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  1. #121
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    yeah of course... nothing is risk free... the closest we get is government stock and evn those have fallen over in the past... but i'd generally accept that cash deposits in one of the big banks are as near as we'll get to risk free.. if the ANZ/BNZ/Westpac is going to be in a position to not be able to pay the money back that they have borrowed... it would be safe to sssay that the housing market would have crashed by 75% prior to this...

    remember the OCR in NZ is 7.0%, and in australia yours is 5.5%... so theres a free 1.5% risk free to get in NZ which is a big portion of your difference...

  2. #122
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    Halebop,

    Thanks for your thoughts.

    I especially like a couple of points you make:

    Assuming 5% growth, on average, in order to maintain 25% capital growth, I need to on average maintain 80% leverage too....

    On top of this, in order to maintain my returns I have to keep borrowing 80%. So cash flow gets progressively worse under current market conditions while my risk for performing exactly the same historical function rises as yields fall. It has the hallmarks of a Pyramid Scheme. The growth orientated property investor must risk ever greater amounts of capital, supporting ever greater amounts of debt, funded by a proportionately shrinking cash pool. I suspect it is largely unrecognised that this is all propped up by the taxation system.

    This is a very important point. In the example outlined in my previous post, a punter was buying a $400,000 property on a 5% gross rental with 90% gearing ($360,000 mortgage).

    If the property market were to suffer a sudden downturn, perhaps due to a spike in interest rates wrought by rising inflation (not out of the quesion in the next few years), and rental yields were to rise to a seemingly innocuous 7%, the property value would plummet all the way to $285,000. One now has a negative equity situation of $75,000, as well as needing to continue to meet the $10,000 annual outgoings (and if interest rates have increased, much more). Not a great place to be.

    Even if you managed to hold on for the next 10 years, the 5%pa annual economic appreciation would carry the property back to $465,000. $65,000 in capital gains would be made, but you would have outlayed perhaps double this in outgoings & interest over the decade; in short, pretty much a complete disaster.

    Yet as you mention, in order to sustain high rates of return, it is absolutely necessary to maintain high levels of gearing. If we had only geared to 60%, the arithmatic would look much less attractive:

    Purchase Price: $400,000
    Mortgage: $240,000
    Equity investment: $160,000
    Rental - costs: $14,000
    Interest @ 8.5%: $20,400
    Net loss after tax (39%): $3,904
    Capital gain @ 5%: $20,000

    Net profit: $16,096
    Return on investment: 10.06%

    Sure, it is true that property seldom gets knocked down from say $400k to $285k in a short space of time. Property prices have an empirically well-known tendancy to be "sticky" on the downside; landlords & especially owner-occupiers will tend to stubbornly refuse to take a loss; instead, volume tends to dry up substantially, and days to sell dramatically increases, as sellers hold out for a buyer that will pay up what they paid.

    And there are buyers in the market. Many market participants (esp owner-occupiers) are buyers in the market irrespective of "value", provided the timing & finance suits their personal circumstances. It just takes longer for a seller to find one.

    Of course some over-leveraged investors will be sellers who need to sell in a hurry, so there will be some downside tendancy to prices, but the overall market outcome tends to be relative price stagnation.

    An alternative way for yields to rise to 7.0% is for rents to keep rising at 5.0%pa for 7 years, with static prices. But even if this relatively benign situation was to eventuate, the landlord has suffered accumulated cash outgoings of $70,000, and much more if interest rates had risen. And that's not even talking about opportunity costs.

    Yet as Halebop astutely notes, to maintain high prospective returns, one must be prepared to endure this ever present risk by gearing highly. Its a risky business.

    Unlike shares, where the most you can lose is 100%, in leveraged situations held in one's personal name, one stands to lose much more than this should the market really turn.

