Second homes - a bad idea?

With the current economic conditions there have been several stories about people being forced to sell (or attempt to sell) their second homes. While a second home has its attractions from a lifestyle perspective, and may provide a sense of well being etc, from a financial standpoint they are a poor way of allocating capital.

I ran a spreadsheet comparing the cost of owning and maintaining a second home against the equivalent amount of money invested in long term bonds and renting serviced apartments when needed. The result is at least partly dependant on what property you are looking at and how frequently it will be used, but based on the particular example I considered, the bond portfolio was a clear winner.

With the ownership option, there is the purchase price, the costs of acquisition and the cost of furnishing the property. I assumed that I would not have to redecorate or do any repairs. On an on-going basis I would have to pay rates (property taxes), body corporate fees and routine maintenance and would have to pay someone to visit periodically to air it out etc. Longer terms, it would need repainting and more substantial maintenance which was ignored for the purpose of my comparison.

With the the serviced apartment option, there is no immediate cost - I would buy a portfolio of bonds (or bond funds) and collect the interest payments. I would pay for the use of the serviced apartment as and when I use it. I assumed three months a year of usage (which is the longest time I can spend in the country without triggering a possible tax residency). Shorter periods of usage would make this option even more favourable.

If I could assume that the numbers would remain static for as long as I wished the arrangement to continue, the serviced apartment option would be a clear winner. In fact the cost of renting the serviced apartment would only be about 20% higher than the annual short term expenses of owing the second home. Put differently, I would have to allocate 3.6 times as much capital to owing a second home than I would need to invest in bonds to pay for the serviced apartment.

Unfortunately, the numbers will never be static. Inflation will play a role. It will increase the costs of renting the serviced apartment, increase the costs of owning the second home and increase the value of the second home. There is also roll over and reinvestment risk on the bonds. However, if I use the property for three months a year, I would have to experience long term inflation of more than 3.6% pa before owning a second home becomes the better choice. Even then, this ignores longer term maintenance issues and the likelihood of using the property for less than the full three months each year.

For completeness, I did not consider renting out the second home for short term periods when I am not using it. If it is my home, I would not want other people living there. However, if I did rent it out for part of the year, this would obviously reduce the cost of owning a second home. I also ignored factors such as the greater flexibility and possible non-availability of the serviced apartment option and the ability to take out a mortgage against the second home or simply convert it into a rental property.

In conclusion, a second home only makes sense from a financial perspective in a high inflation environment. In a low inflation environment, investing in bonds and renting serviced apartments as and when needed is the better choice.

The anecdotal recession (1)

Even without the media coverage, it is easy to see evidence of an economic downturn. Day to day observations can give a pretty good indication of the state of the economy. Here are some examples:

1. shipping volumes: our home has a partial view of the shipping channel into the Hong Kong container terminal. The number of empty or only partially loaded ships is very noticeable. This is a good indication that trade volumes are down;

2. taxi queues: the length of the queue for a taxi during peak hours has fallen to insignificance over the last 12 months or so. Given that a large number of the people in the queue are either directly or indirectly working in the financial industry, this is a pretty fair reflection of the state of the banking and finance industries;

3. vacant shops: we are just beginning to see more shops become vacant. One assumes that retail sales have fallen;

4. restaurant bookings: in better times, lunches at popular restaurants required a booking two weeks in advance. I can now get same day reservations and there will be plenty of empty tables making the reservation unnecessary.

None of 2, 3 or 4 have reached the state of affairs that prevailed during SARS at the end of the Asian crisis. The most noticeable difference is the shipping volumes which remained robust during the Asian crisis. This reflects the fact that this time it is different - the whole world is facing economic problems - not just Asia.

The trick is to identify the things which will indicate that the economy has turned. Some of these indicators will be evident before the economic data reflect a recovery.

Valentine's Day - annual romance killer

Tomorrow is Valentine's day - that day of the year when florists, restaurateurs and others do their utmost to kill romance with inflated prices, tacky advertisements and poor value pre-packaged services.

I had hopes that one of the fringe benefits of the economic recession would be a reduction of the extent of the price gouging. Sadly, those hopes have not been realised. The cost of a dozen roses actually went up this year and restaurants still insist on offering "specials" comprising over priced meals that offer limited choices on food and very ordinary wine at prices that would embarrass a hedge fund manager.

As usual, I have succumbed to the pressure to deplete the bank account for the flowers (in spite of mrs traineeinvestor's request not to waste money) but will boycott the restaurants and cook a candle lit dinner for two at home with an only somewhat overpriced bottle of very good wine.