Monday, December 31, 2007

Negative Real Interest Rates

Among the week's worth of mail that was waiting for us when we returned from our Christmas holiday were notices of changes in interest rates on two of our mortgages. The new rates are 3.95% and 4.00%. Given that these are all tax deductible (at an admittedly low rate), this means that the cost of borrowing is very close to the most recent official inflation rate of 3.4%. In effect, the real cost of borrowing money in Hong Kong is approaching zero.

Looking at the issue from a different perspective, if you put money on deposit the interest rates at most banks will range from zero (for small amounts on call) to close to 3% (for large (HK$1.0 million +) 12 month deposits). There is no tax on interest in Hong Kong. In effect, putting money on deposit is a losing proposition. Every day that you leave money sitting on deposit, the real value of that deposit is declining by more than the interest that is being earned.

If you believe that the true rate of inflation is higher than the official rate (which it probably is) then the position is even better for borrowers or worse for depositors. There are widespread expectations of further interest rate cuts in 2008. At the same time most of the forecasts for the inflation rate are in the range of 3-3.5% (I have seen at least one forecast for inflation to rise to 5% in 2009). If these forecasts turn out to be accurate, then the real cost of leaving money on deposit will increase and the real cost of borrowing will shift from mildly positive to mildly negative.

The implication is that it is better to be a borrower than a lender/depositor.

Of course there is no such thing as a free lunch. Borrowing money carries risk. Money that is borrowed has to be invested somewhere that will show a better nominal return than the nominal cost of funds. If the investment fails to generate the required return or loses money then material damage to your wealth can result. My own view (and practice) is that it is better to take the risk of borrowing in moderation than accept the certainty of wealth erosion that comes with leaving money on deposit.

When you take the reality of negative real interest rates and add the huge build up of deposits in the Hong Kong banking system, it is hard not to be at least reasonably optimistic about investing in Hong Kong (credit crisis notwithstanding).

Sunday, December 30, 2007

Monthly Review - December

My net worth increased by 1.7% in December. The increase for the year is 35.4%.

The return on my investments was mixed. Spending was low (the Christmas holiday had been expensed back in October). Income was strong, with a small bonus in the Christmas stocking.

Here are the details:

1. my unit trusts declined in value during the month. The declines were most noticeable in the emerging markets funds and represent the continuation of a trend;

2. my residual share portfolio depreciated in local currency returns but benefited from currency movements to end about even for the month. The takeover offer for one of my holdings announced last month did not proceed;

3. my investment in silver appreciated;

4. my tenants continued to pay the rent on time and rents continue to be higher than the expense component of the outgoings. The tenant who was late with her rent has caught up (but annoyingly still refuses to set up an standing instruction). The only negative here is the new flat which is now fully renovated but in need of a tenant (which may take a while in view of the fact that the building will be covered with scaffolding as the exterior renovation is undertaken over the next five months);

5. currency movements were in my favour for the month;

6. expenses were moderately below budget. There were no large items (the family holiday had been expensed in prior months). I reviewed the accruals for future expenses and decided to increase the provision for future tax bills;

7. my income was high. I received a small bonus this month.

The combined effect of the combined effect of the above resulted in a 1.7% increase in net worth at month end. The only investment activities undertaken during the month were regular monthly payments into two small cap investment funds.

A full review for the year will be made in a separate post.

Wednesday, December 12, 2007

Hong Kong Property Market - looking good

The SCMP's Property post carried a very bullish article on the Hong Kong residential property market. Key points to note:

1. new supply for each of the next 3 years is estimated at around 12,000 units (compared to 20-25,000 units a year on average over the last decade);

2. market activity driven by end users rather than speculators (unlike the 1990s boom);

3. rents rising in line with price increases;

4. stock market profits and pay raises are "buoying" home buyers;

5. affordability levels remain in the "comfort zone" of buyers.

Oddly, there was no mention of lower interest rates or liquidity. No negatives were cited.

