in euros or pounds. There have been a few occasions when I have considered buying a property in London but have been deterred by the difficulties in managing a property in another jurisdiction (I have enough problems managing back home where I can rely on relatives to help out if need be) and limited knowledge of the local market. If I rule out direct investment in UK or European property, I am left with allocating a portion of my equity investments to dividend paying European equities. At least some of these dividends would be spent on our European travels.
Similar considerations apply to some other parts of the world that we would like to spend more time in.
This approach to asset allocation is different from the text book approach which focuses on allocation solely for the purposes of reducing risk and increasing returns in a portfolio that exists independently of the circumstances of the individual. Quiet frankly, I am not sure if it matters too much since I would inevitably include equities from a number of countries in my portfolio anyway. However, it did strike me as an interesting question.
Mortgages To Remain Cheap and Plentiful
Mortgage loans against residential property are both readily available and cheap. With the possible exception of the sub-prime market, I expect this to continue. There are several reasons for this - most of which are risk related:
1. mortgage loans are secured over a tangible asset. Even if the asset declines in value, there is usually enough equity to protect the lender's position (or at least most of it);
2. historically, individual borrowers have shown low default rates on home loans and, where there is a default, the loss to the lender is very low compared to other types of defaulting loans;
3. transaction costs are low. Residential loan and mortgage documents are much more standardised and less negotiated than almost any other types of loan. Transaction size (compared to credit cards and other personal loans) also provides for some economies of scale for lenders;
4. mortgage loans can be securitised which removes them from the balance sheet (freeing up capital) and, depending on the terms of the securitisation, may also remove the default risk from the lender;
5. under Basel I, residential mortgage loans receive a very favourable risk weighting (50%) which means that banks have to provide relatively less capital against residential mortgage loans than against, for example, commercial loans. Under Basel II the risk weighting for residential mortgage loans will be reduced (to 35%) reducing the amount of capital required to support residential mortgage loans and making them even more attractive to banks.
In summary, there are good reasons why residential mortgage loans are both readily available and cheap. With banks already beginning to move to Basel II there is reason to believe that this situation will continue for lending which involves sensible financials (at least some deposit and reasonable debt servicing ability). In Hong Kong the excess liquidity means that many banks have surplus capital. This has resulted in intense competition between banks both for market share and volume in absolute terms. The cost of borrowing and the terms have become progressively more favourable to borrowers like me over the last few years.
The above comments are directed at conforming or typical loans made to a borrower who is able to document the ability to service the loan and who is able to put down a meaningful deposit. The emerging problems with America's sub-prime lending market make me more hesitant to express a view on the sub-prime or non-conforming section of the mortgage market.
1. mortgage loans are secured over a tangible asset. Even if the asset declines in value, there is usually enough equity to protect the lender's position (or at least most of it);
2. historically, individual borrowers have shown low default rates on home loans and, where there is a default, the loss to the lender is very low compared to other types of defaulting loans;
3. transaction costs are low. Residential loan and mortgage documents are much more standardised and less negotiated than almost any other types of loan. Transaction size (compared to credit cards and other personal loans) also provides for some economies of scale for lenders;
4. mortgage loans can be securitised which removes them from the balance sheet (freeing up capital) and, depending on the terms of the securitisation, may also remove the default risk from the lender;
5. under Basel I, residential mortgage loans receive a very favourable risk weighting (50%) which means that banks have to provide relatively less capital against residential mortgage loans than against, for example, commercial loans. Under Basel II the risk weighting for residential mortgage loans will be reduced (to 35%) reducing the amount of capital required to support residential mortgage loans and making them even more attractive to banks.
In summary, there are good reasons why residential mortgage loans are both readily available and cheap. With banks already beginning to move to Basel II there is reason to believe that this situation will continue for lending which involves sensible financials (at least some deposit and reasonable debt servicing ability). In Hong Kong the excess liquidity means that many banks have surplus capital. This has resulted in intense competition between banks both for market share and volume in absolute terms. The cost of borrowing and the terms have become progressively more favourable to borrowers like me over the last few years.
The above comments are directed at conforming or typical loans made to a borrower who is able to document the ability to service the loan and who is able to put down a meaningful deposit. The emerging problems with America's sub-prime lending market make me more hesitant to express a view on the sub-prime or non-conforming section of the mortgage market.
