Borrowings invested in property is the best hedge against inflation

[Brendan Burgess]

€300,000 over 30 years at a fixed rate of 3% is €1,260 a month. It is unusual that you have that much certainty about an investment. At 5% the repayment is €1,590.

Even at these rates, borrowing is very risky.

But are these rates available today?

These are AIB's rates for Buy to Let



I can't see any lender offering longer than 5 year fixed, but I don't know the market well enough, so there may well be someone offering 30 years at 3%?

Brendan

 

[PebbleBeach2020]

If you had a house (PPR) with a mortgage, it would make sense, if you afford it, to retain the property as a rental, if moving to another PPR or purchasing a property.

You could retain a buy-to-let at a much reduced interest rate.

 

[Brendan Burgess]

Hi PebbleBeach

It would certainly be better to hold onto a PPR as a rental if you have a cheap tracker than to buy an investment property at Buy to Let mortgage rates.

But in most of the Money Makeover cases where this has been analysed, it has generally been better to get rid of the first home and use the equity to pay down the mortgage on the new property.

But each case must be looked at on its own merits.

Brendan

 

[ClubMan]

If you had a house (PPR) with a mortgage, it would make sense, if you afford it, to retain the property as a rental, if moving to another PPR or purchasing a property.

You could retain a buy-to-let at a much reduced interest rate.

For most people this would mean concentrating most, if not all, of their net worth in one asset class and geographic region (Irish domestic property - and leveraged with borrowing at that) leading to a severe lack of diversification and all the concomitant risks.

 

[NoRegretsCoyote]

But many lives were seriously damaged by borrowing to invest.

The problem was excessive leverage, not leverage itself.

Take a landlord who bought an apartment in 2007 for €400k at a 50% LTV on a tracker for 30 years. Their mortgage started around €1100 and fell to about €600 by 2009.

Rent probably started at €1400, declined to €1,000 in 2012 or so, and is maybe €1,700 again now.

Negative equity was very small and very brief, and property was always at least breakeven on a cashflow basis after tax. For the last half a decade generating a comfortable cash surplus. By now with an LTV of 30-ish %.

This landlord has made more with 50% leverage than with 0%, while of course 100% would have ruined them. There is a happy medium.

 

[Brendan Burgess]

Hi Coyote

The best leverage is 0%.
That is the least-risky hedge against inflation.

You are right that the 100% loans were a big cause of the problem. But don't forget that those who got 100% loans, generally got cheap trackers.

These days, you can't get 100% loans but you can't get cheap trackers either.

When things are going well, as they are at the moment for most landlords, there is an assumption that the good times will continue forever. They won't. There will be very bad patches ahead. Most landlords will survive and still be around for the recovery.

But many leveraged landlords will get into serious difficulty.

Is 60% LTV safe? It's certainly safer than 100% LTV. But it's not safe.

The safest is to avoid borrowing altogether.

Brendan

 

[NoRegretsCoyote]

But don't forget that those who got 100% loans, generally got cheap trackers.

Trackers weren't cheap when they got them! In 2007 people were paying 5% interest on properties that yielded 4%. With a 100% LTV this was always incredibly risky as you were subsidising your mortgage from Day 1 in the hope of capital appreciation!

Is 60% LTV safe? It's certainly safer than 100% LTV. But it's not safe.

Leverage always introduces risk. The issue is whether it's tolerable for buyer and seller. The arithmetic is very different today because yields are so much higher.

Suppose I had €200k and wanted to be a landlord. I would happily take €200k in borrowing at 5% and buy two apartments yielding 8%. Risk of not being able to sell very low for me, and risk of non-recovery of capital very low for the bank in event of default. I'd be diversified too - even with prolonged non-payment of rent on one property I'd still be able to cover the mortgage payments from the other.

It would increase my return for not a huge extra amount of risk. It would also be profitable for the bank.

 

[DK123]

Trackers weren't cheap when they got them! In 2007 people were paying 5% interest on properties that yielded 4%. With a 100% LTV this was always incredibly risky as you were subsidising your mortgage from Day 1 in the hope of capital appreciation!



Leverage always introduces risk. The issue is whether it's tolerable for buyer and seller. The arithmetic is very different today because yields are so much higher.

Suppose I had €200k and wanted to be a landlord. I would happily take €200k in borrowing at 5% and buy two apartments yielding 8%. Risk of not being able to sell very low for me, and risk of non-recovery of capital very low for the bank in event of default. I'd be diversified too - even with prolonged non-payment of rent on one property I'd still be able to cover the mortgage payments from the other.

It would increase my return for not a huge extra amount of risk. It would also be profitable for the bank.

