bubbles defined

[L Bernham]

I had to check what I wrote as I thought I must have missed something.
I was right the first time. I think you may have missed the words Present value of future cash inflows.

Because the difference in the amount you would pay now to recieve an amount 100 years or 1000 years down the track is fairly small the calculations hold true for 100 years, 500 years or 10,000 years.

Isnt the PV formula used by most investors to determine value?
If not, it would explain why a townhouse near my place that rents (when it eventually finds a tenant) for $250 pw recently sold for $330K.

LB

 

[L Bernham]

Type this formula into an excel cell -

=PV(0.065/12,12*200,250*4)

REsult = $184,614.95

This says that the price that one should pay to get $250 a week rent (paid monthly) at a discount factor of 6.5% for 200 years is $184,614. This assumes no expenses, no risk and only a few weeks vacant period per year.

Run the same thing for 50 years and you get $177,394. Not much difference.

To justify paying $330K for such an investment you would need to significantly reduce interest rates for the entire period and increase rent just to break even.
Unless, as I mentioned earlier, you're relying on the greater fool to buy from you. But this goes against many peoples strategies of "never sell" anyway.
So whats wrong.

 

[Les]

G'day L Bernham,

What Inflation figure are you using to arrive at the above conclusion?? Is this an "average Inflation figure over 30 years" or.... what?

BTW, I applaud your "outside the square" thinking, LB - and always look forward to your next post !!! (I may not always agree, but you certainly "rev up the grey matter" whenever you post, so, "Thank you !!!" for that).

Regards,

 

[abcdiamond]

Yes LB, You are right,

The things that can be proved by using imaginitive figures, graphs etc.

Amway used to prove future income for its targets using creating thinking and figures, but again, ALL TRUE, and couldnt be discounted.

What will a loaf of bread cost in 1,000 years at the same rate of inflation ?
I used 10% pa to get my property correct under your calcs. so a loaf of bread (currently 1.50) will cost .....
$407,538,931,470,994,000,000,000,000,000,000,000,000,000.00

Will someone please check my figures ??????? surely that can't be right !! I'm INVESTING in BREAD !!

 

[L Bernham]

I've obviously lost you abcdiamond.
Your post demonstrates neither logic nor relates in any way with the point I was making. Its why I don't often bother with people who don't have a basic understanding of ordinary financial concepts. I thought posting on an PM Economics thread I would avoid this type of response.

Les. Thanks.
There is no need to estimate or use an inflation figure as it all inflation does is keep things relative. If inflation were to rise dramatically interest rates would have to move up as well cancelling out the effect. The only effect they would have from an investment perspective is if you speculated that inflation will rise more than interest rates. But the opposite is just as likely to occur so its pretty risky.

LB

 

[Les]

Hehe, this one is coming thick and fast !!! LB, you were obviously posting a reply even as I was posting mine - whew!!!

So whats wrong.

In a nutshell, I would say the "Supply and Demand" curve !!!

Sydney is NOT going to disappear in the next 50 years (IMHO) - thus, there will always be someone who will want to live in Sydney, and they will pay "the asking price" to live reasonably close to the "hub" !!!!!

With the Northern Hemisphere becoming more and more unfriendly, why would "people of means" NOT want to move to the "New York of the Southern Hemisphere"??? Especially as our prices are a JOKE for many who currently reside in many larger Northern Hemisphere cities.

The Internet makes it possible for people to live ANYWHERE they wish, and still conduct business. And, in a nutshell, many still want to be around a "hub" of business (SOME of us would rather be near a beach, or a National Park........) - and they will gladly pay an "over the top" amount to buy a piece of Sydney.

And this kind of aberration tends to make a mockery of NPV's and the like..... Please don't get me wrong - NPV's have their place, but some decisions do tend to ignore such frippery !!! Thus, prices contiinue to climb, even when it can be proved (demonstrably) that they SHOULDN'T !!!!!

Looking forward to further views - from ALL sides !!!

Regards,

 

[L Bernham]

So if people are willing to pay a premium to live in a certain area (which I dont dispute at all) why isnt this reflected in the rents.

If one bought an IP in one of these areas on the basis of its premium status shouldnt they be able to charge the rent that would reflect this?

Sure rents in some places are higher than out in the sticks but they arent as high as they should be given the prices of the associated properties.

NPVs have their place in all types of investment decision and have (up until recently in Oz) been fairly accurate in determing value of any property in any country. They should never be the sole method used but their result should never be ignored.

And when the result doesnt match reality one needs to figure out what else is being priced in to attain the value. ie an increase in rent much greater than inflation, a decrease in interest rates that stay for an extended period or an expectation that the value of the property will rise inexplicably.

Fact is why would anyone buy a property to hold forever when its never going to pay itself off unless rents rise significantly above inflation. Thats the big question.
My guess from observations of current buyers are for reasons so removed from normal valuation methods its not funny ie scared to miss out, beleive it can only go up, mismatching the level of immigration with its effect on prices etc.
Its these types of things that contribute to asset price bubbles but they can rarely sustain them.

