# Pay Down Debt vs. Investing



## kid hustlr (18 January 2012)

I'm sure this discussion has come up before however I performed a search and couldn't get any meaningful discussion.

Does anyone have a way of caluclating whether one should pay down their debt or invest?

At a glance I feel like anyone with a mortgage who is paying 7% interest should simply pay down their debt as its equivalent to an after tax return of 10-13% (depending on tax bracket, and im sure other factors etc).

I can't think of many investments which return 10-13% so therefore paying down your debt always wins?

This being said its obviously far more complicated than that due to things like capital growth and income which one can earn.

I guess an example would be an investment property which slowly appreicates in capital value as well as gradually gaining more and more income each year (increase rent)

Can someone point me in the right direction or is it really as simple as calculating your cost of debt (a) and comparing it with your investment return (b) and unless b>a you pay down debt.


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## prawn_86 (18 January 2012)

*Re: Pay Down Debt vs Invest*



kid hustlr said:


> Can someone point me in the right direction or is it really as simple as calculating your cost of debt (a) and comparing it with your investment return (b) and unless b>a you pay down debt.




No need to complicate things.

Unless you can earn more after tax than that 10 - 13% 'return' you would make by paying off your debt, then yes, you are better paying off your debt.


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## kid hustlr (18 January 2012)

*Re: Pay Down Debt vs Invest*

So the effect of a compounding return (like capital value increasing at say 5% each  year or earning rent which steadily increase over time) doesnt, at some point overtake the fixed, consisten repayments of a loan?

I guess what I'm saying is although in year 1 you may be paying off your debt, in year 20 because of the compounding effect you would have been better off to invest?


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## Bill M (18 January 2012)

*Re: Pay Down Debt vs Invest*



kid hustlr said:


> I can't think of many investments which return 10-13% so therefore paying down your debt always wins?




We had the same dilemma in the early 90's when we were paying off our mortgage. In the end we decided to hit the mortgage with everything we had and stand by on other investments, 4 years later the house was paid off and the pressure was off. Best decision we ever made.


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## ROE (18 January 2012)

*Re: Pay Down Debt vs Invest*



kid hustlr said:


> So the effect of a compounding return (like capital value increasing at say 5% each  year or earning rent which steadily increase over time) doesnt, at some point overtake the fixed, consisten repayments of a loan?
> 
> I guess what I'm saying is although in year 1 you may be paying off your debt, in year 20 because of the compounding effect you would have been better off to invest?




If you have a mortgage at 7% you cant beat paying off debt as it is very hard to get 10-13% return annually ... and the compounding effect works for paying off debt as well not just for investment... say you paying off a mortgage and the property  increase in value, reward you a tax free status return ...

also paying off mortgage is a guarantee return, there is no other investment that offer this assurance...every dollar you paid off you get 7% after tax Guarantee return.

Triple AAA government bond offers you half of that return


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## Tysonboss1 (18 January 2012)

*Re: Pay Down Debt vs Invest*



Bill M said:


> , 4 years later the house was paid off and the pressure was off. Best decision we ever made.




It's a great thing to live in a paid for house, When I made my last deposit into my home loan account I took my shoes of and walked through the back yard, The grass felt so much better once it was paid for 

Once your house is paid for, Then your income is really freed up and you'll have major fire power to start an investment plan, And if you spent the time learning about investing while you paid of your debt, you'll be alot smarter about it.


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## Tysonboss1 (18 January 2012)

*Re: Pay Down Debt vs Invest*



kid hustlr said:


> So the effect of a compounding return (like capital value increasing at say 5% each  year or earning rent which steadily increase over time) doesnt, at some point overtake the fixed, consisten repayments of a loan?




As Roe said, as you pay of your debt the compounding affect is still working in your favour,

Each months payments will contain less interest as the loan decreases and more and more priciple will be extingished, so the affect is the loan reduces at a faster and faster rate.

eg. in month 1 a payment of $1000 may only reduce the loan by $150 because you had to pay $850 in interest, But by month 120 you still pay $1000 but you may pay $900 0ff your loan because now the loan is so much smaller and there is only $100 interest.


