"Even a journey of a thousand miles...

[topcropper]

Are banks really a safe haven?

They are the ones who lent all this money in the first place. There must be a few people who bought property right at the top, with a 10% deposit, and now have negative equity.

I must say though that the Commonwealths profit report surprised me. It appears that business lending is compensating for the drop off in property investors. Banks are the big market darling, and they won't drop until the profits do.

I think the market is starting to look fully valued. Average PE's are still below average, but that is mainly because of resource stocks who are making more cash than they know what to do with. BHP could buy a Western Mining every year if it wanted to if current commodity prices hold. But will they? That is the question.

Just as the sharemarket went much lower than any rational thinking person would have thought in early 2003, it could go much higher than people expect. I'll start to take profits again shortly. Only stocks that have been held for 12 months, which fortunately is most. It would be good to be cashed up for the inevitable correction.

See ya's.

 

[quoll]

Actually, the one proviso I would put on stocks is that the banks may run up to PEs of 20 when things turn sour, as a lot of money will run to them for safe haven in the face of recession.

G'day TFB

That R word is starting to scare me!

cheers
quoll

 

[thefirstbruce]

Actually the threat of R will be interesting. There are a lot of foreign lenders adding competition to the Oz banks. When/If things soften significantly in Oz, I would bet they will wind back operations. This happened in the late 80s/early 90s. ie Natwest was one I saw close up.

If the foreigns scale back, Oz bank profitability should not be too adversely affected during an R.

 

[MichaelW]

It is a point that has been made countless time before on this forum, but depending on your marginal tax rate and the interest rate payable on your mortgage, each dollar put in your offset account could be earning you as much as 13% pre-tax equivalent (remembering that PPOR mortgages are paid from after-tax dollars in many, not all, cases).

In a low-yield, low-capital gain market (perhaps what we have atm?), it certainly could be argued that parking excess cash in mortgage offset accounts is a very effective use of your money - and with close to ZERO risk too!

See attached a simple spreadsheet.

Mark

Mark,

I'm having a Forest Gump moment... Can you please help explain to me how a 6.75% mortgage offset can equate to 13.37% effective earnings? Please use little words, I think I've got it but...

I looked at your spreadsheet and can see how it flows through, are you suggesting that since I need to pay tax on any investment earnings of that offset dollar, then to get the same "return" I would need to earn 13.37% gross to equate to 6.75% net and be a better option than to offset my interest cost on my PPOR.



Thanks,
Michael.

 

[ArJay]

It is a point that has been made countless time before on this forum, but depending on your marginal tax rate and the interest rate payable on your mortgage, each dollar put in your offset account could be earning you as much as 13% pre-tax equivalent (remembering that PPOR mortgages are paid from after-tax dollars in many, not all, cases).

In a low-yield, low-capital gain market (perhaps what we have atm?), it certainly could be argued that parking excess cash in mortgage offset accounts is a very effective use of your money - and with close to ZERO risk too!

Hmmm.....hang on folks, can we back up a minute.

Aren't we preaching a variation on the old "save it for a rainy day" addage in here?

Could be wrong, but wasn't the first rule of property investing 101 to leverage your capital (OPM)?

Even in a softish property market there are still gains to be made above the 13.37% quoted.....

eg.
MichaelWhyte's 100k into PPOR offset acc @13.37% pa = $13370 pa return.
MichaelWhyte's 100k as 20% deposit (500k) @ 3% pa = $15000 pa return.

For plebs like me on a lower wage the advantage becomes even more pronounced...and the property has the advantage of compounding in value whereas the offset will decrease in spending power the longer it "sits".

Am I missing something?

Just a thought.

ArJay

 

[see_change]

If you were to keep the money in the Offset / LOC, the main reason to do that would be because you think that Prices are going to go further backwards ( in particular in Sydney ) so you are acting on the belief that you will get a better buy at some stage in the future.

The other suggestion offered was to gear into managed funds, which might give a better return than the two options you compare.

Remember leverage is a double edge sword. You make more when things go up , but you loose more when they go down. I know a couple of people who had what would been considered a healthy amount of equity who managed to go bankrupt because they over leveraged at the wrong time in the last property cycle.