Hi Coyote

The best leverage is 0%.
That is the least-risky hedge against inflation.

You are right that the 100% loans were a big cause of the problem. But don't forget that those who got 100% loans, generally got cheap trackers.

These days, you can't get 100% loans but you can't get cheap trackers either.

When things are going well, as they are at the moment for most landlords, there is an assumption that the good times will continue forever. They won't. There will be very bad patches ahead. Most landlords will survive and still be around for the recovery.

But many leveraged landlords will get into serious difficulty.

Is 60% LTV safe? It's certainly safer than 100% LTV. But it's not safe.

The safest is to avoid borrowing altogether.

Brendan

I think if you go below say 50% LTV [leverage] on a well located residental property for renting then you are "playing your cards so close to your chest that you cannot see them"perhaps.

 

[Brendan Burgess]

"playing your cards so close to your chest that you cannot see them"

A great expression which I had not heard before.

Brendan

 

[Gordon Gekko]

There’s a level of borrowing that’s appropriate, and it’s neither 0% nor 100%.

Being too cautious is dangerous in itself.

Imagine saving to buy a property rather than using some leverage.

 

[Brendan Burgess]

Imagine saving to buy a property rather than using some leverage.

We are not talking about buying a home where borrowing is necessary.

We are talking about borrowing to buy a risky investment.

Brendan

 

[Gordon Gekko]

We are not talking about buying a home where borrowing is necessary.

We are talking about borrowing to buy a risky investment.

Brendan

But borrowing to invest in a rental property is “okay” once it’s at a prudent level.

 

[Brendan Burgess]

Investing in property or shares is risky.

Once you borrow, you increase that risk, unnecessarily.

Clearly a 20% LTV is less risky than a 100% LTV.

But there is no need for it, so it shouldn't be done.

Brendan

 

[elcato]

Investing in property or shares is risky.

Can't really compare imo. You always have a plot/site/house in property amd you choose when to quit. In shares that decision is often out of your hands and you are kicked out with a big loss. Eircom being a prime example.

 

[ClubMan]

In shares that decision is often out of your hands and you are kicked out with a big loss. Eircom being a prime example.

With property you can't schedule stop/limit orders at a particular price like you can with shares.

 

[Purple]

In shares that decision is often out of your hands and you are kicked out with a big loss. Eircom being a prime example.

In any investment doing your due diligence really well should allow you to avoid the really bad decisions. Eircom being a prime example.

 

[zander1983]

Just came across this thread - I have a similar one. I broadly agree that property is the best and safest hedge against inflation. So then, why are all the landlords leaving? Genuine question. 2 possibilities: 1/ they dont understand the thesis the OP outlines above, or 2/ the thesis outlined above applies elsewhere, but not here, where landlord properties rights have been eroded by every political party for years, and will be further eroded soon when SF are elected.

 

[NoRegretsCoyote]

I broadly agree that property is the best and safest hedge against inflation. So then, why are all the landlords leaving?

Mainly because of tax.

Say you are 45 and have surplus cash and you want to boost retirement income. You would be crazy to put it into property given that the income to buy the property has been taxed, capital gains if it appreciates in value will be taxed, and rental income would be taxed. Compare that to pension contributions where you get tax relief on the way in, capital gains are untaxed, and only pay tax on drawdown (and can take out 25% tax free).

 

[joe sod]

What about the interest payments?

Interest rates reduce the demand for all assets , that's the reason why stock markets and especially bonds fall when interest rates are rising.
Property is slightly insulated from this due to the lag effect but eventually interest rates reduce the price of property as well, remember the 1980s after the massive interest rate rises during the 70s.
I know you are making the same point jpd

Another factor missed is that we have already had extraordinary property price increases in the western world over the last 2 decades even when we had little inflation in other things. Now the price of energy and food and other basics are experiencing very high inflation. Therefore inflation has now to play catch up in all the areas that had very low inflation for years. Property does not fall into that category. If people are paying much higher prices for fuel and food and paying higher interest rates on debt they are not going to have any ammunition to throw at a property bubble.

 

[DublinHead54]

Trying to work this out in my head. Inflation is based on the CPI that includes mostly the costs of goods and services, and not debt.

My monthly mortgage payment of 1k is insulated from inflation, it is the bank that is exposed to inflation i.e. the money I give them can buy less goods and services.

If my company decides to give me a pay rise of 9% to match inflation, theoretically that should create a net 0 benefit as it provides additional income to pay for services that have higher prices now. I could reduce my spending and direct that additional pay rise towards my mortgage, which would be a benefit.

inflation may be a factor that increases / decreases house prices, but there are lots of factors that drive house prices.