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## kid hustlr (18 January 2012)

*Re: Pay Down Debt vs Invest*



ROE said:


> If you have a mortgage at 7% you cant beat paying off debt as it is very hard to get 10-13% return annually ... *and the compounding effect works for paying off debt as well not just for investment*... say you paying off a mortgage and the property  increase in value, reward you a tax free status return ...
> 
> also paying off mortgage is a guarantee return, there is no other investment that offer this assurance...every dollar you paid off you get 7% after tax Guarantee return.
> 
> Triple AAA government bond offers you half of that return




I think the bolded portion is the aspect I'm not taking into account. I guess I hear stories of all these people with high debt levels, a great number of investment properties who never paid off their PPOR mortgage etc etc who have done well but the fact of the matter is it has been on the back of very high nominal capital returns, not the compounding effect of steadily increasing rents and cap value


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## Tysonboss1 (18 January 2012)

*Re: Pay Down Debt vs Invest*



kid hustlr said:


> I think the bolded portion is the aspect I'm not taking into account. I guess I hear stories of all these people with high debt levels, a great number of investment properties who never paid off their PPOR mortgage etc etc who have done well but the fact of the matter is it has been on the back of very high nominal capital returns, not the compounding effect of steadily increasing rents and cap value




Yeah,

In my veiw it's not "Good debt and Bad debt"

It's "Bad debt and Worse Debt"

The high debt model works great 95years out of 100 years, But in the years it doesn't work it will completely wipe you out, Look and the big failures of recent years.

Prudence pays.


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## kid hustlr (18 January 2012)

Drill it into me one more time.

Let's use an example.

I buy a property in year 1 which is exactly neutrally geared instead of paying the mortgage. Obviously in year 1 from a nominal perspective i make a 'loss' when compared to just paying down the mortgage.

Yet in year 2 the property appreciates a little in value and i also up the rent by say 3%. This year the return I receive for that investment is still going to be less than paying down the mortgage, but by a slightly reduced amount?

Continue forward to year 20 where the property value is now much much larger and the rent payments are so large that its actually a very strongly position +ve cashflow property. In this year is it not feasible that the return could be much much larger than simply paying down the mortgage?

Does this make sense at all or am I dribbling?


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## Tysonboss1 (18 January 2012)

kid hustlr said:


> Drill it into me one more time.
> 
> Let's use an example.
> 
> ...




I am not quite sure what you mean,

Are you saying that rather than make extra payments off your existing mortgage, you use those extra funds to buy an investment property, 

Eg, Instead of paying $10K off the existing property you use those funds to pay the stamp duty, legal fees and loan app fees to buy a second property, which also happens to be neutrally geared from then on.



In that case, Rather than having $10,000 earning say 7% compounded tax free, risk free off your existing mortgage, you now have $10,000 invested technically earning nothing, and you have taken on alot more risk,

You will have tenant risk, market risk, interest rate risk, and risk that your circumstances may change.

As you pointed out though, There could also be substanial return if every thing goes well, But that is not a "free" return. Any extra return over and above the risk free 7% you could have got else where is payment for taking the extra risk.

If Here's the thing though with this stratergy, when things go in your favour, you may beable to earn very large returns, But if the wheels fall off, you may suffer substanial losses, 

As a once off stratergy when the time is ripe for it you will do very well, But if you stratergy is to constantly contiune to leverage up over the years, eventually the wheels fall of and you will lose your entire net worth.


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## kid hustlr (18 January 2012)

Thank you for the replies Tyson.

I recognise that higher debt = higher risk.

I also recognise that a deicsion to invest should be weighed up against the opportunity cost. In this case we are comparing the return we get from paying off the 7% mortgage (anywhere between 10-13%, depending on your tax level) vs the return we can get from investing.

Let me try another example.

We get a 10k bonus from work. rather than pay 10k extra off the mortgage, I invest in the initial ABC IPO. 

In year 1 ABC makes no profits and the capital value does not change. At this point we would have been better off paying off the mortgage.

In year 2 ABC makes some profits and our capital value is now 10.2k and we receive a small dividend of $50. Once again the return we receive in this year is less than us simply paying off the mortgage.

ABC continues to grow and steadily over time the dividend becomes larger and larger.

In year 20 the capital value is now 10k and we now receive a very strong divided, amounting to 1.5k or 20% of our initial outlay. At this point the return we are receiving is far far greater than the 7% we could receive by paying off debt.

A little bit of a farfetched example but I guess I'm trying to draw the comparison at how an interest only loan has the same level of payments each year, therefore 'the time value of money' cost is actually decreasing over time, whereas if we invest in an asset which will continue to grow and provide larger cashflow year after year (rent payments?) at some point in time way down the future the decision to invest 'back in the day' will prove to be a good one.


