Friday, January 28, 2011

Portfolio review #2 - real estate

Real estate is our biggest asset class. Almost all of the real estate is located in Hong Kong and, baring one small retail shop, it is all residential.

Good returns to date

Hong Kong real estate has been an excellent asset class to hold following the low point in 2003 during SARS. Asset values have appreciated significantly. Rental levels have risen at a more sedate pace but have still outpaced inflation. Returns have been compounded by using leverage - with interest rates having fallen during this period to the currently low levels of less than 1%. To repeat - Hong Kong real estate has been very good to us.

Hong Kong real estate is expensive

But it is now expensive both in absolute and relative terms by most (but not all) measures. We have no present intention to buy more Hong Kong real estate at this time. I do not see value there and, in spite of all the other investments made over the last three years, it is still our biggest asset class (with or without the gearing).

But rents are rising and cash flow is good

That said, I see no need to sell anything either. Rents are rising. Net rents more than cover the outgoings (including mortgage payments) and will do so even if interest rates rise and/or we have the occasional vacancy (as happened in Q4 2010). Over time the mortgages will fall away and we can start using the cash flow for living expenses. By the time the last mortgage is fully repaid, the net rents (on an admittedly aging portfolio) will be fairly close to our total budget for living expenses. Being able to meet living expenses out of cash flow in retirement is a very comfortable position to be in - no pressure to sell assets to make ends meet, much reduced reliance on capital gains and the required cash reserve can be smaller (freeing up more money for productive investments).

A long term inflation hedge

Also important is the fact that the combination of real assets and low cost debt (negative real interest rates) provide a very useful hedge against long term inflation.

Accordingly, I have no wish to sell any of our Hong Kong properties. If prices get seriously out of control I may revisit. I may also consider selling one or two with the intention of buying a better quality property.

Overseas property

In terms of the New Zealand property, the mortgages have been repaid already. While yields are low, the net cash flows will be enough to fund accommodation, car hire and living costs in New Zealand for a month or two each year. To the extent that the rents are not being spent, they are being reinvested (along with dividends from my Australian shares) into more Australian/New Zealand equities.

I generally like property as an asset class. I have spent a small amount of time looking at properties in other markets but keep running into a number of practical and other issues with making such an investment. The biggest issue is that identifying good properties being offered at attractive prices is very difficult without at least a reasonable knowledge of the local market and the time to do a lot of comparison shopping. The road shows being offered in Hong Kong are generally poor places to start looking. Other issues are needing to get on top of a new set of (usually complex) tax laws, the need to appoint an agent who is unlikely to give sufficient care and attention to a foreign owner with a single property to manage and generally being too far away to intervene should the need arise. The financial property centres of New York and London look superficially attractive but, for now at least, I will pass on buying properties in markets that I do not know very well. I would consider buying in Australia or New Zealand but not at this time. The yields are not there, prices are generally expensive and there is better value in the equity markets (where I do not need a mortgage either).


Most likely we will keep what we have, without either selling existing properties or buying additional properties. The combination of cash flow and inflation protection make a good case for continuing to hold long term. Valuations make a compelling case for not buying more property in Hong Kong at this time. The case for buying overseas property is not great but can be looked at.

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