See Change

 

[MarkB]

Aren't we preaching a variation on the old "save it for a rainy day" addage in here?

Yes, I guess it could be called that.

Could be wrong, but wasn't the first rule of property investing 101 to leverage your capital (OPM)?

Perhaps it was, or is, or whatever.

Risk equals return is also another rule.

Don't invest in something you don't understand (yet another).

Having money sitting in a PPOR mortgage offset account is still investing in property - your home.

Even in a softish property market there are still gains to be made above the 13.37% quoted.....

Sure there are, and I acknowledged as much when I said:

Look hard enough and smart enough and yee shall find

eg.
MichaelWhyte's 100k into PPOR offset acc @13.37% pa = $13370 pa return.
MichaelWhyte's 100k as 20% deposit (500k) @ 3% pa = $15000 pa return.

Yes, leverage does increase the return. I can't argue with that point, I have used it myself countless times on this forum.

But $100k will not buy you a $500k IP @ an 80% LVR. Depending on stamp duties, legal fees, and other acquisition costs, $100k will get you into an IP of about $420k.

In Qld, a $420k IP @ 80% LVR (so a deposit of $84k) will attract $13,175 in transfer duty + $1064 in Mortgage Stamps. That leaves you about $1800 for legals and other costs.

Ok, so you still only need to earn 3.33% on your $420k IP to match the return on your PPOR, but that 3.33% has to be after holding costs (interest, insurance, rates, etc) and so on (yes there are holding costs with your PPOR, but you would incur these anyway).

For plebs like me on a lower wage the advantage becomes even more pronounced

At a 30% marginal tax rate, the estimated pre-tax benefit is still close to 10%.

...and the property has the advantage of compounding in value

This is why I said that money sitting in a PPOR was virtually risk free, because the savings you make are not dependant on CG.

Whether you call it an educated guess, smart buying, a gamble, whatever - when you buy an IP the CG is something you can only ever assume (that is, unless you have a pre-existing arrangement to sell at a higher price on a specific date).

...whereas the offset will decrease in spending power the longer it "sits".

Ok, you got me with this one. Since the money in an offset account is not earning interest (it is only saving interest) it does, over time, lose some of its purchasing power (currently 2.5% pa).

...Am I missing something?

No, you turned over quite a few stones with that post.

I hope you were satisfied with the creatures you found hiding underneath.



Mark

 

[MichaelW]

Even in a softish property market there are still gains to be made above the 13.37% quoted.....

eg.
MichaelWhyte's 100k into PPOR offset acc @13.37% pa = $13370 pa return.
MichaelWhyte's 100k as 20% deposit (500k) @ 3% pa = $15000 pa return.

Arjay,

Except that the 20% down also requires 80% new borrowings using the IP as security. So, in reality, I am borrowing 100% on the IP with 20% coming from the LOC on my PPOR and 80% secured by the IP.

So my costs become 20% at 13.37% and 80% at 6.75% = 8.07% cost of capital. So my $500K IP now needs to return net $40,370 to break even. 8% IRR is getting a bit harder to achieve than the 3% mentioned above. And that 8% just covers my borrowing costs and not all the other holding costs!

Suddenly, it looks a lot harder to turn a profit in the current market that would justify not parking my $$ in the offset for the moment.

If I were to use that $100K as 50% down in to a managed fund (Navratrade or others), then my borrowing costs would become 50% at 13.37% and 50% at 6.75% = 10.06%. If Navratrade returns more than 10.06% net then it covers my holding costs. Anything less is going backwards.

Am I right, or am I once again off on a tangent?

Cheers,
Michael.

 

[ArJay]

Remember leverage is a double edge sword. You make more when things go up , but you loose more when they go down. I know a couple of people who had what would been considered a healthy amount of equity who managed to go bankrupt because they over leveraged at the wrong time in the last property cycle.

Mmmmm....sure SC this is a given, but we're not talking options and warrants here, we're talking IPs. I have a great deal of pity for those who've lost by selling at the wrong time in the cycle (such as my parents), but I'll have to go out on a limb here and say that investing in property is not rocket science. There is a lot to learn, but it is all within reach of the anyone who's got the interest/time to persue it. Sure I've know people who've been forced into a sale and combined with purchasing at the height of the market have lost, but that's not your average formite's course of action.