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## Tysonboss1 (18 January 2012)

kid hustlr said:


> Let me try another example.
> 
> We get a 10k bonus from work. rather than pay 10k extra off the mortgage, I invest in the initial ABC IPO.
> 
> ...




The $10K that you put against your home loan compounds also, 

By year 20 your $10K would be worth $37,203 (initial $10,000 + $17,203 of compounded interest savings) and it would be generating $2,689 per year in interest.

Either way it all comes back to the fact that the alternative investment must have a low risk return in excess of 9.1% to beat the home loan allocation.

Offcourse it is entirely possible for you to allocate funds in a way that can beat the risk free return, However this takes alot of skill and knowledge to do it is a way that is not gambling and is genuinely low risk.

In my veiw I think paying of the homeloan while you take the time to learn about investing in companies would be the way to go, Other wise the ABC company you spoke of might turn out to be ABC learning centres and worth nothing by year 5.


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## kid hustlr (18 January 2012)

When I was typing ABC i was chuckling to myself, I'm glad you picked up on that.

Appreciate the assistance Tyson.


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## ROE (18 January 2012)

kid hustlr said:


> Thank you for the replies Tyson.
> 
> I recognise that higher debt = higher risk.
> 
> ...




You are assuming your asset always appreciate in value, and increase in dividend payment..

there is no guarantee of that and when it comes to people chasing an extra few percentage point, there are far more money loss in this venture than money losing at gun point.

go to any adviser and they can draw you a pretty diagram and tell you why you should not pay off debt but load up debt and invest, their diagram only works one way, that is stuff going up.

Turn it around and predict stuff going backward for a decade and see what happen when you have large pile of debt..this looks worse than hell....

Also their diagram works on average compounding rate so it looks very very good..
but in real life it's a zig zag and when it comes to compounding zig zag isn't very pretty.

actually most people failed to see this that why they never have enough for retirement
because those wonderful diagram show how much they have at the end of their working life because of that magic average compounding number..

here is something you can do ... take ABC or XXX stock ..year one gone up 10%, year 2 gone up 15% year three backward 15% what is your total return?
7% over three years on initial investment ....does that look pretty?

Where as if you don't even count compounding, and get a guarantee 7% a year
paying off the mortgage, that's 24% over three years....and the longer this goes on you are way a head...

this logic also applied in the internet bubble days...they discard stocks like coke and 
McDonald claiming well internet  stocks has higher earning potential and the sky is the limit for these stocks....eventually they will earn far more money than coke and McDonald... Let put it to a simple maths logic.

Coke those days make around a billion dollar profit a year but  yahoo worth as much as coke and make bugger all money, so for every year yahoo don't make profit Coke is 1 

Billion a head and the longer this goes on the harder and harder for yahoo to catch up 
do yahoo make a billion profit a year these days even after 12 years?, not even close
and so yahoo pretty much lost the race forever because they are some 20B profit behind coke , yahoo probably wont even make 20B in its life time...

Coke now make 2-3B profit a year....

The take away? dont compare pie in the sky number for a guarantee return


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## McCoy Pauley (18 January 2012)

kid hustlr said:


> I'm sure this discussion has come up before however I performed a search and couldn't get any meaningful discussion.
> 
> Does anyone have a way of caluclating whether one should pay down their debt or invest?
> 
> ...




There is one thing that you've omitted from your deliberations: inflation.  Although we're currently in a low-inflation environment, there can be no guarantee that in the future, inflation will not increase beyond the RBA target range.  In any event, inflation eats away at the real purchasing power of your liquid assets, so any return on your investment needs to be considered in an after-tax, after-inflation scenario.


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## Eager (18 January 2012)

*Re: Pay Down Debt vs Invest*



ROE said:


> ... say you paying off a mortgage and the property  increase in value, reward you a tax free status return ...



Yes, but it is all relative. The house that will be bought next will have also increased in value by the same percentage over the journey, give or take, as the one just paid for. That is why it is silly to count on your own home as an investment - there is no need to get all warm and fuzzy if it has gone up in value by $300k by the time you sell it if the house you want to buy next has also increased by at least as much and is still as much out of reach!!! By all means pay it off as early as possible  because it will always put you in a better position down the track, but don't forget to have a life in the meantime, and if you can afford it, invest a dribble in shares or whatever every now and then too.

*kid hustlr*, can you maybe afford to pay an extra $50 a fortnight off the mortgage, and then use any lump sums that come your way, such as your tax return, to buy shares?


