Portfillio size? Whats normal for a personal self managed porfillio?

[Te Whetu]

Actually neither of you are correct, ENP you have failed to account for the cost of your mortgage and Te Whetu you have failed to account for the gearing.

AA. Please re-read my post.

I know exactly how gearing works, you'll note I didn't state what the actual return was. The reason I didn't state the exact return is that it depends on the exact circumstances and I couldn't be bothered running further NPV examples.

The point I was making was: With leverage, assuming 3% increase in prices, ENP's return on investment may be negative and defiantly will be less than 15%.

House prices have exceeded growth of 15% pa many times through out history with interest rates well below 15%

The geometric mean of house price increases has not exceeded 15% pa over any sustained period of time since we left behind inflation >10%. Yes prices may spike in a year, and if they do you'll be lucky in that year. They may also have very good runs like we got pre-GFC, but 15% yoy growth is a pipe dream today.

Are you saying your forecast is for 15% yoy growth in house prices over the next three years?

If you want I'll happily put a high level forecast out there... 1% growth yoy in nominal terms over the next three years. Feel free to revise your estimate, but lets see who's closer?

Seriously.

Te Whetu

[Te Whetu]

Hi Te Whetu, my reply was regarding your previous posts regarding your zero sum game comment, you were implying with the cost of the mortgage you would be no better off with the gearing , sorry I should have made that clearer.

My apologies if I was not clear. In any case let me clarify my comment.

Unexpected inflation above or below forecast is a zero-sum game. That is you gain when inflation is higher than forecasts and lose when it is below, however the probability weighted present value outcome of these two scenarios for all participants in the market should equal zero. Thus "zero-sum game".

I was not suggesting leveraged investing in property was a zero some game. At a simple level applying leverage to an investment is a linear relationship between risk and return. However in this case with the expected return on the asset arguably less than the cost of debt, it's not a very pretty linear relationship*.

Te Whetu


*Less return with more risk. Yes, the perfect investment!

[ENP]

So the way I see it are:

1. Save in term deposits, buy in 2-3 years time.
2. Save in term deposits, delay purchase, maybe do an OE, etc and buy in 4-5+ years.
3. Save and invest into shares, buy in 2-3 years time.
4. Save and invest into shares, maybe do an OE, etc and buy in 4-5+ years.
5. Buy a cheaper 2-3 bedroom house in the $250-300k range instead.
6. Buy a rental elsewhere and continue to rent myself.
7. Pay off my entire student loan of $28k

Initially I was hell bent on #1. But now I've listened to all the comments here, I'm more inclined to sway towards #4 or #6

[Te Whetu]

My question to you Te Whetu if holding property long term (30 years plus) is ones intention, and historically home ownership has been a extremely good investment due to leverage and inflation, both of which are still here.

(the leverage which is available is far far greater than what is available in shares unless you move into CFDs etc, im a share trader so i do know, try borrow $250,000 worth of shares with just $50,000)

wouldn't you rather buy after a fall in house prices, when you know from history house prices will increase over time, even if not straight away, its the build up cycle, the boom cycle will come, isn't this an opportunity to enter the market at a very good price level, knowing house prices will catch up to inflation at some point in the next property boom cycle. While your waiting for that,inflation is increasing your wages while your Debt stays the same.

I can easily find good quality companies with LVR's of 50-60%, and LVR's of up to 70% are available from ASB. No I can't borrow $250,000 on $50,000 (LVR circa 16.7%) like you suggest with property. In the end if 30 years is your time horizon then it actually gets fairly easy to model so maybe some other time I'll show the impact of that.

Also the argument that prices will eventually go up is weak. Yes, I agree they will at some point, but so will a diversified portfolio of bonds and shares. The question is will they go up by enough to justify the investment (i.e. for levered property that means will the asset returns after allowing for all cash flows be greater than the cost of your loan).

If I told you that there was a 100% chance of property AND rents going up by 2.5% per annum into perpetuity, would that make it worth investing? Well the answer is still a resounding maybe. It would depend on what rents were and what the costs associated with the property were (e.g. rates and maintenance). It would also depend on inflation (above or below that 2.5%) and the interest rates you're paying. Finally it would depend on the opportunity cost of investing in the property.

Oh! oh! oh! I've got a good example!!!

