When can too much 'good' debt be bad ?

[Intrinsic_Value]

fair enough, except in property you can be eaten alive before you can exit. i know because about a year ago i had to sell a property and there just wasnt a market to sell into. putting together a deal in that type of environment will give you years of experience in a very short time. eastpac was about to push the button on me so i HAD to get a result

you are spot on Ausprop.
Property is 'illiquid', when the tide moves against one (ive got to keep reminding myself to use 'one' instead of 'you', people keep seeming to think that i mean them when i just want to make a point, i am not refering to the poster when i say 'you' in a general context), exiting can be difficult.

Your post is interesting because it brings flashes back to mind of reminiscences of a stock operator (the ultimate trading book).
Somewhere in the book it talks about the need to offload a position, not at its optimal price, but where the MARKET WILL TAKE UP THE SELL POSITION.
In otherwords as a trader you cant always offload at the price you would like, you have to offload when there is a sustainable market for your securities (ie read bull market).

I am doing something like this in the melbourne market at the moment. I have the 'traditionally' worst kind of property investment: high rise inner city apartments. But i bought them below my perception of intrinsic value, well below replacement cost. But they are not A-grade properties, so therefore they dont deserve to stay in a hold at all costs portfolio (actually some are better than others, some are more 'uniquie', so i am offloading the lowest quality ones first whilst the buying market is strong).

 

[Reality Cheque]

It's ok to have high LVR's as long as you have liquidity in other areas. I'm very wary of the property market at the moment yet my LVR on property has risen from 68%to 88% in the last 6 months.

But I'm in a much safer position. My LVR on total investments has dropped to 48% and I now have excellent liquidity.

Property's biggest disadvantage is illiquidity. I found it interesting in my thread about asset allocations that a lot of people are close to 100% property, very little cash/ shares. Very low liquidity. Combine that with a high LVR and......well......lets just say it's not my cup of tea at the moment.

I'm not saying that its not a good strategy, I've used it myself. But it's a boom time strategy.

I'd rather take the blinkers off and roll with the punches.

RC

 

[devo76]

Just a small point.

Many people say that they keep cash buffers with neg geared portfolios. Often the amount is worked out on the current shortfall. Say $1000 per month so they have $24,000 or 2 years buffer. Problem is the current shortfall is worked out after a decent tax reduction. And the problem in the future may be loss of work. This will instantly remove much of the tax deduction and increase your weekly cost.Your buffer will reduce significantly.

Just a thought.

 

[Paul Do]

In my experience, experienced investors invest with low or no debt, while novices tend to overextend themselves. They might have gone to a seminar and become motivated to make up for lost time.

But a little knowledge is a dangerous think. Debt magnifies your returns, but because the interest has to be paid every year in relatively fixed amounts, while the return of the investment is variable and uncertain, it increases your risk. The return on some investments are more predictable and certain, which allows the use of more debt, but the danger is that people become tempted to push the envelope.

So good debt is a bad thing when you overextend yourself. It's not just bad when things go pear shaped, it's bad because of the increased risk (that's an important thing to manage as an investor; novices don't seem to have any concept of this) and also the sleep at night factor.

 

[RumpledElf]

Property's biggest disadvantage is illiquidity. I found it interesting in my thread about asset allocations that a lot of people are close to 100% property, very little cash/ shares.

Guilty as charged. I'm basically 100% property and one has been for sale for over a year. Couldn't get much less liquid.

I have a bite on it this weekend though so it might get more liquid. What's that process called, when you sell a very illiquid house? Melting?

 

[Brett IP]

Good debt becomes bad debt when you cant sustain and hold out through the tough times in the market. As has been said many times before, property "investing" is usually a long term strategy and you have to find your level of safety vs risk. This is also dependant on your strategy.

There are always going to be reasons which could force a house sale or action along those lines, such as the main wage earner losing employment for an extended period or major family health problems, thats just part of the risk, its hedgeable in ways but you cant escape risk completely.

If people calculate their investment with a semi negative view, i.e allow for bad times, then there shouldnt be too many issues. realising its not always going to be rosy is a good start.

As house prices keep moving north it is getting harder for young investors to physically enter the market (for PPOR and IP) even at 90% LVR. If one was to pay down their PPOR before investing further then they wont be investing for a very LONG time unless they are on fantastic wages. I know I couldnt pay off $350 - $500k in a short time.

 

[wobbycarly]

But a little knowledge is a dangerous think.

Freudian slip, Paul? I still like it!

 

[Peter Parker]

I am reading a book by Anita Bell on Prop Investing. She seems to propogate the idea of paying off PPOR and IP1 before taking on IP2...although I am still yet to figure out how she paid off her PPOR and IP1 in less than 3 yrs..

She:

1. bought at a time when house prices were a lower multiple of income than now (though interest rates might have been higher)

2. bought something cheap in a suburban fringe location

3. scrimped and saved, putting every spare cent into the mortgage

I don't know if she took in borders or worked multiple jobs as well

 

[wobbycarly]

I read her first book "How to pay off your mortgage in [whatever] years, but someone who did it in [a lot less than whatever]"

The first piece of advice in the book was useful - get the right loan.

The rest of it may as well have been called "how to live like a miser". Obviously we all have a choice, but for me it was a bit OTT, especially when using examples something like:

Second hand deep freezer - $400
Normal sausages - $5/kg
Bulk sausages - $4/kg
Running costs of the freezer - 11c/day

So if you buy 400kg of bulk sausages, you pay for the cost of the freezer. But for a year it costs you about $40 to run the freezer, so that's another 40kg of sausages before the freezer's paid for itself.

