Debt = Wealth ?

[always_learning]

Yesterday my wife and I had another open and "frank" exchance of views in regard in regard to (my) debt.

Me:
"Prices on more expensive homes in the Sydney North Shore are coming down (a little) I think we should act in the next 6 months: dual occupancy rules have recently been changed in Ku-ring-gai (upper north shore) area, we could buy a dual occpancy site, build our dream (Japanese style) home and another for rental (to Japanese corp ex-pats)"

Wife:
"How much would that cost?

Me:
"$1.5 to 2.2M depending"

Wife:
"How can we do that we dont have any money?"
( No money for my wife means no large term deposits in banks)

Me:
"Finance and our LOC of course"

Wife:
"I dont want any more debt, I hate being so poor."

Wife:
"Sell them (IP's) all now, pay off all debt put the money in the bank for latter, then we can think about buying just one house"
(meaning one house for cash)


In this"How did you start" thread tomdaher said:

It finally clicked to me as long as capital growth exceeds interest you are making money so who cares about the debt.

I concur, if you invest as much capital at your disposal into investments you expect to gain at a rate higher than the cost of capital then why not take on as much debt as you possibly can?

For most of us when we were young the "debt" = "poor" equivance was drumed into us. In Jan's books she talks about this subject, but how many of you agree with the opposite:

Debt = Wealth


General Rule of Investors:The greater debt. the greater net wealth.

Naturally long term increasing debt level on consumerable goods (eg Cars), is drawing you into a world of pain, a different subject in my opinion, this is not capitalism => I am talking capitalism here.

Of course another factor comes in, risk of capital, we should of course seek to create returns in excess of our cost of funds but we also need to make allowance for risk, common sense really, the greater the chance we could loose our (or some) capital the greater the return we would expect before we would invest.

So how many of you in your hearts would agree with
"Given well prepared steps have been made to limit the risks, would you take on as much debt as possible if you could find investments expecting to show returns (returns + gains) in excess of the cost of funds?"

 

[Lissy]

Always learning
Some of your final comments sound very similar to Robert Kiyosaki and his "good debt, bad debt" concept. It was reading about this that FINALLY convinced hubby that I wasn't a total nutter wanting to borrow money for property.
However, he still has his moments when he says "I just want to sell the whole bloody lot and live in a log cabin somewhere".
Yeah, right...!!! hehehe
Sometimes it must be really hard for the non investing partner to cope. I'm lucky that hubby has been willing to take on a lot more than he's really comfortable with.
Having said that, though, he's beginning to enjoy the benefits (ie studying full time at something he loves rather than working full time in a job he hates) so he keeps his complaints to himself a lot more nowadays!

 

[Sunfish]

For some reason R/E advisors have avoided the licencing acts which dog financial advisors. For them disclosure is normal.

The most common one you will find on anything to do with results of your super. "Past performance is no quarantee of future results". This is true of everything in life.

So you've had a few good years of gains in residential property! You cannot guarantee this will continue however. By failing to understand this, many lost more than they made in stock market booms and if you are too highly geared it could happen in R/E too. AL's question infers debt to equity of 90% which means a 10% drop in value renders you theoretically insolvent. A 25% drop may be impossible to hide and you walk away from the table leaving behind the chips you brought with you.

Listen to this if you're game.
http://www.netcastdaily.com/fsnewshour.htm
This is not what AL wants to hear I fear.

I apologise for being the Devil's Advocate..... Thommo

 

[always_learning]

This is not what AL wants to hear I fear.

What I want of course is to generate some thinking and discussion, if I had all the answers to all the questions and my thinking was inflexible then I wouldn't waste one more minute on this forum.

So I do want to hear about it!

My question doesnt infer any level of debt 90%, 100% or what ever, the concept is all contained within "Risk Managment", ie 90% may be too great a level of risk. Actually it doesnt mean even property investing, could be taking a short position on Indian butter futures.

 

[Sim]

Simply put, in the short term, I'm young, get paid a very good and stable salary, and have plenty of time to recover from mistakes - so right now I'm pretty highly geared.

