You have two investment options - which one would you choose?

[MarkB]

You have two investment options - which one would you choose? (read carefully)

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Option A: 4 properties @ $250k each


Option B: 1 property @ $1m



For the sake of simplicity assume:

- acquisition and holding costs are equal, and

- LVR is not an issue.


Therefore, what determines whether one is better than the other is the expected CG over the coming 5 years.




Option 1 - Expected return 56%

- 10% chance that it will increase by 99.5% in 5 years ($995k equity gain)

- 15% chance that it will increase by 75% in that 5 years.

- 25% chance that it will increase by 60% in that 5 years.

- 40 % chance that it will increase by 52% in that 5 years

- 5% chance that they will lose 10% in value over that 5 years



Option 2- Expected return 56%

- 10% chance that it will triple in that 5 years ($2m equity gain)

- 25% chance that it will increase by 75% in that 5 years.

- 35% chance that it will increase by 55% in that 5 years.

- 20 % chance that it will have nil CG in that 5 years

- 10% chance that it will lose 10% in value over that 5 years



But they both have the same return?!

Which one would you choose?


Mark

 

[knightm]

I'll take 4 thanks

not because of different cg projections, just because I like spreading cashflow risk. 1mil is a lot of mortgage for me to cover during a vacant period. Chances of all 4 being vacant at the same time? very slim indeed

 

[Sultan of Swing]

I'm with Knight

Spread the risk. 4 at 250k should be more liquid than one at 1mil.

 

[DavidMc]

I'm with Knight

Spread the risk. 4 at 250k should be more liquid than one at 1mil.

Same. 3 @ 333k would be my favourite choice (not that it's offered).

 

[keithj]

I see this as a 'speculator vs investor' poll, rather than a risk spreading poll.

Investors would go for 5% chance of loss and 95% chance of good gains, while speculators would be more likely to go for 30% chance of loss, 60% chance of good gains and 10% chance of exceptional gains.

I voted A, as I'm an investor and also prefer to spread risk.

 

[Rixter]

I go for Option A. for a number of reasons , mainly spreading cashflows & minimising market over exposure risks.

 

[calvin@34]

Looks like I'm a sheep on this one!

I go for Option A. for a number of reasons , first of all it was a gut instinct and then, more importantly spreading cashflows & minimising market over exposure risks.

 

[Merovingian]

I would definitely buy the four houses valued at $250K. For a couple of reasons:

1. The vacancy risk. There are four properties and four tenants — much less risk of all four properties being vacant at the same time.
2. Four separate loans. The structure is much more flexible than having the one loan on one property.
3. The four houses are more than likely near a city's median price, and thus there are many more potential tenants in that price range — i.e. harder to find a tenant in an upmarket property, I presume.

Can't think of any more.

 

[kissfan]

I would definitely buy the four houses valued at $250K. For a couple of reasons:

1. The vacancy risk. There are four properties and four tenants — much less risk of all four properties being vacant at the same time.
2. Four separate loans. The structure is much more flexible than having the one loan on one property.
3. The four houses are more than likely near a city's median price, and thus there are many more potential tenants in that price range — i.e. harder to find a tenant in an upmarket property, I presume.

Can't think of any more.

Ditto. For the same reasons

 

[natmarie73]

And if you absolutely had to sell for whatever reason you could sell one and keep the other three!

 

[Jamie]

Hi Mark,

Do both options involve the same class of property - eg are both options residential, or is one option commercial?

Jamie.

 

[WillG]

I would generally go for the 4 properties @ $250k but if the 1mil property had something gong for it like 'harbour views' then I may be swayed.

I believe it would be difficult to predict capital growth over the next 5 years.

My decision would also e based on where I was at with my investment goals

 

[MarkB]

I'll take 4 thanks

not because of different cg projections, just because I like spreading cashflow risk. 1mil is a lot of mortgage for me to cover during a vacant period. Chances of all 4 being vacant at the same time? very slim indeed

Acquisition and holding costs are equal.

ie. Your comment about vacancies is not applicable.