    Also,

    A perennial investment maxim is to never invest on the basis of tax. Governments can be capricious, covetous and sometimes just stupid. If tax is a key pillar holding aloft the mathematics of the transaction then you will one day be disappo

  3. #123
    Legend minimoke's Avatar
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    Purchase Price: $400,000
    Mortgage: $240,000
    Equity investment: $160,000
    Rental - costs: $14,000
    Interest @ 8.5%: $20,400
    Net loss after tax (39%): $3,904
    Capital gain @ 5%: $20,000

    Net profit: $16,096
    Return on investment: 10.06%

    Dimebag
    How does your ROI look if you put in 5% of $200,000 (being say the improvement value) cash expenditure on maintnace and capital replacement. And also 5% depreciation on the $200k through your tax?

  4. #124
    Senior Member Halebop's Avatar
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    Minimoke mathematically it's a zero sum equation. Assuming your maintenance and capex equal your depreciation allowances, then $1 in is equal to $1 out. The only benefit is that capex cashflows (perhaps the mathematical opposite to depreciation) tend to be lumpy. So there are some tax deferral benefits due to timing differences or until you sell the property for more than the depreciated value. The "win" of a tax benefit/tax loss is often marginal and must by it's nature either be clawed back or balanced by operating losses.

  5. #125
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    Wns,

    Thanks for your thoughts also. After those perhaps overly extensive comments in response to Halebop's post, I didn't get round to commenting on yours as well.

    I pretty much agree with you. Negative gearing is a cash-flow nightmare and, like you say, seriously impedes your ability to purchase multiple properties, which is important for rapid accumulation of wealth in property.

    However, as much as we would all prefer positively geared properties, market conditions are not always conducive to this outcome. So if one cannot get positive cash-flow properties, the next thing to consider is whether, given the opportunities that are available, any of them constitute a reasonable investment opportunity.

    My analysis shows that this may be possible, although the investment case is far from ideal. And you are very right to point out the practical cash-flow difficulties that such an investment strategy would entail.

    Regards,
    Dimebag

    Mick Jagger,

    Yes, you are correct to consider opportunity costs, but this can equally be done by considering that "I can get 25% in property with x risk, and, say, 7.5% from a terms deposit with y risk", and asking which one you prefer.

    Cheers,
    Dimebag

  6. #126
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    PS

    Does anyone have any statistical information on how much rents have increased pa in Auckland over the past 20-30 years.

    It would be intesting to compare this information with the rates of inflation and economic growth experienced over this period, to consider whether the assumptions I had used were reasonable.

    I think I read somewhere that rents had increased by only 2.7%pa over the past 20 years. If this is so, there is a gaping whole between this and the 5.0% I specified.

    This error of analysis could have been due to a number of factors:

    Firstly, it is possible that the increases in land prices that are driven by economic growth are actually themselves a primary cause of inflation. Land & rentable space is a key resource in many businesses, and as its price goes up, the increased business cost is passed on to the goods & services it is used to produce. Therefore, adding both economic growth and inflation would be "double counting" the increase in economic property values.

    Secondly, the 5% figure is perhaps only applicable to the land. It is possible to build up, not just out. As more and more appartments crop up, as well as high rise corporate offices, more rentable space is created. And more rentable space = more supply, and rental prices are simply the balance between the demand and supply of space.

    You can't create more land, and the ability to build up on it makes it more valuable, so the original drivers remain intact. However, as far as the building upon the land are concerned, they are liable to be devalued by the increased supply of space by other building up. So the combined average increase in the rentable value, and hence capital value, of a "property" is likely to be somewhat less than 5.0%.

    Furthermore, when someone builds up, it arguably devalues the remaining stock of land. Again, more "supply" has been created, and this must reduce the demand for remaining land.

    If the 2.7% figure is correct, then this would tend to indicate that properties only tend to appreciate at about the rate of economic growth. As such, one could not realistically hope for appreciation greater than this longer-term (probably about 3.0% pa). This would render property values tremendously overvalued at current prices.

    Cheers,
    Dimebag

    PS

    "But property prices have increased much faster than 2.7% over the past 20 years" I here property proponents cry. Yet this is largely because interest rates have fallen so dramatically. This critical piece of information should not be overlooked.

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