Which is better? This (our latest real estate investment), or…
this. www.finance.yahoo.com chart of US dollar to Japanese yen since December 2012.
A reader recently asked this question: You pay cash for real estate but advocate the use of leverage in currency investments. Why not leverage your real estate investments?
Kyle Bass, Dallas TX Hedge Fund manager, was recently quoted as saying the best thing one can do now to overcome the coming inflation is to buy an apartment complex and put long term, low interest debt on it…in so many words. He also said short Japan, buy gold and go to sleep…everything will be fine when you wake up in ten years…again probably not a quote but you get the point.
My reply to this reader can help understand more about leveraged investments and when, how and why to borrow to invest.
I wrote: The differences between borrowing to buy real estate and leveraging an investment account include management, risk protection and cost.
Let’s look first at management. My report Borrow Low-Deposit High outlines that borrowing low and investing the loan high is mainly about earning positive carry. For example you borrow at 3% and earn 7%. You make 4% extra for taking the currency risk. This can be managed very inexpensively.
Ideally the currencies do not fluctuate for extended periods so you maximize your income. In a perfect scenario in the end after years the borrowed currency falls and one exits the position with a nice profit.
A good example was the yen in the 1980s when it was 111 yen per dollar and could be borrowed for 4%. Dollar bonds at that time were paying 8% and even more.
The yen continued to strengthen and over several years rose all the way to 79 yen per dollar. The losses on paper were terrible…. but all this time the borrowed yen was earning an extra 4% and 5% per annum. Finally the yen collapsed and fell all the way to yen 145 per dollar. I exited and enjoyed a nice forex gain after having earned the positive carry for years.
I had earned income even though I showed a loss on paper. In real estate during times of loss, income flow is more easily cut off leaving an investors with a negative income.
Next is risk protection. The Borrow Low-Deposit High report has a schedule so investors can pre calculate forex profits and losses before taking a position.
The report recommends that before taking a position an investor set a stop loss and immediately clear the position if they earn a certain profit or suffer a certain loss. The highly liquid nature of the multi currency sandwich allows an almost instant end to the speculation whenever one’s position moves into a loss position.
Plus leverage in the borrow low deposit high recommendation is quite low… a maximum of four to one, but more normally two to one. Invest $100,000 and borrow $100,000 or $200,000 at maximum.
In real estate the leverage can at times reach 19 to one (5% down) and the value of the asset is imprecise and liquidity often low.
The idea of leveraging real estate is a great one. I have a number of friends who have made huge fortunes doing exactly that.
However I have also known many people who borrowed heavily on real estate and in the 1970s, the 1980s and mid 2000s went bankrupt.
We have recommended buying rental real estate in Smalltown USA for several years but there is far higher management costs to the real estate than currencies. Jyske for example charges between 3/4% and 2% to manage a position. Real estate managers typically charge 10% to 15%. Real estate is not as fungible nor as liquid as currencies.
Any one dollar or yen or euro is the same anywhere and is worth at any moment the same almost any place and can be sold almost immediately 24 hours a day. This is not so for real estate.
The costs of entering and exiting real estate is also very high compared to currencies. A currency turn can bu around 3/10s of 1%. Buying and selling a piece of real estate can be 12% or more.
Currently it looks like the real estate we have been buying will do very well if the economy continues to recover as expected.
Yet in downturns there are multiple real estate carrying costs… insurance, taxes, maintenance, plus a vacancy rate.
Real estate sales prices can vary depending on multiple circumstances and the huge number of foreclosures and short sales that remain in the market speak of this problem.
My nephew was one of the biggest house builders in Oregon and had huge real estate loans when everyone went south in 2007. He saw the problem and auctioned off every property he could. Yet he still suffered great losses.
Buying real estate is a good business. There are many ways to do this and many use leverage. We prefer to buy real estate with cash and find that most readers we meet would be better off thinking this way.
In the end this boils down to whether one wants to make an investment or have a business.
I agree by the way with Kyle Bass on the yen. This site posted a recommendation to borrow (short) yen in December.
This site often recommends buying rental real estate. This site often recommends borrowing low and depositing high. This site also often recommends having a micro business.
Real estate can form the basis of a good investment or of a micro business. The difference is the amount of management you plan to put in. If you are going to leverage real estate… be sure you have a a good base of renters and the ability to manage or a good management company because if the market turns the wrong way you cannot quickly get out.
Should you borrow or not? If you have enough money to do what you wish without leverage… and the extra profit won’t really make a difference to your lifestyle, don’t borrow. Investing with leverage increases risk and you should never borrow more than you can afford to lose.
Get the “Borrow Low – Deposit High” report free when you order our “Embracing Change: How to Invest in Changing Times” This report is about Managing Risk.