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.


Anonymous said...

Hi Trainee,

Slightly off-topic, but I wanted to get your view on asking prices / offering prices for properties in Hong Kong, and how best to assess market value.

I've noticed the asking price for a property can vary substantially. For example my landlord wanted 3.8 M for my appartment, downstairs they'd accept 3.27 M, one floor below the asking price is 3.2 M. 10 floors up it's 3.5 M, and the developer recently sold some properties about 30 floors up for 3.5 M.

Looking at the HSBC site, and asking a few banks, they've valued the property downstairs (asking price 3.27M) at 3.1 M (ICBC), 3.2 M (HSBC) and 3.26 M (BOC) respectively.

So given the low valuations relative to the asking price, I've told the agents I'm not really interested unless the vendor is willing to drop their price further.

But the question I have is, how much further would they have to drop their price to be 'fair'?

I know they bought their property from the developer about 1.5 years ago for 3.35M, so they're selling at a loss. At the same time, many of the places in the Merton have dropped around 200k since they were first sold by the developer.

So how best to value the property? Unfortunately they're arn't many recent sales of this particular flat (flat C), although looking at recent transactions of other flats, they tend to be below HSBC's valuation.

Any ideas or advice on how to come up with a reasonable estimate of market price?


Anonymous said...

And a bit more on topic, I love interest only loans. It's just a shame that you can only get them for 3 years in Hong Kong.

In the US apparently they offer an even better loan where you don't even pay off all of the interest, and the principle grows each year. Now that is gearing!

Personally, with a 7.25% interest rate on my property in Australia, and with a rapidly appreciating Australian Dollar, I find that sending my money back home and into my mortgage offset account is a good default choice if I don't have any interesting investment opportunities at a particular point in time.

For example, the AUD appreciated 14% last year, plus 7% investment, means an after-tax return of 21%, with no risk and complete access to my money if I ever need to redraw it, not bad really.

Of course you can't always count on the AUD to appreciate, but that said I can always use a stash of AUD, even if it is just there to pay off the compulsary payment of my mortgage each month, and having a few years worth of mortgage payments stashed away against a rainy day does give me a good feeling.

traineeinvestor said...

Hi Raphael

With the usual disclaimer that I am not an expert.....just a small investor:

1. the property market is a lot less transparent and liquid than the share market. There can be, and often are, material inefficencies in the market. Asking prices can vary quite significantly even for similar flats.

2. Hong Kong property owners are a very diverse bunch. Many are realisitic about pricing. Some of them are in fantasy land. The example you give of your landlord asking $3.8M when comparables and bank valuations are around $3.2M sounds like a classic example.

3.Market prices relative to bank valuations is a bit of a guessing game. At the moment most of the properties I am looking at are selling at or close to bank valuation. The exceptions tend to be buildings which have just undergone a significant refurbishment of the exterior and common areas where the bank valuations tend to lag the market prices and brand new devlopments where there may be a gap between the prices the developer is getting and prices in the secondary market.

4. The interior condition can make a difference - but not that much. One thing to watch out for is paying for an expensive fit out/redecoration. Even if done to a sensible standard (and I have seen some really silly things) for investment properties an expensive fit out may be a waste of money (depending on what segement of the market you are investing in).

5. As an investor, you have the luxury of being able to be unemotional about your investment. If someone is asking a silly price, don't waste your time. I would start with the property that is being offered at the most reasonable price and see what you can negotiate off the price. As the market is reasonably boyant I would not expect to get much of a discount off an already reasonable asking price. Assuming there is little to chose between the flats you ave mentioned, it sounds like either the one two floors below you ($3.2M) or (if available) the one ten floors up ($3.5 M) would be the better starting points. You may wish to mention the lowest of the bank valuations as a negotiating tactic. Generally developers are pretty inflexible on price but may be willing to offer incentives. a calculation on the rental yield. Even if you are going to live in the property, the number crunching exercise can help you figure out if you are getting a good deal or not.


Anonymous said...

Thanks for the comments.

Funny that you mention rental yield, it seems to be extremely attractive, around 4.8% or so, even if you use the asking price of the property as your guide (which is a good 100-200k above the bank valuation).

So the rental yield is telling me it's a good deal, but I'm still hesitant buying above the bank valuation.

By the way, is it common practice in Hong Kong for vendors/agents to add 5% to the asking price in the expectation of a negotiation?

traineeinvestor said...

Hi Raphael

Yes, it is very common for vendors to ask for more than the market price. Some are willing to negotiate down a bit. Some are very stubborn and will only sell if they get the inflated price that they are asking for. You can end up wasting a lot of time with the latter group of people.

5% is not really a useful measure, as it depends on where they vendor has started the process. For some properties a 5% reduction would be a great deal. For others, the price would still be inflated.