So you have a government bond which returns 3.5% after tax and is inflation adjusted! Would you borrow at 7.0% to invest in the bond? Of course! It's guaranteed to go up in value with inflation AND it provides a return. It helps pay itself off!!! All you have to do is top it up every so often. The best thing about it is that after 10-30 of contributing it will be worth more than it's initial value. That a great return! All you need to do is ignore all your top-up's. *

*please don't sue me... I'm joking.

I think you are focusing very short term at the detriment to your financial wealth long term.

By my very nature I take a longer term view than most of my peers. That's the beauty of the share market, unless you are a skilled trader you NEED to take a longer term view. I base my current investment decisions on what I feel will be true in 1-3 years, but still only invest if I can see myself being happy to be still holding the investment in 10+ years in case things don't go my way. I'm always happy for the market to correct once I'm in, but don't require it for the exactly because I take a longer view.

Will I be happy with my choices to forego home ownership for a while in 10+ years? Well that depends on what the housing and share markets do in the intervening time. However with all current knowledge, I give much higher probability chance to being happy with the decision than not.

Im sure we can agree to disagree here

Yep, agree to disagree.

Te Whetu

[buns]

This has gone well away from ENP’s question.

AA – I think your assumptions completely degrades your whole argument.

Try doing your same calcs you are doing now with house prices rising 1% for 5 years, and 3.5% to terminal value. With interest rates at 6% for 3 years and 8.5% to terminal value. Add in some maintenance costs as well if you really want the spread sheet to go red.

Yes – these are assumptions, let’s not argue them as there is no correct answer.

I see no way you can make that calculation favour housing.

But remember, it doesn’t matter as ENP has a bunch of other things he values which cannot be put in the NPV.

Seriously – Someone in NZ needs to write a book on this, using exact figures, facts and meaningful assumptions easy to understand for the general 20 year old who is coming into some money. It would seriously hit home with a lot of kiwi's in ENP’s position, allowing them to weigh up a question like “Are my non-financial reasons for owning a home worth more than X$?”.

The government should also subside the thing (because it wouldn’t make money with the kiwi housing mind-set) as it would solve a heap of their problems all at once.

[Te Whetu]

AA, the analysis you propose is good, but I would suggest the following:

1) Inflation was extremely high during periods over the last 30 years, no one expects a return to those levels of inflation so inflation should be isolated considered separately.

2) To do this find a historic time-series of both inflation and house price changes, adjust changes in house prices for inflation to get the real change in residential property over time.

3) Ad back inflation at between 1.5-3.5% (model with a couple values to get some sensitivities).

4) You then need to take the geometric mean of the rates over time.

5) When looking at interest rates should do the same thing, look at interest rates assuming we never had >10% inflation.

Now I don't know what rates of change you will find, I've never done this analysis. But I suggest that it will not be huge. The problem changes in capital value make up only one small part of the return of owning a house. As we all know, we also need to factor in items such as rent, and/or avoided rent, expenses etc.

Still it would certainly help inform this discussion.

...

Ok since it didn't look too hard I've done the above (at least for house prices). It's likely not perfect but as an indication and to help inform the conversation:

Inputs:
1) Data-series since 1962 (that's when the StatsNZ house price index I found goes back to).
2) Housing data is for detached houses only, I suspect units and apartments would have lower growth.
3) Inflation based on CPI.

Outputs:
4) Nominal annual ∆ in prices has been 8.6%
5) Real change in prices has been 2.1%
6) If we assume 2.5% inflation then this would imply a nominal growth rate in house prices of 4.7%

Which to be honest is not too bad, certainly higher than I thought it would be. NOTE: This is still past data, so while it may help give a reasonableness check, it does not guarantee future changes.

Personally I don't believe property prices can outstrip changes in peoples income indefinitely. I feel we will have a time of contraction and consolidation before the continued slow march continues. Even if that slow march does continue at some point, it doesn't mean buying now is a positive investment decision.

Cheers
Te Whetu

[Sauce]

Personally I don't believe property prices can outstrip changes in peoples income indefinitely. I feel we will have a time of contraction and consolidation before the continued slow march continues. Even if that slow march does continue at some point, it doesn't mean buying now is a positive investment decision.

Hi Te Whetu

I am on holiday and have been enjoying this discussion from my iphone.

Anyway, enjoyed your posts and agree with your view entirely.

When talking residential property there are really two types and they are valued (by the market) very differently and people always seem to miss this point in general discussions..