LB

 

[suggo]

What about when yields were 7-10% only just a couple of yerars ago. It was worth investing then wasn't it?

So when the market stops and price stagnate, over time wages rise and rents rise then at some future stage the yields again will reach these high figures!??
Then the cycle goes around again! Isn't that how it works?

 

[abcdiamond]

LB
You didn't actually lose me, I followed your figures, did my own calculation before you posted your formula, but posted my own laymans comments.

Your figures are correct, but irrelevant, the same as my price of bread in 1000 years.

If we follow your argument that we should not pay a figure based on figures calculated 1000 years into the future, then, yes that is where I do seem to lose the point. I know a lot of people invest for the long term, but bringing 1,000 years into it ?

Les mentioned

people to live ANYWHERE they wish, and still conduct business

Yes this happens, I was one of them, living in sunny OZ, but running my UK based business for a number of years, getting the best of both worlds, a high value UK income, but spending it in low priced OZ. Then managing to sell up just before the OZ $ climbed up again

 

[L Bernham]

suggo
Yeah thats pretty much it. This time round though its going to take a while for an intrinsically valued $180K property to get to its last selling price of $330K. even longer if interest rates rise.

abc - the point of using 1000 years is the same as saying that it will generate this return "in perpetuity" which is what a property does. I used the example of 1000 years to simplify for those that probably wouldnt have understood otherwise, just to show how an investment could effectively never pay for itself.

How much would one pay for the Right to receive $5K 100 years from now. Not much. thats why its the closest years to now that have the most weighting in PV calcs. Thats why even if rents increase dramatically in 10 years time the amount one would pay for that benefit is less than if they rose now.

Its irrelevant that we wont be alive in 100 years time as the right to receive $5000 in 100 years time will always have a present value as the right can be bought and sold. Seeing as its value is so small its suggests that you should really aim to buy a property that has a postive NPV after about 20 years. Any more and you're speculating too far into the future.
Good luck

 

[L Bernham]

Your figures are correct, but irrelevant, the same as my price of bread in 1000 years

I couldnt let this go uncommented. HOw can my figures be irrelevant??

Would you pay $300K for the right to receive $180K worth of income over 100 years. If so please email me because we could do some business.

 

[abcdiamond]

Originally posted by L Bernham
Your figures are correct, but irrelevant, the same as my price of bread in 1000 years

I couldnt let this go uncommented. HOw can my figures be irrelevant??

Would you pay $300K for the right to receive $180K worth of income over 100 years. If so please email me because we could do some business.

Tell us how much the rental income would be for each of the first five years ?
I would estimate $ 300x52 = $15,600 in year one
less the interest cost of the loan = $18,210
add the tax relief of (18,210-15600)*30% = $783

therefore total cost to me in year one = $3,393
If Capital Growth for the year is 1.5% (conservative / low figure) that equals $ 4,500 Capital Growth profit.

Proft for the year $4,500 - $ 3393 = $ 1,107 PROFIT

If the Capital Gain exceeds 1.13% during that year then I am in profit, any higher is more profit.

The above figures are factual. To me it is irrelevant what the cost figures be in 1,000 years time. What is relevant is that if Capital growth exceeds 1.13% then I am better off with the property than not with it.

To me thats very basic and very simple.

 

[L Bernham]

yes but its a pretty risky $1000 profit when you are relying on full occupancy, no expenses relating to the property ie rates, insurance, transacation fees and I'm sure you know the rest.

NOt only that, the opportunity cost of $300K would have to be between $20K and $30 invested elsewhere.

Finally you havent taken into account the possibility of capital loss which seems much more likely in the coming years.
LB

 

[abcdiamond]

Originally posted by L Bernham
yes but its a pretty risky $1000 profit when you are relying on full occupancy, no expenses relating to the property ie rates, insurance, transacation fees and I'm sure you know the rest.
NOt only that, the opportunity cost of $300K would have to be between $20K and $30 invested elsewhere.

Finally you havent taken into account the possibility of capital loss which seems much more likely in the coming years.
LB

Sorry, I dont follow the opportunity cost figures: $300,000 compared to $20 or $30 invested elsewhere.

The $1000 profit is based on 1.5% capital growth, If you increase that to only 3%, I am sure there will be sufficient to equalise the other expenses out of the extra $4500 CG Profit, plus of course the extra tax releif on tghose expenses.

Regarding Capital Gain or Loss, everyone is saying that the area I have picked should keep going up for the next three years at about 36%, even if other areas do drop a bit. Thats a gamble I am prepared to take, and I feel the odds are with me.

 

[L Bernham]

actually, the 36% over 3 years is just BIS shrapnels opinion referring to Brisbane that has been promoted widely enough to make others quote it so that it looks like everyones saying it when really they are just going off one bit of research.
You have to pretty careful about reading that type of stuff. I wonder who commissions some of these reports.

Pay me enough and I'll do a report that will tell you anything you want to hear.

 

[suggo]

Ok, so if what I said is pretty much right then in a few years (maybe 5-10 I think is fair?! yes/no??) everyone again, including yourself will be interested in buying these properties. And then prices will again rise until again the return makes it not worth buying again for another 1000years, and the market stagnates again and 10 years down the track they are worth buying again.