Gotta admit I haven't read the next installment about paying off the IP, but I guess if you can pay off a mortgage in a few years, you can apply the same principle to an IP.

Gotta say, I admire where she's got to. Lots of sacrifice and hard work, just more sacrifice than I would want!

 

[Reality Cheque]

She:

1. bought at a time when house prices were a lower multiple of income than now (though interest rates might have been higher)

2. bought something cheap in a suburban fringe location

3. scrimped and saved, putting every spare cent into the mortgage

I don't know if she took in borders or worked multiple jobs as well

My brother paid off his first home in 3 years. Finished paying it off last year. 3 bedroom, brick and tile, 1500sqm block, nice area in country town.

He pretty much lived on fresh air and water for 3 years but he's in a good position now. Even starting to put a bit of weight back on.

RC

 

[BayView]

although I am still yet to figure out how she paid off her PPOR and IP1 in less than 3 yrs..

Thanks for your patience & comments.
K

It can only happen by one of two ways;

1) she was a very high income earner and put a lot of her (and her partner's) income into the loans.
2) they were very cheap properties, and she was still in category 1) as well.

Further to the question, it is ok to keep on accumulating large sums of good debt as long as the cashflow attached to it can support the assets and their debt.

Now, for us, our journey has never involved a high income, so the cashflow HAD to be good for us to keep on going.

We are now more in debt than ever, but the cashflow behind the assets is enough to support it all without our own income, and the LVR has dropped as the assets have grown in value.

 

[stargazer]

Hi

Paul Do
In my experience, experienced investors invest with low or no debt, while novices tend to overextend themselves. They might have gone to a seminar and become motivated to make up for lost time.

But a little knowledge is a dangerous think. Debt magnifies your returns, but because the interest has to be paid every year in relatively fixed amounts, while the return of the investment is variable and uncertain, it increases your risk. The return on some investments are more predictable and certain, which allows the use of more debt, but the danger is that people become tempted to push the envelope.

So good debt is a bad thing when you overextend yourself. It's not just bad when things go pear shaped, it's bad because of the increased risk (that's an important thing to manage as an investor; novices don't seem to have any concept of this) and also the sleep at night factor.

So as a new investor how do you start with low or no debt you have to be in a risk position at the start unless you spend years and years saving even then the prices would possibly run and get further away from you.

SG

 

[Intrinsic_Value]

It's ok to have high LVR's as long as you have liquidity in other areas. I'm very wary of the property market at the moment yet my LVR on property has risen from 68%to 88% in the last 6 months.

But I'm in a much safer position. My LVR on total investments has dropped to 48% and I now have excellent liquidity.

Property's biggest disadvantage is illiquidity. I found it interesting in my thread about asset allocations that a lot of people are close to 100% property, very little cash/ shares. Very low liquidity. Combine that with a high LVR and......well......lets just say it's not my cup of tea at the moment.

I'm not saying that its not a good strategy, I've used it myself. But it's a boom time strategy.

I think we are doing a similar strategy at the moment, except i keep low LVR in property but use a margin loan against shares.

I'd rather take the blinkers off and roll with the punches.

RC

I think we are doing a similar strategy at the moment, except i keep low LVR in property but use a margin loan against shares.

As you highlighted i am especially attracted to liquidity in the current environment.

 

[Intrinsic_Value]

fair enough, except in property you can be eaten alive before you can exit. i know because about a year ago i had to sell a property and there just wasnt a market to sell into. putting together a deal in that type of environment will give you years of experience in a very short time. eastpac was about to push the button on me so i HAD to get a result

Yes this is why i am nervous on property in the current environment.
I can still see 'both sides of the street' with property and shares, but shares give me liquidity (at least more so than property, it can still be a bummer trying to dispose of small caps when the stock market is going through a bout of fear).

Liquidity gives the the flexibility to act on new information.

 

[Paul Do]

Gotta say, I admire where she's got to. Lots of sacrifice and hard work, just more sacrifice than I would want!

Reminds me of the Mexican Fisherman
http://www.inspirationpeak.com/shortstories/mexicanfisherman.html

 

[jaycee]

Paul, that's how a lot of non investors see those who strive conciously to invest etc

 

[Paul Do]

Hi



So as a new investor how do you start with low or no debt you have to be in a risk position at the start unless you spend years and years saving even then the prices would possibly run and get further away from you.

SG

As a new investor, you would look at the relative valuation of different asset classes and go from there. For example, the stock market is around 2/3 of its highs, while the property market is at its all time highs and high as a multiple of income. So the low risk option might be to stand aside from the property market and invest in the stock market.

 

[jaycee]

Paul, So with or without leverage for said new investor today.....

 

[Paul Do]

The extent of leverage doesn't vary by experience level, unless inexperienced investors pay significantly over market value.

The extent of leverage should vary with valuations. Borrow more near the bottom of the cycle, borrow less near the top of the cycle, not the other way round.

 

[jaycee]

The extent of leverage doesn't vary by experience level, unless inexperienced investors pay significantly over market value.

The extent of leverage should vary with valuations. Borrow more near the bottom of the cycle, borrow less near the top of the cycle, not the other way round.

Sorry Paul, not sure if you did it on purpose, but too cryptic for me to understand.