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## Smurf1976 (18 January 2012)

*Re: Pay Down Debt vs Invest*



kid hustlr said:


> So the effect of a compounding return (like capital value increasing at say 5% each  year or earning rent which steadily increase over time) doesnt, at some point overtake the fixed, consisten repayments of a loan?
> 
> I guess what I'm saying is although in year 1 you may be paying off your debt, in year 20 because of the compounding effect you would have been better off to invest?



Paying off debt also results in compounding via the interest saved.

Another thing to consider is the "sleep at night factor". Repayment of debt is absolutely a low risk option and it's not easy to beat the after tax return you'll make by doing so for the average investor.

The reduction in overall stress, simply because I don't have to worry about paying off a mortgage, is worth a lot in itself. No more worries about interest rates going up. Even if you lose your job and have to take a lower paying one somewhere else it's not going to be a disaster if you actually own your residence. A lot less stress.


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## Bill M (18 January 2012)

*Re: Pay Down Debt vs Invest*



Eager said:


> That is why it is silly to count on your own home as an investment -




This comment needs addressing, *it is *an investment. Your own home is the biggest investment you will ever make for your future. There is nothing like paying no mortgage or no rent, believe me I am there, totally rent/mortgage free. It has enabled me to retire early, of course it is an investment because I don't have to pay for any accommodation at all (apart from running costs). It means all extra monies earned is available for other investments. Further more your own home is totally capital gains tax free, you can keep trading up until you retire and get rid of the kids. Then you can downsize and pocket large sums from the sale of your family home tax free (i have done this), surely that's worth something.

To kid hustlr, mate I've been where you are now and as others have mentioned there are no guarantees in life. Just imagine if you were to go down the investing in shares path back in November 2007, you would have suffered a 40% capital loss until now. Also I have investment property, right now prices are stagnating, some are predicting prices even going lower. How long can you sit out a downturn? Shares have gone nowhere in 7 years! Link here for that. My opinion is to clear that rotten mortgage ASAP, right now nothing is beating that 13% quoted and there are no guarantees anything will for some time to come yet, cheers.


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## Eager (18 January 2012)

*Re: Pay Down Debt vs Invest*



Bill M said:


> This comment needs addressing, *it is *an investment. Your own home is the biggest investment you will ever make for your future. There is nothing like paying no mortgage or no rent, believe me I am there, totally rent/mortgage free. It has enabled me to retire early, of course it is an investment because I don't have to pay for any accommodation at all (apart from running costs). It means all extra monies earned is available for other investments. Further more your own home is totally capital gains tax free, you can keep trading up until you retire and get rid of the kids. Then you can downsize and pocket large sums from the sale of your family home tax free (i have done this), surely that's worth something.



Yes, I hear you. But the house itself is not an investment vehicle first and foremost. It is primarily a roof over your head, and at the end of the day, if you were to happily remain in your modest first home once it was paid off, it doesn't matter at all if it never appreciates in value.

Trading up is something that most of us do however, me included. But it normally results in bigger and bigger loans!


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## kid hustlr (20 January 2012)

Really really appreciate all the thoughts in this thread.


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## tech/a (20 January 2012)

*Re: Pay Down Debt vs Invest*



Eager said:


> Yes, I hear you. But the house itself is not an investment vehicle first and foremost. It is primarily a roof over your head, and at the end of the day, if you were to happily remain in your modest first home once it was paid off, it doesn't matter at all if it never appreciates in value.
> Trading up is something that most of us do however, me included. But it normally results in bigger and bigger loans!




My Oh My OH my.

Attitudes like this guarentee mediocrity.

But consider this.
Had you rented for 20 yrs (The average time it would take Joe very average to pay the home off).You wouldnt have a home.
20 yrs ago the home would have been $60,000
Today same home $400,000

Not an investment?
Your kidding yourself just in this area---let alone the endless opportunities in good use of equity.


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## prawn_86 (20 January 2012)

*Re: Pay Down Debt vs Invest*



tech/a said:


> 20 yrs ago the home would have been $60,000
> Today same home $400,000




But do you honestly believe, with at least a few years (at a minimum) of contractionary credit conditions coming up, that 400k house will be worth 2.6m in another 20 years time?

And also, how does one unlock the value in that house without either selling (which has associated costs) or drawing down on a mortgage which means that you will then be paying interest on that value? Unless you move houses and rent out your original PPOR i guess


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## tech/a (20 January 2012)

*Re: Pay Down Debt vs Invest*



> prawn_86 said:
> 
> 
> > But do you honestly believe, with at least a few years (at a minimum) of contractionary credit conditions coming up, that 400k house will be worth 2.6m in another 20 years time?
> ...