If it only takes ten years to make a property worth buying then doesn't that sort of make your calculating redundant ??(spell check!)

 

[abcdiamond]

LB

How much did you increase your rental income by each year in your initial calculations ?

I have a feeling that you omitted to allow for rent increases.

 

[abcdiamond]

LB

My rental figures here differ from your expected returns:
eg:
Year One: Rental Income $12,480
Year Two: rental income $12,480 add 5% increase = $13,104, less 6.5% Inflation = $12,304
Year Three: rental income $12,304 add 5% increase = $12,919, less 6.5% Inflation = $12,130
etc
In 15 years, by the year 2018, you will have reached $180,000 in rent received at todays value.
That’s 985 years earlier than predicted in your original post

This confirms my original comment that figures can be used to confirm anything, a point that you yourself accuse others of doing. eg: BIS shrapnel.

LB, you quoted this in your orginal response to me:

Its why I don't often bother with people who don't have a basic understanding of ordinary financial concepts. I thought posting on an PM Economics thread I would avoid this type of response.

I assume you do not like people who take a different position to you, and you assume that they do not have the same level of intelligence as you. I would just like you to be aware that I do take offence at your comment. I may be getting on a bit now, and I probably am not as good as I used to be, but to say that I do not have a basic understanding of ordinary financial concepts ? My qualifications include 1st place in the UK in Higher Stage Accounting with the LCCI, and I even got a pass in Economics, but thats many years back now, and i dont go around saying how clever I am, or that I dont discuss points with those who don't fall at my feet and agree with everything I say.

I feel I have gone a bity further than I wanted to here, so I will apologise, fo the way I feel, but, LB, please consider how you talk to people. Treat people equally, and listen and learn from others. Thats what I thought this forum was for, to put points forward, not to be in fear of being condemded by those that are "more intelligent".

Also, if I make a mistake I am more than willing to say I am sorry, even though I used to be clever, (many years ago) I do make mistakes, and I know that we ALL make mistakes, but we do not deserve to be treated with contempt.

regards

 

[Les]

G'day LB,

So if people are willing to pay a premium to live in a certain area (which I dont dispute at all) why isnt this reflected in the rents.
If one bought an IP in one of these areas on the basis of its premium status shouldnt they be able to charge the rent that would reflect this?

I would say this is because the areas that have HIGHER than normal Capital Growth will produce a Lower Yield. (Refer p92 of Jan's "More Wealth from Investment Property" - she explains it far better than I could).

One other thing I don't see reflected in your original argument is the fact that we don't put $300k on the line to purchase a $300k property. If I were investing in a "moderate" way, I'd probably be putting only 20% in (plus costs) - say 25% of total value. Thus a $180k return on $75k "in perpetuity" sounds pretty reasonable to me. Am I missing something here?

And what about buying at a Discount to Market Value?

As you read this, you may well be able to pick holes as I am NOT trained as you - and others - obviously are. I'm simply using the little knowledge I do have to come to grips with your proposition - so please bear with me.

Moving on, re the 25% I'm putting into the deal ($75k) - in actual fact, this would probably be largely (if not all) "existing Equity" that is used to generate this "$180k in perpetuity" return. So, in effect, am I not generating an income stream from NO input? Or, at worst, generating an Income stream from the payment of (say) 6.5% of 75k (the cost of borrowing the deposit) - i.e. $4875 per annum. Assuming here that rental income is successfully off-setting the remaining Interest and expenses - simplistic, I know, but it seems reasonable based on current yields, Tax relief available, etc.

And then thinking further, isn't it true that the actual mortgage payments ALSO have a decreasing NPV as time marches on? And this is where I think of Inflation, and the fact that $4875 in 10years won't hurt as much as $4875 today !!!

Does Capital Gain NOT have a place in the NPV calculation? I always thought it DID (but I might be confusing NPV with IRR...)

Do these facts require a change in your calculations, LB? I don't know..... At least on the surface, my calcs seem pretty good to me....

Interested in your response....

Edited later to fix some pretty stupid mistakes
Regards,

 

[Les]

G'day LB,

After posting the last response, I then went back to your original puzzle:-

Type this formula into an excel cell -

=PV(0.065/12,12*200,250*4)

REsult = $184,614.95

This says that the price that one should pay to get $250 a week rent (paid monthly) at a discount factor of 6.5% for 200 years is $184,614. This assumes no expenses, no risk and only a few weeks vacant period per year.

Run the same thing for 50 years and you get $177,394. Not much difference.

To justify paying $330K for such an investment you would need to significantly reduce interest rates for the entire period and increase rent just to break even.
Unless, as I mentioned earlier, you're relying on the greater fool to buy from you. But this goes against many peoples strategies of "never sell" anyway.

So whats wrong.

LB, what I think I'm seeing here is a pure "yield" calculation!! Am I right in saying there is NO provision for Capital Growth in your calculation? And, if not, why not?????

Regards,