AAR & TOL 01 (May 08 - Oct 08)

[tangoandrew]

Given the below scenario...would you take the risk/reward?

1) Suppose you can borrow 100k @ 2.5% over 20 yrs. You have to pay the interest & principal as in a housing loan, $530 pm for 100k loan [1060x12/200k = 6.36%].

Say, you use the 100k to buy dividend-paying reits/trusts [5 to 10% yield] that have dropped 10/40% in price over the last 2 mths.

BTW, you have 100k (standby $, park at money fund) available to pay down the loan at any time so that you don't have to sell-off the reits/trusts.

If average return is 7.5%, then net gain is 5% (have not less fees, etc), monthly gain = 625 - 530 = $95 pm. For 20 yrs, 95 x 20 = $1900 gained plus the reits/trusts as the loan has been paid off by then.

2) Above looks ok...but what is the risk or downside? Are there other factors needed to be taken into consideration?

[helios]

yo tang0andrew,

TOL:

1. the primary credit risk that the 100K loan will be dafaulted by banks or lenders, whatsoever? i am assuming that 20 years is a damn long time period. What-if the loan is suspended or defaulted? And the worse part, u are still committed to pay off your house in mid-way ...

2. no leverage, any other leveraging factors to stretch this pool of $$$?

3. where's the breakeven point (in terms of timeline)? which part along the 20years is the crux?

4. legal risk.

[tangoandrew]

sorry..an error in the gain calculation...gain p.a. is $95 x 12 = 1.14k... so 20 yrs, 22.8k.

hi san2,

1) Don't really understand credit risk because the loan is given by local bank as like a housing loan in terms of interest rate, locked-in period, tenure, etc. it's separate from the housing loan but full repayment of loan must be made when property is sold. So, as long as the property is not sold off, just make the monthly repayment of $506, depending on the changing interest rate.

2) Not sure what you mean??? Actually maximum amt of loan is pegged at [80% of valuation less outstanding hse loan less cpf used - cpf interest accrued]...but you can opt for lesser amount. Bigger amount, bigger risk/reward.

3) Not sure this is the best way to look at breakeven point....($506 x12) p.a. is 6.1% of 100k, so as long as the gain is = 6.1%...the capital 100k stays intact. If reits/trust prices drop, then % gain must > 6.1% to keep BE...and if reits/trusts prices go up, then % gain can be <6.1% for BE.
A 20% drop in reits/trusts prices (80k left), would require a 7.6% yield for BE. 30% drop needs 8.7% yield for BE.
From the amortization table, at the end of 3-yrs, the outstanding balance of loan is 88k, so it means that if yield is 6.1% for the 3 yrs, i.e. breakeven, there will be no net gain or loss if the reits/trust prices dropped by 12% [(100k-88k)/100k].
Reits/trusts have dropped in prices recently...so question is the probability of further drop vs likely recovery. But any drop has to be compensated by a bigger gain to balance off.

4) no legal risk

Some comments:
a) it is using the property to leverage the borrowing...but the risk involved is the movement of the price of reits/trusts.
b) the 100k cash can be on standby to redeem loan fully if need to use the property as collateral for a new OD loan.
BTW, an OD loan interest rates are from 4.25% to 6.5%, though you can opt to pay off just the interest & not the principal.

So question in this case is "Does the reward outweighs the risk?
Would you take the plunge? Why? Why not?

[kennynah]

it seems so complicated to me...but i thought i share my simple thoughts...

u have $100K in money markets. u wana borrow $100K at some interest costs and you figure you can make a better return from this borrowed money but u are also aware of the risks involved. if things dont work out, you have that original $100K to settle that $100K loan .. i assume this is an accurate summary.

that being that case,

why give yourself double exposure to risks?

you borrow - risk #1 exposure to interest rate flucs
you invest from borrowed money - risk #2 from investment vehicle

when all you could do is risk your original $100K, and that's that.... you win or you lose in your investments, it's your $100K....not a borrowed collaterized money....

that's my simple take..... anything deeper than this.... my brain shuts down....

[ishak]

Won't take the plunge as it is too complicated.