Medium term I will start to actively work to reduce debt, and long term I would like to have the flexibility offered by low debt levels.

 

[Sunfish]

It seems I have managed to offend you. I can only think that we have a different speech idiom in the bush. Positively no offence meant.

In my reply I ignored your last sentence "Given well prepared steps have been made to limit the risks, would you take on as much debt as possible if you could find investments expecting to show returns (returns + gains) in excess of the cost of funds?" as being too vague. I took more notice of the simple very bold statement "Debt = Wealth". (again I'm being direct) I also read your public profile and notice that you are in Tokio. Do you know that by the end of the '80s Tokio R/E was worth more than that of the whole of the USA? Ask around and find out how many Japanese who borrowed big in the '80s (stocks, R/E or whatever) are still wealthy. Tokio apartments lost 90% of value.

There will be fortunes made by the brave in the oughties. I just don't think you can make a new fortune with old ideas. I stress the idea of "new fortunes" and have no wish to influence those who already have reached their goals.

It is important also to preserve capital. If you loose 50% you must make 100% in the next deal to get back to square 1. If you loose 100% you have to go back to work for 5yrs to get another stake. I no longer have the physical or mental strength to start over. I, personally, have been reducing debt for the last year. That does not mean I have retired from investing, merely waiting.

In 10yrs time Oz will be a giant quarry. Find a way to invest in resources.

Thommo

 

[always_learning]

I dont think you tried to offend me, I wasnt offened, no need for concern.

(BTW, I am well aware of the problems of the late 80's bubble in Japan. I also see people many still very wealthy property investors not everyone lost his/her shirt, some sold at the peak and purchased again latter )

 

[Tibor]

Hi AL,

I agree with the philosophy with a slight modification

Good debt = Wealth

if you have the cashflow to service it

More good debt = more wealth

if you have the cashflow to service it

and on, and on and on.

Your better half might had talked to mine. How many times I have heard the same story???

 

[thefirstbruce]

My Dad was in the National Bank for all his working life.
He had two sayings I have come to treasure.

"Smart people use the bank's money, the bank uses ignorant people's money"

"When you owe the bank $200k, and can't afford to meet repayments, you have a problem. When you owe the bank $10,000k and can't afford to meet repayments, the bank has a problem."

My way of looking at things is this. Most of the people who visit this forum are above average intelligence and prepared to take a risk. The majority of people aren't. A healthy economy and society needs people like those who come here to take calculated risks to match private sector supply to demand. In this way, we end up with a more efficient market economy. The more people that take an active interest in borrowing society's capital to meet the legitimate demands of that society, the heathier Australia will be financially and socially.

I personally feel a moral imperative to take an active role in borrowing to fund projects that will help match demand and supply more efficiently. If we don't do that, then the government or less efficient or less ethical people will do it, and prosper. I know my ethics are better than many of the fat cats I know, and I know I shall reinvest my money in a socially responsible way.

If the ethical amongst us don't get involved, then we are letting society down, and leaving it open to exploitation by less ethical people then ourselves.

another of my favourite sayings
"for evil to succeed, good men must do nothing"
It is time for all good people to take a proactive role in using society's capital for smart ethical projects.

If you calmly and methodically analyse economic and social needs, you will soon discover opportunities to make more money then the interest you pay. This is especially true in times of change, and we certainly have that now.

 

[Sunfish]

I also see people many still very wealthy property investors not everyone lost his/her shirt, some sold at the peak and purchased again latter )

In other words they knew to back off. Knew when NOT to borrow to the max. To everthing there is a season.

Thommo

 

[Steve Navra]

Hi AL,

Maybe I am missing the point?

Surely the amount of assets under management (Irrespective of the debt) = Wealth.

So the more assets you control, the greater the wealth being generated will be.

Not to ignore the debt:
Debt levels can range from 0% to 100% and this depends on cash flow.

What amount of cash flow is required to service the debt???
This question ought to be stress tested from current borrowing rates right up to the heady days of 18% interest rates.