Such as yourself....you cant tell me that you couldn't go out and buy in an area where you were more than assured to get returns of 5% CG+ even at the moment. Hell, I'm in Adelaide and I can name at half a dozen...

Perhaps interstate where things a a fair bit more volatile you could get caught out, but I'm skeptical....

ArJay

PS- Hope this post doesn't sound knarky (sp?). Not supposed to...

 

[ArJay]

Yes, leverage does increase the return. I can't argue with that point, I have used it myself countless times on this forum.

But $100k will not buy you a $500k IP @ an 80% LVR. Depending on stamp duties, legal fees, and other acquisition costs, $100k will get you into an IP of about $420k.

In Qld, a $420k IP @ 80% LVR (so a deposit of $84k) will attract $13,175 in transfer duty + $1064 in Mortgage Stamps. That leaves you about $1800 for legals and other costs.

Ok, so you still only need to earn 3.33% on your $420k IP to match the return on your PPOR, but that 3.33% has to be after holding costs (interest, insurance, rates, etc) and so on (yes there are holding costs with your PPOR, but you would incur these anyway).

Ya.....good point. I was really just using Michael's rough figures here.

This is why I said that money sitting in a PPOR was virtually risk free, because the savings you make are not dependant on CG.

Whether you call it an educated guess, smart buying, a gamble, whatever - when you buy an IP the CG is something you can only ever assume (that is, unless you have a pre-existing arrangement to sell at a higher price on a specific date).

Ummm....have to kind of disagree on this one. CG is prob the only reason why I/we would buy...but that's another discussion that has been hammered to death elsewhere in the forum. Assuming you have done your homework you should have more than a fighting chance, even now...

Don't get me wrong Mark, I respect your opinion completely and have myself learnt much from your postings, just trying to get my head around the concept here. Interesting discussion....

ArJay

 

[TJamesX]

Actually the threat of R will be interesting. There are a lot of foreign lenders adding competition to the Oz banks. When/If things soften significantly in Oz, I would bet they will wind back operations. This happened in the late 80s/early 90s. ie Natwest was one I saw close up.

If the foreigns scale back, Oz bank profitability should not be too adversely affected during an R.

Just read this article - very relevant

http://www.aireview.com/index.php?act=view&catid=7&id=2412

Apparently 'this time could be different' with regards to overseas competition retreating or not....

 

[see_change]

Arjay

There are plenty of people on this forum who would be at risk. Lots of people with LVR's around 80-90 % and lots of people who negative gear who are potentially at risk.

There was a poll a while ago and I was suprised by the number of people who said they would struggle with only a relatively small rate rise.

If you combined a small rise in rates with increasing unemployment, a few tenants in the same position and not paying , couple of trashed houses ( which is more likely to happen if things go bad ) and I think there will be many people struggling. If the banks start getting twitchy and revalue properties or decreasing limits then things will get messy.

Obviously this is not about to happen in the next few months , but one thing I've learnt through life , sport and shares is you need to get your defence correct before you attack otherwise you aint going to win.

Further to my previous comment , the only people I have known to go bankrupt ( for personal / social circles ) who have gone bankrupt have done it through property. These are not dumb people and know a lot more about property than the average forumite , they are people who are financially literate and two of them have gone onto make a serious amount of money in the current cycle.

See Change

 

[ArJay]

Arjay,

Except that the 20% down also requires 80% new borrowings using the IP as security. So, in reality, I am borrowing 100% on the IP with 20% coming from the LOC on my PPOR and 80% secured by the IP.

So my costs become 20% at 13.37% and 80% at 6.75% = 8.07% cost of capital. So my $500K IP now needs to return net $40,370 to break even. 8% IRR is getting a bit harder to achieve than the 3% mentioned above. And that 8% just covers my borrowing costs and not all the other holding costs!

Suddenly, it looks a lot harder to turn a profit in the current market that would justify not parking my $$ in the offset for the moment.