The experts quoted predicted price rises of 20-30% in 2008 (up to 40% in the luxury sector).

This makes the Hong Kong market look very different from parts of the US market.

Unfortunately, it will be a while before I can put together a deposit for another property.

Sunday, December 09, 2007

Investing in overseas property

Hong Kong has no shortage of real estate developers and agents promoting offers to invest in overseas properties. From time to time when I have nothing better to do I go to one of these exhibitions as a form of entertainment and as a means of learning a little bit about other markets. While there have been occasions when I have been tempted to buy, I have never done so. My reasoning is essentially:

1. it costs a lot more to market a property in an overseas market. Someone has to pick up that extra cost, and it usually ends up being the buyer;

2. if the developer could sell the property at the same price in the local market, why would they bother marketing it in Hong Kong? The short answer is that they increase the price when selling overseas properties to Hong Kong based buyers. I usually don't bother, but on one occasion I asked a friend who was living in the city where a development was being built (Melbourne) to check the prices being offered to local buyers. The prices being offered to Hong Kong buyers were typically 3-5% higher than the prices being offered to local buyers (if I recall correctly). On another occasion, I was with a friend who already owned property in the relevant city (London) who told me that what was being offered to Hong Kong buyers was "far too expensive" for the location and type of property;

3. as a foreigner you are more vulnerable to other types of scams and your own ignorance than local buyers.

If I want to invest in an overseas market, I would favour going there in person and doing a lot of research first. Even then, while investing in other cities can be profitable and can help to diversify a portfolio, managing properties long distance can be challenging and will definitely involve more hassle than investing locally. As a single example, you will have to familiarise yourself with a new set of tax laws.

The only overseas properties I own are in a city which I (i) know very well having lived there for a number of years and (ii) have relatives living who can help out if necessary. I have been tempted to invest in other cities (London, Shanghai and Bangkok (during the Asian crisis)), but have never quite managed to overcome my worries about making a sizable investment in an illiquid asset in a market in which I have significantly less knowledge that either local investors or the vendors.

Saturday, December 08, 2007

Tenant default

One of my tenants failed to pay this month's rent when it was due last week. I have had the agent contact her and she has promised to make the payment on Monday. I have also repeated an earlier request for her to set up a standing instruction (which all my other tenants have done). She declined without giving a reason.

Tenants who fail to pay on time every time are, quite frankly, a pain. Given that I do not want to leave any more money in the non-interest bearing account used to collect rent and make the mortgage payments than absolutely necessary, unreliable tenants force me to keep the float in that account higher than I would like. I now add a clause to my lease agreements requiring tenants to pay by auto pay. While this does not guarantee that a tenant will not default, experience to date shows that auto pay significantly reduces the risk of late or missed payments.

Monday, December 03, 2007

Monthly Review - November

My net worth increased by 1.8% in November (0.6% was due to correcting an error in previous balance sheets).

The year to date increase is 33.1%.

The return on my investments was mildly positive. Spending was low. Income was strong.
Here are the details:

1. my unit trusts declined in value during the month. The declines were most noticeable in the emerging markets funds;

2. my residual share portfolio appreciated (largely due to one of the two largest shares in the portfolio being subject to a takeover offer);

3. my investment in silver was almost unchanged;

4. my tenants continued to pay the rent on time and rents continue to be higher than the expense component of the outgoings. The only negative here is the new flat which is now fully renovated but in need of a tenant (which may take a while in view of the fact that the building will be covered with scaffolding as the exterior renovation is undertaken over the next five months);

6. expenses were moderate. There were no large items;

7. my income was high.

The combined effect of the combined effect of the above resulted in a 1.8% increase in net worth at month end. Currency movements were negligible this month. The only investment activities undertaken during the month were regular monthly payments into two small cap investment funds and a small speculative trade in HSI warrants.Looking ahead to December, I expect a small increase in income, a smaller increase in expenditure (due to the Christmas parties and buying presents) and have no material plans to change any investments.

2007 looks like being a great year for my finances.