> You use it as collateral.
> Unlocks incredible opportunity.




Sorry stuffed up that format!


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## McLovin (20 January 2012)

*Re: Pay Down Debt vs Invest*



prawn_86 said:


> But do you honestly believe, with at least a few years (at a minimum) of contractionary credit conditions coming up, that 400k house will be worth 2.6m in another 20 years time?




Exactly. At some point there is no more capacity to allow for higher prices. I'm not saying the entire property market is stuffed -- there will always be growth somewhere -- but generally property looks expensive. How many baby-boomers have their retirement nest-egg tied up in the family home? How many baby-boomers are going to be tapping that nest-egg soon?

The other big issue is the soaring cost of living. I'm fairly certain I could live cheaper in London than I do in Sydney (regardless of exchange rates) which is absurd.


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## kid hustlr (20 January 2012)

Your PPR should be considered an investment. At some point in some time the value of your place will matter - be it whether you decide to sell or your kids decide to sell or you want to redraw equity etc etc. It definitely matters.


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## tech/a (20 January 2012)

> Exactly. At some point there is no more capacity to allow for higher prices



. 

How do you work that out?

You could have said the same thing 30 yrs ago.
So inflation will stop?
Wages will not increase?
The $ will not rise and or fall?
Money will stop being printed.
Prices of ANYTHING will stop rising??---because there will no longer be capacity?? ----Get outa here!!

You could have said the same thing 150 yrs ago.
My Great Grand dad paid 10 Guineas for 5000 acres 20 miles from the 
CBD of the time Thats about $17.
You couldnt put a price on it.--- now.


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## McLovin (20 January 2012)

tech/a said:


> .
> 
> How do you work that out?




Like this...


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## notting (20 January 2012)

Nice chart but Mr average aint always the driver.
He's stays average whilst things go up.
The devide increases and has not taken too many backward steps over time.
Inflation is the polically popular tax, for democracies.
Even comunists can't avoid it.
Unions are jumping up and down with good reason, but no desert.
I guess that's why commodities are popular.


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## tech/a (20 January 2012)

McLovin said:


> Like this...




All will catch up like it has in the past.
May take longer but convergence will occur

*Then*
Off it will go again.

Enjoy the opportunities if your able.
If your mediocre then youll more than likely watch and lament or complain.
(not meaning you personally!).


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## prawn_86 (20 January 2012)

Going off track so this will be my last post about this in this thread, but there are a number of reasons pointing to a 'stagnation' or prolonged period without economic growth.

1. Western children born now are the first to have a lower life expectancy than their parents
2. Medical innovations are taking more and more time to acheive and costing more and more with less actual results
3. Energy/resources are finite meaning increasing costs put added pressures on other budget areas
4. Less innovation. What new products have we had in the last 10 years? Most have been a modification of an existing product
5. Baby boomers beginning to retire/down size.

Many people i know are also saying the same thing. We are in a contractionary/stationary period in which we will see very little growth until the World can get itself out of all the debt it has binged on in the last 30 odd years. We need to shift from growth to sustainability, and as that shift (very) slowly happens we probably wont see the same price increases as we have in the 20th century


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## notting (20 January 2012)

Inflation is the real problem not debt.
They print it's simple.
I'v been waiting for the housing crash for about as long as I was waiting for the Stock market crash that happened in 2008.  Doesn't look too likely.
Australia is the best place in the world there for it should be the most expensive, people have worked it out.


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## McLovin (20 January 2012)

tech/a said:


> All will catch up like it has in the past.
> May take longer but convergence will occur




I don't doubt that. I certainly wasn't trying to speculate on when or how, I was just making an observation.

To be quite honest, I find discussing property always seems to end up in arguments. Most people get way too emotional about it. (not meaning you )

Property is to investing what the Melbourne Cup is to betting on horses; everyone becomes an expert.


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## Tysonboss1 (20 January 2012)

notting said:


> Nice chart but Mr average aint always the driver.
> He's stays average whilst things go up.
> .