Yeah I get you here Michael....remember though, these costs average out over the life of the asset. The longer you hold the less these become significant. I guess it could be argued that you could hold until you saw a decent rise in the market, but then you're going to have to outlay on these costs at some point in the future regardless if you buy IP...

Plus this is one of the reasons you don't have the volatility of other investment vehicles in property. It costs a hell of a lot to speculate!

ArJay

 

[ArJay]

Further to my previous comment , the only people I have known to go bankrupt ( for personal / social circles ) who have gone bankrupt have done it through property. These are not dumb people and know a lot more about property than the average forumite , they are people who are financially literate and two of them have gone onto make a serious amount of money in the current cycle.

Yep SC, point taken...and a good one. I can see how if you were highly leveraged this would be a testing time in the market. Suppose I was just coming at it from a "smaller time" investors angle.

Cheers.
ArJay

 

[thefirstbruce]

Just read this article - very relevant

http://www.aireview.com/index.php?act=view&catid=7&id=2412

Apparently 'this time could be different' with regards to overseas competition retreating or not....

Nice article TJX. It makes some very valid points and I shall revise my views accordingly.

I know Natwest and BNP suffered in the late 80s due to picking up the dodgey commerical stuff the domestics wouldn't touch.

The article makes some good points re the changed climate- third party brokers, more aggressive foreign bank competition for high margin home mortgages, higher profit margins here than OS. This prompted my memory re General Electric, who bought Wizard and are here for the long term in an aggressive manner.

 

[MarkB]

Can you please help explain to me how a 6.75% mortgage offset can equate to 13.37% effective earnings? Please use little words, I think I've got it but...

I looked at your spreadsheet and can see how it flows through, are you suggesting that since I need to pay tax on any investment earnings of that offset dollar, then to get the same "return" I would need to earn 13.37% gross to equate to 6.75% net and be a better option than to offset my interest cost on my PPOR.

MW

Sorry I missed this question last week.

Yes, that is precisely what I am suggesting.

To convert an after-tax saving on a PPOR mortgage, you need to take account of marginal tax rates.

Once you have done that, then you have a pre-tax return equivalent, and this return can be compared with other investment opportunities (which are also pre-tax).



My other main point was that this pre-tax return is very close to risk free.

Mark

 

[Tim]

Michael,

couple of comments about your proposal (and I recently had $250k in LoC to burn so can empathise with the feeling of wanting to act now!)

1) Not much property diversity , one hugley expensive property at $500k.....

2) Less diversity with $250k in Navra fund??? Sorry I find it hard to fathom you would do this, because I am currently in 7 different managed funds (Navra included), and one thing is for sure, there is no way I would put all my eggs in one basket (especially not $250k!)

I know Navra fund has returned good profits, but seriously, how could you say that their fund is soooooooooo good that it is pointless investing in any fund except theirs??????

One fund I am in currently, Perpetual Geared has returned over 60% in 12 months, another UBS Propert fund has returned 20% over 5 years. There are plenty of funds that return around 20% over 5 years.

I think just because Navra work out your plan, how could they possibly suggest you invest all those funds with them without diversifying? Obviously they stand to make money from it but really, shouldnt they be attempting to selll what is best for you not them? Not being critical at all of Navra funds, just trying to bring in some objectivity.

Tim

 

[Tim]

Sorry I just re-read your post.

$500k in Navra retail, not $250k!!!!!!!!!


Is anybody else thinking what I am thinking? That to me is seriously risky, to not consider diversifying that $500k and only having it in one managed fund.

A book on investing I read recently suggested that risk reduction in manged funds is achieved through diversification through an optimal amount of 8 different managed funds (in the same market), after that diversification benefits from additional managed funds taper off considerably.

Tim

 

[Glebe]

I have about 40% of my wealth with Navrainvest. It's doing very well. The remainder is split between hedged and unhedged international funds, other Aussie share funds, and Aussie property funds. Whilst the Navrainvest fund is possibly the highest returning currently, having the diversification is good for the soul

 

[Aceyducey]

Tim,

Doesn't it depend on the size of your total net worth

For many people $500K is not a significant proportion.

Cheers,

Aceyducey