Are you an investor or a speculator?

[Gerrard]

KPI June edition: Interview with John Erikkila, New Zealand Home Loans

Do we have Interest Only loans? Yes we do. But the really important thing to establish is what market you are actually in. Are you a speculator, or an investor? If you're an investor the only investment you're going to get out of property is when it really starts returning. And the only time it's really going to start returning is when you own the thing. When are you going to start repaying it then? When is the principal going to come into the principal and interest loan? Of course there are massive tax advantages with Interest Only loans, but you need to establish if you are just in the game for capital gain i.e. a speculator, or are you a genuine investor?

Well said John!

[fudosan]

If I'm cashflow positive, have very low LVR, and want to use interest-only to minimize my cash outflow so that I can buy more properties, am I still considered a speculator?

[Gerrard]

What benefit is buying more properties giving you, rather than paying off the ones you already own?

Gerrard

[fudosan]

Hi Gerrard,

More cash after tax

[Gerrard]

Hi fudosan,

Yes you will have more after tax profit in the short term. However if you pay off the mortgage you will get a far greater return in the long term.

Chasing short term gains sounds speculatve to me!

Gerrard

[orion]

Hi Gerrard, I totally agree with you on this. Not sure if many people saw the Sunday programme with Olly on it the other night. I really don't know what he is on about, maybe he made a decision last year and so badly wants to be right about it, that he is trying to cause a crash. He must be in his late 60's or early 70's by now and I would have assumed that he would have all his properties freehold by now. But if they were freehold, why would he sell if he thought the market would drop, that just does not make any sense at all.
Maybe he is more of a speculator than an investor after all. And assuming he is, he must think that he can buy similar properties again cheaper in the near future than what he would have paid for the properties he has just sold, minus agents' fees and possibly minus tax as well.
Very strange.

Regards
Graeme Fowler

[The_Dog]

Surely buying more houses is fundamental to returns?

If you concentrate on paying one property off before getting another, surely you lose on tax, but also capital gains, and potential gains through buying at a discounted rate / renovating for profit, finding a CF+ asset. I call these business moves, not speculation.

My loans are all P+I, but the problem I have at the moment is Banks declining applications due to limited cashflow. If I was IO, Would that not give me more flexibility?

I thought the definition of 'speculator' was someone buying and selling houses in a short timeframe, or buying with the intent to sell at a profit. I would have thought that going interest only to maximise cashflow, and build up a portfolio is still investment.

Woof!

[Gerrard]

Hi Dog,

If you concentrate on paying one property off before getting another, surely you lose on tax, but also capital gains, and potential gains through buying at a discounted rate / renovating for profit, finding a CF+ asset. I call these business moves, not speculation.

I'm planning to acquire more properties too, but will keep paying down the mortgages on the existing ones thereby creating more equity for me to use. If the market is going flat or backwards then paying off the loan will create equity faster then waiting for any capital gain.

My loans are all P+I, but the problem I have at the moment is Banks declining applications due to limited cashflow. If I was IO, Would that not give me more flexibility?

ASB do all their servicing calculations based on P&I so they don't even recognise IO in the equation. ASB is quite conservative so I'd be interested in finding out how other banks do it. Anyone else know?

I thought the definition of 'speculator' was someone buying and selling houses in a short timeframe, or buying with the intent to sell at a profit.

I've always associated speculation as a high risk activity. I never thought of IO as being higher risk until Graeme Fowler raised in in one of the earlier threads. http://www.propertytalk.co.nz/module...p;highlight=io

You don't have to agree with the quote, but I hope it makes you think!

Cheers
Gerrard

[RentMaster]

Not sure if many people saw the Sunday programme with Olly on it the other night. I really don't know what he is on about, maybe he made a decision last year and so badly wants to be right about it, that he is trying to cause a crash.

I thought this program was strange as well. It seems to be a common opinion with everyone except Olly that there is going to be a slight correction or slowdown, but not a crash. I think Olly just wants to sell a few more books.

