Will Property ever Boom again
- Thread starter pickle pickle
- Start date
I find this topic of time value of money, interest rates, amazingly misunderstood on a property investment forum.
Evand is right. Inflation plays a significant role in influencing the time value of money. More inflation, the more a $ today loses value compared to some point of time in the future. Therefore anyone lending you money will charge a higher interest rate to compensate for this loss of purchasing power for the funds they have lent to you. If not, they wouldn't lend.
Sure the principle remains the same, but you have been paying for the privelage of using those funds, and part of the cost of those funds is inflation.
Pre deregulation in this country, mortgage rates were often less than inflation. Good times to borrow in the context of the discussion about time value of money but that had other negative effects on the economy.
Dan
That would have been correct if I didn't receive any rent in those 20 years.
But I did receive rent which covered the majority of the $320K and I also received a tax refund so my shortfall was very small. In fact after all this time the rent would be more than enough to pay the mortgage off or can provide me with an income stream during retirement
Evand and Thommo,
I understand the point you've both made and its a good one. The banks are not in the business of losing money. But that's only because they lend at a margin on what they borrow money at. So they always make their spread.
But the point of inflation is that it does inflate away your debt in "real" terms. I know you understand this as its the basis of the Time Value of Money.
i.e. FV = PV*(1+i)^n
where FV = Future Value, PV = Present Value, i = inflation and n is the number of periods.
So, if we have a loan with a Present Value of $200K and hold it for 10 periods of 3% annual inflation then the Future Value of this loan would be $268,783. But we get that loan for only $200K! If we don't "pay" for this inflation then we're getting a discount of $68,783 on its future value price.
But the point you're making is we pay for that inflation through our interest rate. This is only partly true though. Since interest is only charged on the principal sum which is not indexed to inflation. Lets assume the bank charges 5% interest on the loan and makes a 2% spread above inflation of 3%. This may work in year one, but in year two the FV of that loan has increased in line with inflation but the interest is still only charged on the principal sum of $200K. In time the value of that loan increases exponentially in line with inflation whilst the loan amount which the interest is calculated on remains fixed at the level it was when borrowed in the past.
In fact, after 18 periods the interest charged at 5% does not even cover the inflation rate increases in the value of that money at 3%. i.e. After that period of time, the interest doesn't even cover inflation.
And this ignores the fact that all the other elements like rent increasing at the rate of inflation come into play as well. On a pure and simple time value of money analysis, inflation does erode the value of your fixed principal sum loan.
Cheers,
Michael
I understand the point you've both made and its a good one. The banks are not in the business of losing money. But that's only because they lend at a margin on what they borrow money at. So they always make their spread.
But the point of inflation is that it does inflate away your debt in "real" terms. I know you understand this as its the basis of the Time Value of Money.
i.e. FV = PV*(1+i)^n
where FV = Future Value, PV = Present Value, i = inflation and n is the number of periods.
So, if we have a loan with a Present Value of $200K and hold it for 10 periods of 3% annual inflation then the Future Value of this loan would be $268,783. But we get that loan for only $200K! If we don't "pay" for this inflation then we're getting a discount of $68,783 on its future value price.
But the point you're making is we pay for that inflation through our interest rate. This is only partly true though. Since interest is only charged on the principal sum which is not indexed to inflation. Lets assume the bank charges 5% interest on the loan and makes a 2% spread above inflation of 3%. This may work in year one, but in year two the FV of that loan has increased in line with inflation but the interest is still only charged on the principal sum of $200K. In time the value of that loan increases exponentially in line with inflation whilst the loan amount which the interest is calculated on remains fixed at the level it was when borrowed in the past.
In fact, after 18 periods the interest charged at 5% does not even cover the inflation rate increases in the value of that money at 3%. i.e. After that period of time, the interest doesn't even cover inflation.
And this ignores the fact that all the other elements like rent increasing at the rate of inflation come into play as well. On a pure and simple time value of money analysis, inflation does erode the value of your fixed principal sum loan.
Cheers,
Michael
This is the sleeper issue I believe.
The irony was when interest rates were 13% was the best time ever to borrow money.
That's OK. But you must deduct the FV of your input costs which have already been spent, thus unavailable to you. Then you must reverse the process to find the PV of the ($68,783 - FV of costs).
And for the life of me I still don't understand how you can ignore interest paid along the way. It would be nearly double the $68k, and the FV calculations would make that worse.
I believe rent (dividends) and cap gains are the reward for the risk undertaken and should not contaminate your estimation of finance costs. I have zero interest in waiting 10 years before my investments bear fruit.
Now im not as up to speed as the many whizz bang economic types on here but are we not over thinking it a bit.
Buy a property that has the rental income covering all the outgoings either straight away or as quick as possible.
Fast foward a decade or so and you have a property that is worth significantly more due in part to inflation and at next to nil cash cost to yourself.
I understand both sides of the argument but is the proof in the end result.
A property worth significantly more than it cost you.
Buy a property that has the rental income covering all the outgoings either straight away or as quick as possible.
Fast foward a decade or so and you have a property that is worth significantly more due in part to inflation and at next to nil cash cost to yourself.
I understand both sides of the argument but is the proof in the end result.
A property worth significantly more than it cost you.
but the sole purpose of holding a property for 95% of th epopulation is to rent it out - so it's fair and equitable to assume the dividend.
you're mixing conservative sharemarket startegy with real estate strategy and it's no wonder the two theories don't coalesce.
As it is with shares and net rent is about what can be achieved by an "income" share portfolio. And dividends increase in dollar value each year too.
I really don't see the BIG difference between the asset classes some of you guys see. That is: The same principles of risk/reward should apply. I have never heard a share investor claim that his margin loan "inflates away" if he keeps it long enough. The best they hope for is that appreciation of the portfolio will meet the interest charges and he won't actually have to pay interest monthly. It's a different mindset but not a different problem.
I probably understand inflation better than you do.
If you borrow $100k and buy 100k items for resale and the currency drops 95% o/night you only need to sell 5 thousand items in the new deflated money to be able to repay your lender. Hyper inflation does indeed benefit the borrower provided you are paying less than 2,000% o/n interest. (in this case)
Debts only "inflate away' while interest paid is less than real inflation. That is why the "money centre" banks in the US are rolling in it. They have access to virtually free money but they lend it out with an inflation component in the costs to the consumer.
I don't think there is much disagreement on here really... the connecting dot is that 'we' don't pay the inflation component. in its most simplistic form it is the tenant in a CF neutral property, then any variation from there depending if you go CF- or CF+
no one would seriously argue that in an owner occuiped property that your debt magically disappears just by holding the mortgage.
If have $1m of debt at 100% LVR = $75kpa repayments and I achieve $75k pa rent, how is my debt not deflating?
gross returns on a rental property are:
- capital growth
- debt x CPI
- rent
- tax deductions and rebates
outgoings are:
- interest
- asset value x CPI
- holding expenses
no one would seriously argue that in an owner occuiped property that your debt magically disappears just by holding the mortgage.
If have $1m of debt at 100% LVR = $75kpa repayments and I achieve $75k pa rent, how is my debt not deflating?
gross returns on a rental property are:
- capital growth
- debt x CPI
- rent
- tax deductions and rebates
outgoings are:
- interest
- asset value x CPI
- holding expenses
