Monday, April 30, 2007

Monthly Review - April

My net worth increased by 2.6% in April.

The year to date increase is 12.3%.

Once again, I was slightly surprised to see that my investments showed a net increase in local currency (which was further boosted by a slight weakening of the US$). Here's the breakdown:

1. my holdings of funds were mixed. Vietnam continues to disappoint while the rest were a mixed group. Overall there was a small net increase before currency adjustments and a slightly larger one after currency conversion. My Thai fund (purchased a matter of weeks before the coup) is finally back into positive territory;

2. my investment in silver went up and went down to end about where it started;

3. my direct holdings of equities were mixed and ended up about square before currency movements and slightly ahead after currency movements;

4. my properties generated net income (rents were higher than expenses). With having 100% occupancy for the first time since the third quarter of 2006 and the Hong Kong government giving a waiver on rates for the first two quarters, the cash flow is well above the level of the expenses and this was a meaningful contribution to the month's result;

5. my savings for this month were good although my income (which fluctuates from month to month) was towards the lower end of the typical monthly range and we had some unexpected medical expenses (treated as an expense for now but which will be recovered through insurance in a couple of months).

The only movements in investments this month were:

A. regular monthly contributions to Asian and European smaller companies funds;

B. sweeping up miscellaneous cash that his built up in certain bank accounts and applying it to (i) a very small addition to my position in silver and (ii) a small partial repayment of an overseas mortgage. I am quite pleased that I am now in the habit of monitoring these cash balances and utilising them instead of letting them sit in unproductive low or no interest bank accounts for prolonged periods.

So far 2007 is shaping up to be a great year financially. However, I am not satisfied with my asset allocation decisions on my funds/equities - a subject for another post.

Saturday, April 28, 2007

Investments are better than repayments

Yahoo Finance carried this interesting article comparing making early repayments on a home mortgage against investing the money that would otherwise be spent on those early repayments.

The study on which the article was based concluded that more than 40% of people faced with this issue would be better off putting the additional savings into treasury bonds/mortgage backed securities. For the reasons identified in the article, the 40% number is almost certain low - very low. The time frame for the comparison was 25 years and was based on a number of assumptions on matters such as tax rates, interest rates and the return on the fixed interest securities. While the analysis is obviously dependent on what inputs are used for the financial modeling, the conclusion seems pretty clear to me: if the interest rate on the mortgage is below the long term rate of return (after adjusting for taxes) and your time horizon is long enough, you are better off directing savings to investments and not making early payments on your mortgage.

This is essentially the same conclusion that I wrote about back in February in this series of posts on the returns , the risks and my rather conservative strategy in making additional investments in preference to additional mortgage repayments.

Personally, I prefer equities or real estate to bonds for this purpose as the expected return gap is larger. Obviously circumstances such as tax rates (current and future)and risk appetite are highly relevant. In my own case, while I am happy not to make additional investment in preference to early repayments, I have not taken the logic to its ultimate conclusion and gone for interest only loans.

An unsolicited offer (3)

As an update, our counter offer has been ignored. There has been no response from the person who made the unsolicited approach so I am now assuming that the matter is at an end.

The home as a retirement asset (3)

In the final instalment in this series I consider the role of the home in a retirement plan. The answers to the two previous questions were very clear (your home is an asset and is part of the calculation of net worth). This one is slightly harder and a lot will depend on factors such as personal circumstances, your personal retirement plan and your expectations about future house prices and rental levels.

Starting with the basics:

1. your house represents a store of wealth. As such it can be utilised to help fund retirement. For people who are poor savers, it may end up being their only significant asset;

2. you have to live somewhere. Unless you want to take environmentally friendly living to its logical extreme and sleep on the streets, your choices are to own or to rent your accommodation. In terms of cash flow owners have to pay various outgoings and maintenance while renters have to pay rent;

3. owning your own home usually has a feel good factor that is difficult to quantify but may well become more significant as people get older. Owning your own home (without a mortgage) gives people a lot of peace of mind.