If your cash flow can sustain the stress testing then the level of debt is irrelevant.

MORE ASSETS = MORE CG = MORE WEALTH

Amen,

Steve

 

[see_change]

My thoughts on debt .

Yes there is good debt , but there are times to max out to the hilt and there are times to pull your head in. What the time is at the moment depends on your personal situation

Re

Me:
"Prices on more expensive homes in the Sydney North Shore are coming down (a little) I think we should act in the next 6 months: dual occupancy rules have recently been changed in Ku-ring-gai (upper north shore) area, we could buy a dual occpancy site, build our dream (Japanese style) home and another for rental (to Japanese corp ex-pats)"

Yep , certainly the prices have eased , but I havn't seen any fire sales yet.
One friend bought at about 10 % under what he thought should have been the price, but he knows what he's doing and you can usually get that sort of drop with some vendors anyway . Houses are on the market for longer but generally selling.

There is a block which I'd look at if I was interested in a dual occ, but it is on a busier road and I havn't looked at it closely . I'm not sure on dual occ suitability but it is on 1300 M2. If you do a search on Domain.com.au on Fox valley road, look for 69 Fox Valley Road. It's been on the market for about 2-3 weeks

Similarly search Ada Ave and there are two properties on large blocks. Although it doesn't state it I think 29 Ada is actually on one acre (4000m2 ) . Depends on the extent of your ambition and pockets

I am very curious as to why you say they have changed. Do you have any info to this effect?

I have seen a change recently , but it hasn't necessarily been to the benifit of people trying to get dual occs through council. We put our application for a dual occ in to council in wahroonga in March 2003 and we are yet to get an answer from council. We were due to go to council in Nov 03 , but got bounced down the list. The council were debating a new development control plan which as with all the previous plans has been rejected by the state government. At this stage we were told that everything was ok , the council officers had no problems with our proposal. We have gone though several design changes to accomodate the "tree people" in council as we have a battleaxe site , close to the bush. We have to provide a turning circle for a nine metre fire truck on the property . No problems , here's the design.

We are in Blue gum tree high forrest with over 50 gum trees and we have designed the new house so we only need to take three ( I think ) trees out , and two of these were damaged in the Hornsby cyclone of about 10 years ago so are actually a risk . No problems .

Problem . They have a new director who apparently lives in Paddington . We are on a battleaxe site where are nearest ( of 13 ) neighbours is over twenty meters away from our proposed new house. Some of our neighbours have houses over 70 meters away . On one side there are four houses over fourty meters away . The foundations of these houses are some ten meters ABOVE the ridge line of our new house.

As far as we , all of our advisors , and various staff at the council , our proposed house does not pose a privacy issue to the houses around us....... several of which have no view of the proposed house.

As far as the legislation is councerned ( I haven't checked this myself yet ) we do not need to document the details of any adjacent house , unless it's within 9 meters of their boundary. None of them are.

Does this matter ??? No . We have in the last weeks been told that we have to provide a detailed survey that not only documents the location of all the adjacent houses, including the location of their windows... We havn't had a formal quote, but have an indication that this would cost about $20,000.00

The Director has been quoted as saying he is going to lift the bar. That's the only change I've been aware of recently.

Having said that , we are confident that we will get our proposal through, though that might mean a trip to the land and environment court. The advise we have is that it will take one site visit and we will have our approval. I have also been told (not sure on this) that the LAEC have the power to award costs against council and have done so in the past.

So far the director hasn't been out to look at the site.

Despite all that once ( fingers crossed ) we get approval , we will make a nice profit from our venture.

I would be happy to do it again , but it isn't always easy to deal with Ku ring gai council. You need to be patient. Very patient . Very Very patient.

Some friends we went out to dinner with last night are trying to get approval for a car port. I think it's close to the building line, but there are precendents in the street. Council suggested they would be happy to do that , provided you remove your tennis court , and restore that area to the original creek bed. hehe ...

See Change

 

[Indifference]

On face value of the simple nature of the poll, I consider

Good Debt = Wealth to be the only way forward.

