Borrowing small amounts to invest in property is not risky

cremeegg

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Moved from another thread. Take the following situation

Salary: €90k
Family home - no mortgage
Two buy to lets worth €150k each - no borrowing

Should he buy another buy to let for €150k with a yield of 10% with a mortgage of say 5%?

He is not by any means overborrowed. So the risk is small. But the risk is still increased by borrowing.
Risk arising from borrowing for property investment, where the investment is to be held for the long term is not like borrowing for other investments.

Borrowing for investments is usually short term or can be withdrawn at will by the bank. There are even (shudder) borrowings subject to margin calls. Borrowing for property is different and usually involves a 25 year contract.

If the borrower is able to cashflow the borrowing then there is no risk that he will be forced to sell at a loss. This is one of the many things that makes property investment for the long term different.
 
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Brendan Burgess

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If the borrower is able to cashflow the borrowing then there is no risk that he will be forced to sell at a loss.
But that is not the source of risk in this case? These investments are small in relation to his total assets and he can repay them in full at any time.

If any of the following go wrong, then borrowing will make the losses worse:
  • A sustained fall in value of the property
  • An increase in interest rates
  • A fall in rent
  • A bad tenant who refuses to pay rent
As it happens, in this case, the OP will be able to handle these bad outcomes comfortably, but borrowing does increase the risk and it seems to me that he does not need to do so.

Brendan
 

cremeegg

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Being forced to sell at a loss is the main risk that people refer to when saying that borrowing to invest increases risk.

Of course if you compare a €100k property bought for cash to a €200k property bought with €100k cash and €100k borrowing then the risk is greater in the €200k property, but that is mostly because its a bigger investment.

Only a fall which is sustained longer than the borrowers ability to support the cashflow for the borrowing, or the borrowers wish to hold the property.
This is a risk in the sense that the costs associated with the investment may be higher than expected. Interest expense is only of the many costs involved with a property investment, any sensible investment case will look at the possibility that any of the costs could turn out to be higher than expected. Any interest rate risk is offset by a corresponding possibility that interest rates may fall, and the possibility to refinance at more attractive rates.
No connection with the borrowing, so long as the borrower is able to support the cashflow.
No connection with the borrowing, so long as the borrower is able to support the cashflow.
 
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Brendan Burgess

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Very interesting points creme egg.

Let's look at what would be risky borrowing and why it's risky



Facts: Mortgage free family home: €300k. Savings of €100k. Income:€60k

Case 1) - Buys an investment property for €100k - no borrowing. There is risk in this, but there is risk in any investment.


Case 2) Borrows €300k to buy a property for €400k.
This is very risky. A bad tenant or difficulty letting the property and he will not be able to service the loan and may be forced to sell. Could easily lose his entire €100k equity and more.

Case 3) Borrows €100k to buy a property for €200k
The risk is less.
 

cremeegg

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Case 2) Borrows €300k to buy a property for €400k.
This is very risky. A bad tenant or difficulty letting the property and he will not be able to service the loan and may be forced to sell. Could easily lose his entire €100k equity and more.
The possibility that a borrower will not be able to service a loan taken out to invest in property is certainly a risk. My point is that if the borrower is able to service the loan, there are no other substantial risks. In particular the idea that a fall in capital values will be magnified due to borrowing, which is relevant to other types of borrowing to invest, is not relevant.

In the scenario you outline above, if our hero has an income from employment adequate to finance the €300k loan then he is not at risk of being forced to sell.
 

Brendan Burgess

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My point is that if the borrower is able to service the loan, there are no other substantial risks. In particular the idea that a fall in capital values will be magnified due to borrowing, which is relevant to other types of borrowing to invest, is not relevant.
This is the bit I am trying to get my head around.

You say "not connected with borrowing" which is an interesting point of view.

The problem is that borrowing allows people to invest more. If they invest more, they can make bigger mistakes.

I have investments in equities with no borrowings. I won't be forced to sell them.

If I borrow €100k to invest in more equities, I won't be forced to sell either because I can afford the repayments. But it increases my risk.

Are you arguing that losing a tenant is a risk, but is not connected to the borrowing?