Focusing on #1 as being the most significant factor, if you start to run out of money in your retirement, the value in your home can be utilised in a number of ways:

A. you can sell it (either outright or as a trade down). Sure, you still have to live somewhere but selling the home should be able to fund several extra years of living expenses. Alternatively, the proceeds from the sale of a home could be used to fund a move to an assisted living community or a nursing home (both or which are very expensive and likely to become more so);

B. you can raise money against it. For retirees this is typically a reverse mortgage which means you get to continue to live in the home for life. The financing costs may be expensive but it is an additional source of money to get you through your retirement years.

My own approach to look to the value of our home as a form of insurance policy. It is not intended to be a primary source of retirement funding but is a store of wealth which can be utilised as an alternative to eating cat food should things go wrong.

As a final point, I do not advocate reliance on the home as a means of funding retirement (other than as a source of a lump sum move to assisted living or a retirement home). Rather, I prefer to recognise the fact that the home has value which can be realised should the primary retirement plan run into difficulties.

Friday, April 27, 2007

Your home as a retirement asset (2)

The second post in this series explains why your home should be included in your calculation of net worth. The case can best be illustrated with an example. Consider the following two people:

Person A: this person has no assets and no liabilities. Net worth is zero.

Person B: this person has no assets and no liabilities other than owning outright the family home.

In all other relevant respects the two people are identical.

Those who argue that the home should not be included as part of your net worth would conclude that the net worth of Person A is the same as Person B - which is absurd. (Those who argue that the home is a liability would reach an even more absurd conclusion.) The home has value and that value can be realised. Another way of looking at the question is to consider what you are trying to measure. If you are trying to determine your overall financial position, then your home is clearly part of that calculation and must be included in order to obtain a valid determination of your position. If you are trying to evaluate some sub-set of your assets (e.g. retirement accounts) then it may be valid to exclude your home but in doing so you are not determining your overall net worth - only the value of the chosen sub-set of assets.

A few other miscellaneous points on this issue:

1. wealth surveys often look at "investable assets" or similar concepts and exclude the home from their calculations. The reasons for this approach is often that the surveys are done by institutions who want to sell financial products and services to high net worth individuals (HNWIs). From the institutions' perspective, the home is largely irrelevant as it will seldom (if ever) be available as an investment and is therefore not relevant to the purpose of the survey. Put differently, what these surveys measure is not net worth but a particular sub-set of the assets that comprise the HNWIs net worth;

2. if you want to borrow money, the lenders will look at your net worth and will take the value of your home into consideration in deciding whether or not to grant a loan and, also, in deciding the terms of the loan. Even the fact that you own rather than rent is a positive factor in some lenders' evaluation of your risk profile. From the lender's perspective the home clearly is one of your assets and is highly relevant to the bank's assessment of your credit worthiness;

3. statistically home owners are wealthier than non-owners - much wealthier. The reasons for this are debatable but the correlation is a strong one. One of the reasons may be that owning a home requires a degree of financial discipline both to accumulate a deposit and to pay off the mortgage (many sub-prime lenders and borrowers would have done well to think about this).
For those who lack the financial discipline to save regularly, the requirements of servicing a mortgage is a form of forced saving.

As a final note: while I maintain that the home is an asset and is part of your net worth determination, I have not got into the issue of whether or not it is a good or a bad investment. That is another issue and a much harder one to evaluate.

Next up: the role of the home in retirement planning.

Thursday, April 26, 2007

The home as a retirement asset (1)

There have been several articles written about whether or not your home is an asset or a liability. As an example: Lazy Man and Money has a good article on the subject (the comments also make a good read). As follow on questions, even some of those who advocate that it is an asset claim that it should not be taken into consideration in determining net worth or when planning for retirement.

My view is that not only is your home an asset but it also should be taken into account in net worth calculations and for the purposes of retirement planning. I will address each of these three points in separate posts.

Your home is an asset

Your home is an asset. Unless it is being used as a dumping ground for toxic waste, it has value and that value can be realised. Realisation can be achieved through one of three means:

1. sale (including a partial sale of land if it is situated on a section large enough to sub-divide);

2. as security for the raising for finance (and for most of us a loan secured against an owner occupied home will be the cheapest finance available);

3. generating rental income (either by renting out spare rooms or by moving out and then treating it as an investment property).