Monday, March 12, 2007
Retirement Plan Reviewed
My retirement plan was written in late 2005 and is over due for a review which I did over the weekend. Here are my notes:
1. no draw down: the "no draw down" financial model remains the basis for my plan. Simply put, given the very long period for which our retirement savings must last (50 years) and fears about inflation, I consider relying on draw down of principal to fund retirement too risky;
2. asset allocation: I had considered a more or less equal mix of real estate and equities as the best means of providing both recurring income and protection against inflation. While I still favour these two asset classes, I have been educating myself about the benefits of asset allocation and rebalancing and am more open to adding other asset classes (especially bonds and commodities) to the mix;
3. calculating retirement needs: my model divided my retirement needs into five categories: (i) income producing assets for living expenses (ii) lump sums for completing my children's' education (ii) lump sums for anticipated one off events such as my children's' weddings and a one time change of our primary residence (iv) our primary residence and (v) an emergency fund. I see no reason to change this list of retirement needs. However, I do continue to speculate about (a) the amount of money needed in each category and (b) the best place to invest each category. I am still inclined to view the categorisation as a means of working out how much we need in order to retire and then not distinguish between the five categories in my portfolio management;
4. prioritising asset acquisition: I had intended to put the real estate investments in place first to allow time for rental income to pay off most of the mortgages before retirement. My thinking has now shifted and I am more inclined to start building the equity components at the same time. This process started in April 2006 with a mixture of monthly automatic payments supplemented by lump sum investments into various mutual funds;
5. real estate investments: the number of properties we require has changed. Based on original projections, I had expected to need to purchase one more investment property and to upgrade one of the existing properties. As my vacancy rates have been higher than anticipated, I have decided that I should buy two more properties (as well as upgrade one existing property) to provide an additional safety margin. At present all my Hong Kong properties are residential. I am considering making the last two acquisitions small retail shops to better diversify the portfolio;
6. progress: I am on track to retire at 50 (should I chose to do so). Even after adjusting for inflationary increases in anticipated retirement expenses, I require a return on my investments of 6.1% pa over the next nine years to achieve this. This number (obviously) includes a number of significant assumptions. However, I am confident that so long as both my wife and I remain in our current (or similar) employment divergence in the other assumptions (inflation, exchange rates, yields, tax rates, lifestyle, location) should not have a material impact on timing.
In summary, progress towards the goal of retiring at 50 is going well. The changes to the plan mentioned above are relatively minor and should not effect timing.
1. no draw down: the "no draw down" financial model remains the basis for my plan. Simply put, given the very long period for which our retirement savings must last (50 years) and fears about inflation, I consider relying on draw down of principal to fund retirement too risky;
2. asset allocation: I had considered a more or less equal mix of real estate and equities as the best means of providing both recurring income and protection against inflation. While I still favour these two asset classes, I have been educating myself about the benefits of asset allocation and rebalancing and am more open to adding other asset classes (especially bonds and commodities) to the mix;
3. calculating retirement needs: my model divided my retirement needs into five categories: (i) income producing assets for living expenses (ii) lump sums for completing my children's' education (ii) lump sums for anticipated one off events such as my children's' weddings and a one time change of our primary residence (iv) our primary residence and (v) an emergency fund. I see no reason to change this list of retirement needs. However, I do continue to speculate about (a) the amount of money needed in each category and (b) the best place to invest each category. I am still inclined to view the categorisation as a means of working out how much we need in order to retire and then not distinguish between the five categories in my portfolio management;
4. prioritising asset acquisition: I had intended to put the real estate investments in place first to allow time for rental income to pay off most of the mortgages before retirement. My thinking has now shifted and I am more inclined to start building the equity components at the same time. This process started in April 2006 with a mixture of monthly automatic payments supplemented by lump sum investments into various mutual funds;
5. real estate investments: the number of properties we require has changed. Based on original projections, I had expected to need to purchase one more investment property and to upgrade one of the existing properties. As my vacancy rates have been higher than anticipated, I have decided that I should buy two more properties (as well as upgrade one existing property) to provide an additional safety margin. At present all my Hong Kong properties are residential. I am considering making the last two acquisitions small retail shops to better diversify the portfolio;
6. progress: I am on track to retire at 50 (should I chose to do so). Even after adjusting for inflationary increases in anticipated retirement expenses, I require a return on my investments of 6.1% pa over the next nine years to achieve this. This number (obviously) includes a number of significant assumptions. However, I am confident that so long as both my wife and I remain in our current (or similar) employment divergence in the other assumptions (inflation, exchange rates, yields, tax rates, lifestyle, location) should not have a material impact on timing.
In summary, progress towards the goal of retiring at 50 is going well. The changes to the plan mentioned above are relatively minor and should not effect timing.
Friday, March 09, 2007
Housing Supply To Remain Limited
The latest figures from the Hong Kong Government show that the supply of new housing will remain at levels below the expected take up rate for 2007, 2008 and 2009. The existing stock of unsold units (either completed or under construction) is expected to decline slowly over this period. This is not unexpected but, the confirmation combined with the cut in stamp duty for properties under HK$2 million, tax rebates for the middle class, planned extensions of the MTR line (even if six years away) and the return of negative real interest rates on deposits should help to underpin the market in the medium term.