[graemeh]

I think Olly just wants to sell a few more books.

I ordered my copy last week. I expect it will be an entertaining read. Not sure if I'll agree with it but it should be entertaining.

I saw the recent 20/20 article on the property crash (well that's the way the ads made it sound). The actual story seemed more of a trip around for the journalist interviewing people. The theme seemed to be things couldn't keep going the way they were but I don't remember anyone, even Neil Jenman, saying the sky was about to fall.

[Gatekeeper]

Not sure if many people saw the Sunday programme with Olly on it the other night. I really don't know what he is on about, maybe he made a decision last year and so badly wants to be right about it, that he is trying to cause a crash.

I thought this program was strange as well. It seems to be a common opinion with everyone except Olly that there is going to be a slight correction or slowdown, but not a crash. I think Olly just wants to sell a few more books.

Maybe its the word crash that needs redefined. A housing crash is more like a slowly deflating balloon, it doesn't pop.

There are lots of opinions out there, but to say that most think it will not crash/ie: deflate is not true, there are lots of bearish analysts.

Thought this was pertinent.

<<snip>>
Do Housing Bubbles Burst?

Housing prices never, or rarely, go down. That is the conventional wisdom and the conventional wisdom is correct. Housing is always a good investment, isn't it? It's an inflation hedge and it's an investment that you get to use everyday, plus you get a great tax break. And the home, after all, is a big part of the American dream.

However, government can screw up just about everything. Given enough power and time it will screw up everything. Housing and real estate in America is just the latest example. The Federal Reserve and the Mac-May family (Freddie, Fannie, Sallie, etc.) have conspired to create a housing bubble in the U.S. and as the old saying goes, "what goes up must come down." It's only a matter of time.

Housing bubbles typically do not pop like a balloon; they don't even crash like stock markets. Rather, the air in housing bubbles tends to leak out slowly—painfully slowly—while in commercial real estate markets there is a more noticeable hiss. We really don't know the current value of our homes until we sell them. They are not traded on a daily basis, like shares of stock in Wal-Mart. Some never get exchanged in the market, but are passed on within a family from generation to generation. The market value of a home may drop 20% and the owner might never realize it.

Worse yet, when the market for real estate collapses, prices are less likely to collapse because when buyers fail to make offers houses simply don't sell. Sellers often resist cutting their prices in favor of just leaving the house on the market or taking it off the market. Traditionally the market adjustment to a collapse in real estate markets has come from the quantity side, not the price side—fewer houses are sold—while price reductions tend to come gradually. This doesn't mean that housing bubbles can't exist or that the bust is any less painful, only that it doesn't make as much noise.

It is difficult to predict how long bubbles will last and when they will go bust. The best indicator is interest rates, because when the Fed forces rates down it tends to create bubbles, and when rates are forced upward bubbles tend to pop. My guess is that Greenspan will raise rates after the election. The rates of interest on long-term bonds have already "spiked" up from their historical lows. The chart below shows the recent increase in the interest rate on 10-Year Treasury bonds to the highest levels in almost two years.

<snip>

http://www.mises.org/fullarticle.asp?control=1533&id=69

[orion]

If you concentrate on paying one property off before getting another, surely you lose on tax, but also capital gains,

Hi The_Dog, yes you may lose a little in tax overall - but you have to ask yourself "am I prepared to take that risk for so many years?" When anyone ever mentions capital gains in their plans to me, I believe they are more of a speculator than an investor.
An investor couldn't care less what the prices of properties do - within reason. They could go up 20% one year, stay the same for the next 10 years, double over the next 3 years, then drop 30% during the next 2 years etc etc - so what!! The investor investing for cash flow long term does not care at all . When anyone goes interest only, I am 99% sure they are doing it because they believe their properties will soon go up in value, which to me makes them a speculator.

and potential gains through buying at a discounted rate / renovating for profit, finding a CF+ asset. I call these business moves, not speculation.