Your home is not a liability

The arguments for claiming that your home is a liability are typically based on the liability associated with a mortgage or negative cash flows (mortgage payments, rates etc) or claims that a home is a bad investment. Taking each of these points in turn:

A. the fact that most people will borrow money and secure the debt against the home does not turn the asset (your home) into a liability. The asset (home) and liability (debt) are two separate things. If the claim was valid, it would also follow that any asset which is purchased using debt finance is a liability, which simply cannot be true. Consider an investment property or the purchase of shares on margin as examples;

B, the fact that your home generates negative cash flow does not make it a liability. Many assets produce negative cash flows either during the early stages of their economic lives or until such time as they are realised. As examples, consider a property development, an oil and gas lease, a forestry plantation and a wine collection;

C. the fact that it may be a bad investment (a very debatable point) does not turn an asset into a liability. Almost all investments have the potential to produce either undesirably low or negative returns. If this happens it just means that the asset is a poor one for investment purposes. It does not make the asset a liability. Consider a share that depreciates in value or a negatively geared investment property as examples.

In summary, I see no basis for claiming that a home is a liability. Next up: whether your home should be included in your calculation of net worth.

Wednesday, April 25, 2007

An unsolicited offer (2)

I have done some further thinking regarding the unsolicited offer and looked at a few other properties in the same area (Mid Levels). The conclusions are as follows:

1. the yield on purchase price is attractive (it is higher than the cost of funds);

2. the yield on the offer price is still attractive (at or just slightly below the cost of funds);

3. properties in that area which show better yields are few and far between and usually have major problems with them (e.g. very old buildings or low floors right next to a noisy road). Finding a replacement value proposition in the same price range will not be easy. Most likely we would end up buying something more expensive (which in the longer term we may want to do anyway);

4. the location (close to the escalator) means that it should always be easy to rent;

5. we have no need of cash at the moment;

6. the price offered is right on the bank valuation. Looking at recent sales I think the property is worth more than this. However, the recent comparative sales are for very low floors and there are only two of them meaning that it is hard to be too confident about the market value;

7. my previous thoughts on the difficulty in adding value to the property remain. In the longer term we may wish to sell and reinvest in a better quality property in the same area, but as we are currently looking for another investment property anyway, there is no need to sell this flat now.

I have concluded that the offer is not attractive. I have nominated a price which is slightly above my assessment of the current value. If someone wants to pay the nominated price, that is fine with me. If not, I will keep the property.

Thursday, April 19, 2007

An unsolicited offer (1)

We have received an unsolicited offer for one of our Hong Kong properties. While we usually purchase with the intention of retaining properties for long term income, we recognise that there will be properties which, for one reason or another, should be sold.


While the property's location should make it an easy property to keep rented, we see limited upside - some of the expectations that contributed to our decision to buy this property have not eventuated and the ability to add value is questionable. We also see better opportunities elsewhere. As there is a sitting tenant who has paid the rent on time every month without fail and has never called us with maintenance requests, we are under no pressure to sell or even to make a decision: it's easy to procrastinate when the cash flow is positive and is expected to modestly increase when the current lease expires at the end of this year.


With an offer on the table, we need to reach a conclusion.

Our choices are:

1. keep the property and defer making a decision until the existing lease expires at the end of 2007. Options then would include (i) negotiating a higher rent with the existing tenant (ii) selling vacant as is or (iii) doing a substantial redecoration and then either renting or selling; or

2. accept the offer. Our annualised IRR would be 11.95%. The IRR calculation (done using a somewhat crude spread sheet) takes into account all revenues, costs and expenses and is based on the negotiated price being at the price offered by the potential purchaser. It is pre-tax (although only the rent is subject to tax). This is acceptable if unspectacular.

We could market the property now, but (i) selling tenanted residential properties is harder than selling vacant ones and (ii) the time taken to market may be longer than the purchaser is willing to wait.

(Provisional) conclusion

Current thinking is to try and negotiate a better price and then to accept the offer. However, we need to do more research on (i) comparable sales and (ii) alternative investments before calling it a definitive conclusion. While the sale prices can be obtained easily enough that information needs to be supplemented by additional information such as (i) interior fit out and (ii) outlook. We have some ideas for alternative property investments, but need to to some more homework before committing to them.

Of course, the other factor is that the "offer" is an oral expression of interest. Unless and until it is put to us in writing it is not an offer at all.