Brendan
 

Bronte

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I think the issue boils down to this for me, having had this debate with BB and Creamegg for years. Creamegg and me know and invest in property. BB is an expert in shares. I wouldn't have a clue and hate shares. But I love and understand property. I literally do not see the risks that Burgess sees in property. While I do not see the benefits of shares that he sees. I in fact think they are a risk, a risk I'm not prepared for.

Does anyone else see it this way? Maybe it's not rational. But I think it's fair to say that the three of us have made money in the business/money making we are in.
 

galway_blow_in

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I think the issue boils down to this for me, having had this debate with BB and Creamegg for years. Creamegg and me know and invest in property. BB is an expert in shares. I wouldn't have a clue and hate shares. But I love and understand property. I literally do not see the risks that Burgess sees in property. While I do not see the benefits of shares that he sees. I in fact think they are a risk, a risk I'm not prepared for.

Does anyone else see it this way? Maybe it's not rational. But I think it's fair to say that the three of us have made money in the business/money making we are in.
i believe a person can go against traditional orthodox principals of investing and still make it work and you appear to be making it work , i realise some on this site vehemently disagree , i paid off a 50 k loan with an interest rate of 5.54% in july , i had nine years left on the mortgage , the property cost 121 k all ( in late spring of 2016 ) in including stamp duty and legal fees , its commercial and my net income is a grand per month , one particular poster on this site thought this was incredibly risky due soley to the interest rate being over 5% , in the end i paid the loan off and stuck the money in an equity fund ( they are up since by about 4 % ) as my income is not so high to achieve substantial interest write off on the loan but you are not in the position , you are a high earner with plenty scope for interest rate write off ( btw i used some of the proceeds of a sale of another property to pay off the loan on the commercial property )

my overall point is , some are guided by traditional investing textbook principals , this demands you always minimise risk , always diversify and always be liquid , property is not liquid but it does,nt mean someone who bought a few houses or a house in dublin four years ago made a poor choice , common sense tells you they did not , you feel you would not be comfortable with stocks and thats ok , if you bought them you might panic if the market saw a 10% correction , it happens quite often
 
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Fella

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I think Irish people are obsessed with property , you can own property through shares for less risk by buying REIT's. I'm guilty myself at looking at myhome etc and thinking is that good value , I could rent it out. Maybe its ingrained in our culture to buy property . I can't get away from it even though I don't think I will ever invest directly in property. There is too much interference and concentrated risk for me.
Some people are great landlords and have really made it work , I'd imagine there is a skill in it.

I invested in the stockmarket instead of property around the end of 2014 I think it was ~215k invested is now valued at ~260k I have no idea how much better I would have done had I bought property at a guess I'd say property would have outperformed, you can borrow for property as well so you get that leverage (but that increases risk ).

A quick google search seems to show that Shares have outperformed property over a 30 year period, one factor I don't think is considered is the time cost of been a landlord , are people allowing for the time they spend on property ? Call outs , fixing things , getting tenants etc ? I can honestly say bar the initial hassle I had with reading up about ETF's etc I have put no time into the shares investments , just click buy every couple of months now and reinvest dividends and a bit on top from savings.

The Shares look like numbers on screen and its hard to get excited about the profit made , I did withdraw money recently just to check the whole process , sold shares and had money back in my bank account within 24hours thats the added beauty , if you have to sell a property it won't be that quick. So there are positives and benefits in both , I don't think people should limit themselves to property or shares but instead invest in both either via a REIT or direct property ownership.
 

cremeegg

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Are you arguing that losing a tenant is a risk, but is not connected to the borrowing?
Yes, but not just that.

If I borrow €100k to invest in more equities, I won't be forced to sell either because I can afford the repayments. But it increases my risk.
Well not in percentage terms.

Investing more increases risk, in the sense that you have more wealth at risk. It seems to me a trivial point. It is true whether the investment is financed by borrowing or not.

My point is that if you borrow money to be repaid at interest over 25 years or so, the only risk arising from that is the risk you will be unable to meet the repayments. If you are certain, insofar as any future event can be certain, that you can meet the repayments, then there is no risk.