So called 'sophisticared' property investors tend to prefer multi-income properties from large blocks of flats down to home and income type properties in good suburbs (say a four bedroom home with a granny flat or 1 bedroom flat attachd to it and rented separately). This allows them to get a higher 'yield'. i.e. more cashflow from the investment. These properties are valued (as they should be) by capitalising the cashflow they produce (although most investors get this part wrong but thats another discussion).

A standard 'home' in the 'burbs is valued by the market based upon factors such as the lifestyle benefits and features it provides as a family home, in a rough comparison to what else buyers can get for their money in the same area and previous sales etc.

Now if you are an investor buying a three flat city-fringe rental property in Auckland or Wellington, your long term capital gains are going to be influenced by two things: Rental inflation, and the prevailing cap rates required by other investors. The only time that land value or general family home price inflation even comes into it is if those values were to rise so high the property was worth more as a different use, i.e. a homebuyer converts it into a non-investment property for a family to use, or the land is worth more for some other use.

Now over the long term, rental inflation is a near certainty, particularly in the major centres, as population growth and finite land combine to put pressure on rents.

But cap rates are another story. Currently investors are still buying multi-income properties in Wellington on approximately 7.5% gross yields, which equates to probably less than 5% if people were honest about the real cost of maintenance averaged out over the life of the asset (which they are NOT honest with themselves about in nearly all cases in my experience). In my opinion this is still way to low to provide a return I would be happy with.

look at it this way - its financial equivilent of buying a stock on a PE of 20 that grows earnings at the rate of inner city rental inflation.

Of course it can and is argued that the certainty of the income is so great this low return is justified, and thats a fair argument. But people still need to be realistic that these are simply not very spectacular returns.

Te Whetu is right. Leverage is not a guarenteed way to make excess returns with property. In fact I know for a fact that leverage can and does destroy a lot of wealth in the property sector, and ironically people often do not even realise it..

The few truly 'sophisticated' property investors I have met keep their gearing at under 30% and reinvest their cashflows in new income streams, compounding their returns over long periods of time. They do NOT even care about so called 'capital gains' as they have no intention of selling, they are simply building a larger and larger stream of cashflow. The only time current cap rates are of interest is when they are purchasing. They prefer property because of the certainty of rental income, over the uncertainties of business income. But, for that certaintly, they accept lower returns and lower potential rates of compounding. Of course they still get very wealthy over long periods of time.

Buying on an average yield now, and hoping rents rise AND yields will drop, is simply trying to guess the impossible, and playing the 'bigger fool theory'. It is also stupid as it relies on actually selling to realise capital gains and having to time your exit.

The value of any cashflow producing asset is simply the present value of all the cash it will generate in the future, discounted for the time it takes to generate the cash. Investment property is no different. Hoping someone will pay more than you in a few years and disregarding this fact is a bad strategy on so many levels.

My personal view is that we are going through a large adjustment in the property market right now. Inflation will not include rents and land values but inflation of everything else is going to erode the value of peoples equity in their properties in the short term. Prices won't collapse due to structural factors such as no-oversupply in NZ (unlike the US). But wage and salary's are likely to catchup with home prices at some point.

However, that doesn't mean, if you are a savy investor who is focused on cashflow, that now is not the time to pick up some high yielding investment properties - if you are agressive and look for distressed sellers, you are certainly more likely to find some greedy and foolish overgeared speculator who capitulates and sells you a bargain (i.e. a high cash yield) in this market. I.e. the transfer of wealth from the impatient to the patient..

Generally speaking, property investors spend too much time reading books that teach really poor ideas about finance in general (as applied to real estate).

Come to think of it Terry Seripisos (or his banks) might be about to sell a few bargains...

With regards (from Kalkan, Turkey)

Sauce

P.s. Sorry about bad grammer spelling, clarity etc, don't have time to tidy up this post.

[Sauce]

Sorry I should also mention that my post was a general rant about the differences between property as an investment and property as a home. The reality is these things are very different in practice which was my long winded point.

The home you live in is simply not an investment at all, and it's naive to think it is. For a start you always need to live somewhere ? So that capital is dead money.

A second home might be considered an investment, but people are better to buy for income (and most, but not all, do).

I wasn't posting with regard to enp and his situation.

Cheers sauce

[percy]

Just googled Kalkan.Looks a fantastic place.

[Sauce]

Just googled Kalkan.Looks a fantastic place.

Hi Percy

Kalkan is simply amazing. Got to love the med if you like your sea turquoise and your food delicious.

Speaking of which, I must now go forth and fatten myself..

Cheers

Sauce