I see this as a 'speculator vs investor' poll, rather than a risk spreading poll.

Investors would go for 5% chance of loss and 95% chance of good gains, while speculators would be more likely to go for 30% chance of loss, 60% chance of good gains and 10% chance of exceptional gains.

I voted A, as I'm an investor and also prefer to spread risk.

The implication was that the properties are the same in all relevant aspects except that one is 4 x $250k and the other 1 x $1m.

That being the case - you should be indifferent between the 2.

Do both options involve the same class of property - eg are both options residential, or is one option commercial?

As above, the implication was that the properties are the same in all relevant aspects - so they could be either both residential or commercial (you choose) - but whatever they are, they are both the same.




My comments

While I have to accept that I didnt spell out things to the n'th degree and that people (as often happens on this forum) made certain assumptions - there was a clear bias towards what I can only assume was deemed to be the less risky of the two options.

Yet economic theory says that the results should have been roughly 50/50.

They weren't (80/20 at the time of writing).


To recap....

You were presented with two investment options.

In terms of costs to you they were the same.

In terms of expected gains they were the same.



What was different was:

- the value of the properties

- the distribution of the possible gains (losses)



Because the properties had the same acquisition and holding costs and you had to buy either one or the other - they they were the investment equivalent of a free lunch because all you had to risk was possible gains.

I made this comment yesterday on another thread.....

I will say that it does sometimes annoy me that we can be (as a group) small minded and happy to count our pennies, even when there's dollar bills floating around for those who want to take the bull by the horns.


So it appears that my point is proven.

Mark

 

[Brenda Irwin]

Something you haven't considered is the CGT incurred if you want to sell B to reinvest into another investment. With selection of A, you can sell one IP without incurring too much CGT and free up some money to reinvest into something expecting even more growth and return.

 

[see_change]

possible gains.[/B]

I made this comment yesterday on another thread.....

I will say that it does sometimes annoy me that we can be (as a group) small minded and happy to count our pennies, even when there's dollar bills floating around for those who want to take the bull by the horns.


So it appears that my point is proven.

Mark

I'd disagree Mark.

For me the reason to vote 1 is the 30 % chance of a loss with option 2. Sure the potential gains are higher but without any other info I'd go for the one with the more certain gain . The other points people mention are valid.

One point not mentioned in favour of option two is you only have one property to watch and maintain data on.

It does come down to speculation vs investing.

If for example this was only a small percentage of one's portfolio , one might consider option two , if the rest of the protfolio has more secure gains projected.

See Change

 

[Jamie]

Mark,

Is your post basically a comment that people are too risk averse?

While you're right that, on average the properties may have the same return, this is an example of how you lose some of the details in the numbers.

In Option 1, there is a 5% of the properties having Nil CG or going backwards.

In Option 2, there is a 30% chance of the property having Nil CG or going backwards.

Why is it hard to fathom that people may take the path with the least downside, rather than the most potential upside?

Isn't one of the basic tenets of sound property investing (and one that separates it from speculating) not only return ON investment, but also return OF investment?

Just a few thoughts,

Jamie.

Edit: Looks like seech just beat me to it above

 

[MarkB]

Looks like the Xmas roast is a couple of days early.

/me rotates slowly

Mark

 

[see_change]

Looks like the Xmas roast is a couple of days early.

/me rotates slowly

Mark

That Turkey sure smells nice from here . Open house at your place Mark ?? . Jamies got a nice set of knives I hear

See Change

 

[Rixter]

Jamies got a nice set of knives I hear

I dont think theres any room left on his back

 

[wish-ga]

Option a) = more flexibility

That was my first thought. However, I am very wet behind the ears so thought I may not be seeing the whole pic. Yet many of the very experience investors feel the same way (they expressed it better than I of course)