Take the $100K that you already have, choose a basket of stocks/bonds that provide 8 to 10% returns and reinvest whatever dividends every year. This way, you probably can get back $200K in 9 years though you might have to actively rebalance your portfolio once in a while according to the market trend.

In addition, a 100K standby fund is too expensive to sit around waiting for something to happen and i don't dare to predict which REIT or stock will still be around after 20 years.

You are also not exactly leveraging since you already have in asset 100K, borrow another 100K but only invest 100K, if am not wrong the gearing is effectively 0.

[helios]

Won't take the plunge as it is too complicated.

In addition, a 100K standby fund is too expensive to sit around waiting for something to happen and i don't dare to predict which REIT or stock will still be around after 20 years.

You are also not exactly leveraging since you already have in asset 100K, borrow another 100K but only invest 100K, if am not wrong the gearing is effectively 0.

i like ishak's comment.

if the breakeven is about 3 years span, why not invest your own money for 3 years to prove this reits-based-methodology? u will increase the higher success factor?

forgot to add:

5. human risk. what happen if you win, are you able to keep your head to take profits at the crucial points? Greed always come into the picture, what traits you have that allows you to think more clearly?

6. + other opportunity cost that comes into the micro-picture during the 20 years. you might start your own business, who knows?

AOR.

(u know, if one is wheeled into the hospital, in order for any surgery/ operation/ anaesthesic procedures to be conducted, one has to sign the AOR intent form).

[tangoandrew]

Hi k, agreed that it's complicated...that's why pick brains here!
Your summary is correct...and i understand your reasoning for not taking the double risks.
Would you take the plunge if the 100k is part of standby fund reserve for property purchase within the next 3/4 yrs?

Hi ishak, like your suggested strategy...but would your view change if the 100k is as mentioned above, for property purchase?

Hi san2, that's what i was thinking...test out the reits-based-methodology for 3-yrs which incidentally is the lock-in period, and at the same time have the 100k standby fund in case of good value property purchase.

Ok...human risk...in fact greed is already in the picture when one takes borrowed collateralized money to invest....
On the other hand, fear is present when not taking advantage of leveraging, because another way to view this whole strategy is forced saving.
So for comparison, using a monthly saving scheme of a local bank, for $506 p.m., interest rate is 1% & over 20 yrs, total = $134486 (based on calculator here - http://www.bankrate.com/brm/news/sav/20 ... vings-calc).
For reit-based strategy, assuming constant capital of 100k (which is not) & 5% differential gain of yield over interest, at end of 20 yrs, amount = share price of reits/trusts + 22.8k.
For this to be on par with mthly savings scheme, value of reits/trusts must increased by 11.6% [(134.486k - 22.8k)/100k] over the 20-yrs.

Thanks for your inputs as it help me to think thru...and still thinking thru how best to optimize opportunities but also realized risks & rewards go hand-in-hand. Guess whether the above strategy is suitable will also depend on a person's overall portfolio....

[helios]

So for comparison, using a monthly saving scheme of a local bank, for $506 p.m., interest rate is 1% & over 20 yrs, total = $134486 (based on calculator here - http://www.bankrate.com/brm/news/sav/20 ... vings-calc).
For reit-based strategy, assuming constant capital of 100k (which is not) & 5% differential gain of yield over interest, at end of 20 yrs, amount = share price of reits/trusts + 22.8k.
For this to be on par with mthly savings scheme, value of reits/trusts must increased by 11.6% [(134.486k - 22.8k)/100k] over the 20-yrs.

V good, u have a business plan on-going liao! any other resources u can tap into?? gold rings or whatever? [joking]

a trader's style is the innate ability to implement/ execute your ideas despite adverse conditions.

think clearly, have the courage.

afterwhich, AOR (at your own risk)!

[kennynah]

Would you take the plunge if the 100k is part of standby fund reserve for property purchase within the next 3/4 yrs?

hi toa :

no, i would not, especially if this property purchase is not for investment purposes.

[iam802]

if I have set it aside for property... I might look for a FD (foreign currency) to earn some interest.

eg. $100k on New Zealand FD...can get about 7-8% ?? (don't know what is the current rate)

Personally, I prefer to keep things simple (for myself) to execute easily.