Now if you use that money to make a profitable investment, profitable after all costs including interest, you are in the happy position of profiting on the banks money. That is not a position that can be achieved in many other ways.
 

cremeegg

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I think the issue boils down to this for me, having had this debate with BB and Creamegg for years. Creamegg and me know and invest in property. BB is an expert in shares. I wouldn't have a clue and hate shares.
We are not too old to learn.
 

Sarenco

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i paid off a 50 k loan with an interest rate of 5.54% in july
Paying off that loan gave you an effective, guaranteed, after tax, net return of almost 4.5%! On a risk adjusted basis, that is a stunning return in the current environment - it's no brainer territory.

Investing in a single commercial unit in a provincial town is self-evidently riskier than (co-)investing in a Multi-tenanted retail centre in a large urban centre. You would expect to be compensated for takng that additional risk by way of a higher initial yield.

Leverage carries it's own risks that are separate and distinct from the risks associated with any underlying investment.
 

galway_blow_in

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Paying off that loan gave you an effective, guaranteed, after tax, net return of almost 4.5%! On a risk adjusted basis, that is a stunning return in the current environment - it's no brainer territory.

Investing in a single commercial unit in a provincial town is self-evidently riskier than (co-)investing in a Multi-tenanted retail centre in a large urban centre. You would expect to be compensated for takng that additional risk by way of a higher initial yield.

Leverage carries it's own risks that are separate and distinct from the risks associated with any underlying investment.
i dont regret having paid it off !

im just trying to illustrate to the OP how people have different attitudes to risk , some are more orthodox than others in how they approach risk

regarding your point about my NET return on having paid off that loan , the yield on the property is 10% so a 5.5% loan also leaves a 4.5% return with the added bonus of having forty five grand in cash to spend whatever way i see fit , in my case i couldnt find anything to do with the money anyway so its probably better in the stock market but i dont consider my situation to have been at all risky such was the low loan to book value and high rent
 

Sarenco

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There's no doubt that we all have a different need, ability and willingness to take investment risk if that's your point. Our risk tolerance depends on a variety of factors, including our net worth, age, desire to leave a legacy, etc.

The gross yield on the property won't change because you paid off the mortgage. You won't get a 10% gross yield on a property without taking on material risk - regardless of any leverage.

Incidentally, there's nothing wrong with taking investment risk - as long as you understand the potential downside.
 

galway_blow_in

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There's no doubt that we all have a different need, ability and willingness to take investment risk if that's your point. Our risk tolerance depends on a variety of factors, including our net worth, age, desire to leave a legacy, etc.

The gross yield on the property won't change because you paid off the mortgage. You won't get a 10% gross yield on a property without taking on material risk - regardless of any leverage.

Incidentally, there's nothing wrong with taking investment risk - as long as you understand the potential downside.
i think the higher yield compensates for the less than preferable interest rate , if a property is cheap enough as was the case with dublin property four and five years ago , i believe the interest rate is less important , i think some people over focus on the interest rate and ignore positives like yield , someone with a tracker mortgage is paying a tiny rate but they most likely paid very high prices pre bust , id rather be paying 7% on dublin 2012 prices
 

Bronte

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We are not too old to learn.
That's true. I've two experiences with shares. I bought the Eircom shares back in the day and sold once I got them. My mother bought about 20 K IEP share ares in four comapnies and lost everthing. At least if a house loses it's value you still have the house and it will give you a return. If shares tank you have nothing. My aunt had her savings invested in BofI. She lost something like 100K. Now she's in a nursing home.

Someone else mentioned Reit's. There you have no control, I don't like that aspect to it. Also don't like the fact that the management structure, you have to reply on them and reply on their strategy and rely that they don't go crazy or charge riduculous fees.
 

Bronte

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im just trying to illustrate to the OP how people have different attitudes to risk , some are more orthodox than others in how they approach risk
About risk. My bank KBC did a full risk assessement on me (because we have some cash in the bank idle). Anyway I'm the most risk adverse person apparently. Needless to say I didn't purchase any product they were selling as even the low risk ones (legally they could only show me low risk as far as I understand the rules) I couldn't handle.
 
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