Wednesday, March 07, 2007
Wishing I Had More Cash
I am not a fan of cash and bank deposits as a form of investment. The returns are poor - in fact right now bank deposits show very low or even negative real interest rates which makes them a losing investment. I even take this to extremes and do not have a planned emergency fund.
However not holding a lot of cash has two problems:
1. opportunity cost: when opportunities arise, you need to means to exploit them. If markets continue downwards I may end up wishing I had more cash to buy investments cheaply;
2. exposure to market risk: a no (or low) cash position means that I am fully invested. This means I am fully exposed to market fluctuations. Most of the time this is a good thing as markets tend to trend upwards over time. However, there are times when the markets go down and being fully invested is, in the short term at least, painful.
I know I can't expect to time the market with any degree of accuracy, so have no plans to change my approach. The above represents nothing more than a wish to have my cake and eat it too.
However not holding a lot of cash has two problems:
1. opportunity cost: when opportunities arise, you need to means to exploit them. If markets continue downwards I may end up wishing I had more cash to buy investments cheaply;
2. exposure to market risk: a no (or low) cash position means that I am fully invested. This means I am fully exposed to market fluctuations. Most of the time this is a good thing as markets tend to trend upwards over time. However, there are times when the markets go down and being fully invested is, in the short term at least, painful.
I know I can't expect to time the market with any degree of accuracy, so have no plans to change my approach. The above represents nothing more than a wish to have my cake and eat it too.
New Computer
After a certain amount of running around, I was told that the problem was the motherboard and that I would have to go back to Dell to get it replaced. The cost (parts and labour) to replace was close to half the cost of a new pc with higher specs (not needed but potentially useful for the future), Vista (not needed) and a three year warranty (needed). After finding a taker for the old computer I decided to buy the new one. Not the most economical in terms of immediate cash outlay but hopefully the right decision in terms of trouble free computing.
Sunday, March 04, 2007
Hong Kong Marathon
Nothing to do with personal finance, but I managed to waddle my way around the Hong Kong marathon today.
Warm weather (21-25 degrees C) and high humidity (up to 95%) combined with a woefully inadequate training regime to produce a very very slow personal worst. In spite of it being one of the most painful and unpleasant experiences I have had for a long time I am glad that I did it - just finishing carries with it a sense of acheivement. I will do another one - but only if I have properly trained.
Warm weather (21-25 degrees C) and high humidity (up to 95%) combined with a woefully inadequate training regime to produce a very very slow personal worst. In spite of it being one of the most painful and unpleasant experiences I have had for a long time I am glad that I did it - just finishing carries with it a sense of acheivement. I will do another one - but only if I have properly trained.
Saturday, March 03, 2007
Election Bribes But No Election
In democracies it is traditional for the incumbent political party to offer the electorate bribes in the form of extra spending or (less frequently) tax reductions before an election.
Although Hong Kong's election for the next chief executive is a matter of weeks away, it is not an election in the true sense of the word. Only a handful of people get to "vote" and Donald Tsang's re-election is a certainty.
None the less, the financial secretary delivered a budget containing many election bribes. With a strong economy and a huge surplus, there was plenty of financial room to move. Most of the bribes were directed either to the lower classes (appropriate) or the construction or film industries (completely inappropriate and unnecessary) and the middle class (appropriate). As someone on a reasonably high income, I had hoped for a cut in the standard tax rate which did not happen. What I did get was:
1. a one time tax rebate capped at HK$15,000 per person;
2. waiver of rates and government rent on properties for two quarters (capped at HK$5,000 per property per quarter);
3. a cut in the wine duty from 80% to 40%. With impeccable timing, I had just taken advantage of a sale to top up the wine fridge. This will drop the cost of a bottle of wine by about 25% according to one retailer.
From my perspective, these are nice to have but in total quite trivial.
Although Hong Kong's election for the next chief executive is a matter of weeks away, it is not an election in the true sense of the word. Only a handful of people get to "vote" and Donald Tsang's re-election is a certainty.
None the less, the financial secretary delivered a budget containing many election bribes. With a strong economy and a huge surplus, there was plenty of financial room to move. Most of the bribes were directed either to the lower classes (appropriate) or the construction or film industries (completely inappropriate and unnecessary) and the middle class (appropriate). As someone on a reasonably high income, I had hoped for a cut in the standard tax rate which did not happen. What I did get was:
1. a one time tax rebate capped at HK$15,000 per person;
2. waiver of rates and government rent on properties for two quarters (capped at HK$5,000 per property per quarter);
3. a cut in the wine duty from 80% to 40%. With impeccable timing, I had just taken advantage of a sale to top up the wine fridge. This will drop the cost of a bottle of wine by about 25% according to one retailer.
From my perspective, these are nice to have but in total quite trivial.
Subscribe to:
Posts (Atom)