I agree, I do the same as well as doing quick cash deals - but my main focus is on the long term cash flow. These strategies you mention and others (such as owning businesses) are to provide deposits for properties while building a portfolio, or help you to reduce debt, once you have reached the level of properties you want to own.

My loans are all P+I, but the problem I have at the moment is Banks declining applications due to limited cashflow. If I was IO, Would that not give me more flexibility?

It may give you more flexibility, maybe not. If it were me, I would ask a better question.

I thought the definition of 'speculator' was someone buying and selling houses in a short timeframe, or buying with the intent to sell at a profit. I would have thought that going interest only to maximise cashflow, and build up a portfolio is still investment.

It may be a dictionary definition, who knows. My own opinion is that if you are worried or concerned about what property prices are doing all the time, trying to pick market trends, only buying in areas you think are going to go up in value, selling at so called peaks or highs, or financing using interest only - you are more of a speculator than an investor.
An investor invests for long term cash flow - they want their properties freehold at a certain time, so that wheteher the property market stays static or swings violently every year, they couldn't care less as the cashflow keeps coming in every week from their freehold properties.

Regards
Graeme Fowler

[The_Dog]

What I really wanted to is challenge the simplicity of the statement, which it looks like I have done.

No, I don't expect capital gains; yes I agree positive cashflow is the ultimate goal of property 'investment'. I have been in the game long enough to experience the cyclic nature of house prices. One could say the same of tax. Basing an investment tax savings is also short (narrow) sighted.

What I am challenging is the simplistic 'cash flow vs. capital gain' black/white thinking. I am suggesting there are many more mechanisms for improving capital equity than waiting for market forces. When I mention 'business moves' I am not talking about business ventures outside property, I am talking about dealing with your property portfolio as a business. By applying business principles to property, you may calculate you can get better return (than simply paying down your equity) by utilising various development opportunities. Of those opportunities, CG is only one, and I would suggest CG being the one you have the least influence over (i.e. least favourable option).

So, we have the original quote with the statement(s)

"Of course there are massive tax advantages with Interest Only loans, but you need to establish if you are just in the game for capital gain i.e. a speculator, or are you a genuine investor?"

Or, if you allow me to paraphrase it :

IO = Tax advantage = looking for capital gains = speculator

This is a bankers view, written by a banker. From an investor viewpoint, I am suggesting it should look a bit more like this (but not limited to)

IO = higher cashflow = flexibility to access a variety of opportunities = improved equity and therefore more opportunity leading to (you guessed it) more properties = improved equity + cashflow until a predetermined value of property has been achieved poking out cash that can then be paid off the principle if so desired.

Summary :

It's not back and white. It's not as simples as IO or P&I. It's not as simple as Investor or Speculator. It's not about judging the market and buy buy buy / sell sell sell !!!!

It's about using the full spread of opportunities presented and adapting to the changing (shifting) market.

I currently have 11.6% of my borrowings on IO, and that aligns with the market and cash flow requirements of a particular sector of my portfolio.

Which is nice.

Woof!

[Vern]

My 2 cents worth.

I don't classify any who expects capital gains in a property purchase to be a speculator.

An analogy might be similar to shares. There are income shares. There are growth shares. You invest in income shares for the dividends that will accrue on that share. You invest in growth shares not for the yield but for the expected growth in value of that underlying share (because the business is in a perceived "growth" industry).

The difference between a person who acquires those shares in my view is that an investor will base their decision on (broadly) fundamentals (eg, financials, market information etc). A speculator is simply trying to trade based on predicted future price trends (without regard to fundamentals).

In terms of property, if one is simply investing for income (of itself) then there are probably satisfactory alternatives to obtaining that income. Just look at the double digit yields on some shares on the NZX.