I say the only way forward in the context of: it takes money to make money.
So unless your income stream provides for adequate surplus income, then you need to use externally sourced resources, like someone else's $$$.

Just remember the quote "Boy 1 - My dad is so poor that he owes the bank $200K. Boy 2 - My dad is so rich that he owes the bank $2 mil" (or something like that)

 

[always_learning]

In other words they knew to back off. Knew when NOT to borrow to the max. To everthing there is a season.

Thommo

I would say borrow to the max or not was not there thinking, but risk management was "prices are too high, yeilds are too low, sell now!"

 

[always_learning]

Hi AL,

Maybe I am missing the point?

Surely the amount of assets under management (Irrespective of the debt) = Wealth.

So the more assets you control, the greater the wealth being generated will be.

Not to ignore the debt:
Debt levels can range from 0% to 100% and this depends on cash flow.

What amount of cash flow is required to service the debt???
This question ought to be stress tested from current borrowing rates right up to the heady days of 18% interest rates.

If your cash flow can sustain the stress testing then the level of debt is irrelevant.

MORE ASSETS = MORE CG = MORE WEALTH

Amen,

Steve

Of course what you say is true, just my point is that I have observed that wealthy people generally have lots of debt in comparison to the average person.

I was talking to my Tokyo developer friend, he was dealing with Tsutsumi [ (worlds richest property developer), told him (via his laywers) (nicely) to ante up another US$350M or project cannot proceed, bank calls my friend next day to say that the US$350M is approved. Tsutsumi business is based on huge property holdings (1/6 of Japan) and huge debt. My point being that working towards zero debt may not be the best approach to wealth creation. I dont think Tsutsumi had an argument with his wife (or mistresses ) about "another" US$350M of debt!

 

[Aceyducey]

Chickens fight over chickenfeed.
Farmers choose whichever chicken they want.

Cheers,

Aceyducey

 

[Sunfish]

I'm out of step.

The results of this poll show I'm clearly out of step with most forum members.

I have been aware of this while advising caution in the immediate years ahead. I got scant support and a little mockery. My attempts to warn of possible global failure in banking/finance fared worse.

These were honest posts which took time to compose as I am not a natural writer. Having just been told in a private message from a top 100 member that "Your attitude is not suitable for the forum," I will take the hint and remove myself forthwith.

I sincerely hope I am wrong about the future direction but mere hope on my part will not change it.

Thommo

 

[always_learning]

Well it wasnt me Thommo, who are these people who tell others to get f"ar-away"?. Just keep posting!

Actually I have to agree with what you are saying, there are many examples of "slow-busts" in property in recent history Singapore, Germany in which a booming property market is slowly replaced with depressive expectations and a slow fall and stagation in it's place.

 

[geoffw]

I have been aware of this while advising caution in the immediate years ahead. I got scant support and a little mockery. My attempts to warn of possible global failure in banking/finance fared worse.

These were honest posts which took time to compose as I am not a natural writer. Having just been told in a private message from a top 100 member that "Your attitude is not suitable for the forum," I will take the hint and remove myself forthwith.

I sincerely hope I am wrong about the future direction but mere hope on my part will not change it.

Thommo,

I think it would be a pity if you removed yourself.

I will not always agree with you, but I respect your right to post an opinion, even if it's not in line with the opinion of many.

In the end, nobody's opinion will change what will happen in the future. The economy will get better, get worse, or perhaps even stay the same. At least there will be someone who will be able to say in the future, "I told you so".

As long as opionions are expressed well, there's room for all sorts of opinions on the forum.

There are some who cross the line from opinion into personal attacks. That's something which is not desirable.

 

[Peter Parker]

I will stick to the old formula

Wealth = assets - liabilities

Debt amounts by themselves mean almost nothing. Comparison against assets adds a bit more meaning (ie LVR).

The quality of the assets against which the debt is held is probably most significant.

Also very important is cashflow to assist serviceability.

I think all these and more add to the bigger picture about debt and its role in building a portfolio.

Regards,

Peter