My personal view is that an investor simply cannot go chasing income - when acquiring assets of any type, be they shares or property. You need a mix of investments which provide an income yield (eg, properties in areas where predicted capital growth (because of demographic trends, schools and the like, proximity to the city etc) is good, or growth shares. You also need income producing assets; such as fixed interest instruments and income yielding shares. In the end it depends on each persons individual circumstances as to the mix they choose as each mix will have there own consequences.

Both income yields and capital growth may go up or down. Neither is set in stone or predictable. However, in terms of property, a person who wishes to diversify would, in my view, look at obtaining properties that, in their view, satisfy those criteria.

Accordingly, in my view an investor can be both a person who acquires property for the cash flow, or because of expected or predicted capital growth.


Stephen

PS: On Olly Newland these days he seems busy enough giving numerous income producing seminars so selling his property portfolio might be smart decision so he can concentrate on his main money making business.

[orion]

I don't classify any who expects capital gains in a property purchase to be a speculator.

Hi Vern, that's fine, I'm not asking you to - it's just my opinion.

An analogy might be similar to shares. There are income shares. There are growth shares. You invest in income shares for the dividends that will accrue on that share. You invest in growth shares not for the yield but for the expected growth in value of that underlying share (because the business is in a perceived "growth" industry).

Can you borrow money from the bank to buy shares? Would you borrow money to buy shares if you could? And who pays for the shares - you or somebody else? With property, the tenants pay it off (using P&I) by using good debt and leverage.
Vern, how much property and shares do you currently own, and where does the majority of your income come from? You sound like you are speaking theory, not what you have actually done - I could be quite wrong though, just my impression reading your post.

When I mention 'business moves' I am not talking about business ventures outside property, I am talking about dealing with your property portfolio as a business. By applying business principles to property, you may calculate you can get better return (than simply paying down your equity) by utilising various development opportunities. Of those opportunities, CG is only one, and I would suggest CG being the one you have the least influence over (i.e. least favourable option).

IO = Tax advantage = looking for capital gains = speculator

This is a bankers view, written by a banker. From an investor viewpoint, I am suggesting it should look a bit more like this (but not limited to)

IO = higher cashflow = flexibility to access a variety of opportunities = improved equity and therefore more opportunity leading to (you guessed it) more properties = improved equity + cashflow until a predetermined value of property has been achieved poking out cash that can then be paid off the principle if so desired.

It's not back and white. It's not as simples as IO or P&I. It's not as simple as Investor or Speculator. It's not about judging the market and buy buy buy / sell sell sell !!!!

It's about using the full spread of opportunities presented and adapting to the changing (shifting) market.

Hi The_Dog, very good post.
I believe this one thread is the most important one I've read so far in the 6 months or so that I have been on PT. Unfortunately most people want to continually get hung up on what property prices are doing, where they're located, and what interest rates are doing.
I want to just add something to what you say. While it is all good in theory, and if you can do what you suggest, really well done. Most investors are not that disciplined - period.
Property investment is ever so simple, but 99% of investors want to complicate it - because it is so easy.
What I want to add to what you say, is a quote I heard a while ago which is so true, it goes "people form habits - and habits form futures." So while what you say is great in theory, I don't believe most investors will do what you say. It's like the investors who go interest only and say they will pay down principle with any surplus cashflow from their properties, the reality is - it very very rarely happens. Just ask any bank manager.
I know other successful investors that have been investors for as long as I have (16 years) and longer and are still on interest only, even though their goal is to pay the properties off. Maybe they will sell a whole lot off when they want to retire, maybe not. But if the market were to crash (say a 15% downturn or more) anytime before this, they would stand to lose everything they've worked towards all that time as their gearing is still around 80% many years later.
I stand by my original thoughts on this - if you are relying on your investment properties going up in value, worried (to the extent that you would consider selling any buy and hold properties) about market price fluctuations, or slight changes in interest rates from time to time, you are more of a speculator than an investor.

Regards
Graeme Fowler