And mr average goes from renting a house on a 1/4 acre block, to a smaller house on a smaller block, then a town house and then eventually an apartment,

Mean while that average 1970's house on a 1/4 acre block 10kms from sydney is now a luxury on mr rich can afford,

Hence incease density aswell as inflation means the property owner is far better off, than the renter


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## Tysonboss1 (20 January 2012)

McLovin said:


> Like this...




the number of people living in a city is not fixed, the amount of land in the city is,

if the average wage $60,000 and you have 2million people land value will be X

If you increase the number of people to 3million while still only having an average wage of $60,000, the fact that there is now an extra million people earning $60,000 willing to either buy of rent will mean values of land will increase, even though wages have not.

What you will see is house blocks being chopped up into apartment buildings and town houses, 

a person earning $60,000 can't afford to pay for $1M for a house block, but they can afford it if their exposure is limited to 1 apartment out of 6 on that block


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## Junior (20 January 2012)

Tysonboss1 said:


> the number of people living in a city is not fixed, the amount of land in the city is,
> 
> Not true for Melbourne, govnt keeps releasing more land and the city continues to expand.
> 
> ...





.....


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## Tysonboss1 (20 January 2012)

Junior said:


> .....




Point 1 - No doubt they would have trouble releasing any new land within 10km's of the city, Secondly they new land releases proove my point, they take a big parcel worth maybe $10M in the past and break it up into higher density of 100 blocks valued at $200,000.

point 2 - Thas true, as you would notice apartments don't increase in value as much as high land content property types in the same area. If a land existed where the cities were at their limits, the 1 or 2 remaining suburbs would be sort after by the mega rich, look at the luxury house blocks in and around sydney, you looking at many millions.

Any way thats my last off topic post, this isn't the property thread


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## Eager (20 January 2012)

*Re: Pay Down Debt vs Invest*



tech/a said:


> My Oh My OH my.
> 
> Attitudes like this guarentee mediocrity.



Tell that to your grandparents, who no doubt lived a heck of a lot more modestly than you, but were probably far, far happier.


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## Tysonboss1 (20 January 2012)

*Re: Pay Down Debt vs Invest*



Eager said:


> Tell that to your grandparents, who no doubt lived a heck of a lot more modestly than you, but were probably far, far happier.




I bet they are happier selling their house for $400,000 to fund a better aged care facility, than if their home was still worth 45pounds.

Your home is an investment, first of all it provides a much cheaper roof over your head than renting for the majority of your life, and then it can be sold in the twilight years to fund a more dignified exit in the final act.


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## Eager (20 January 2012)

^ Point acknowledged.


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## Eager (20 January 2012)

I should add though, as far as guaranteeing mediocrity goes, what is a more obvious example of that than the following:

A couple work hard, buy a house, still work hard, upgrade, have a family, work even harder, upgrade again, family grow and leave, upgrade but downsize, become debt free, grow old, cark it. Massive inheritance to the offspring. Which they knew was coming ever since they were young adults....

I fully intend to be a S.K.I. er.


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## kid hustlr (20 January 2012)

One more example. Say we have a mortage costing 8% and we just won the lotto for 100k.

A couple of quick assumptions:

there is no CGT in this world.
there is no set up costs to buying an investment property.
we have the opportunity to buy a 400k property that is _exactly_ neutrally geared.

After 10 years time:
If we pay the mortgage:
we save 100,000(1.08)^10 = $215,892 or $115,892 in interest.

If we invest:

If that property is worth _more_ than $515,892 (which equates to roughly 2.7% compounded) then the better decision was to invest.

Is this correct? Obviously there are loads of if and buts and assumptions and investment risk etc etc. I'm just trying to get my head around the concept of opportunity cost in regards to investing.


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## Julia (20 January 2012)

Eager said:


> I fully intend to be a S.K.I. er.



 Given that by the time you're old and in need of some level of care, how are you going to time your spending to ensure that you don't end up in the lowest and most squalid level of care as opposed to retaining sufficient funding to pay for quality care.

Don't be under any illusions:  aged care by the time you need it will be absolutely user pays.

If you're so determined to leave nothing to your offspring I hope you're not depending on them to look after you when you're old and feeble.


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## Tysonboss1 (22 January 2012)

kid hustlr said:


> Is this correct? Obviously there are loads of if and buts and assumptions and investment risk etc etc. I'm just trying to get my head around the concept of opportunity cost in regards to investing.




Yes, 

But in reality, all those things you excluded do exist and would have a negative impact.

and as I stated earlier, the higher return is based on leverage which works both ways,

Try doing the math on what would happen to you $100K in capital if the investment property which down by 2.7% per year and you still owed $300K to the back.

Almost complete 100% loss,..

thats the risk of your high risk stratergy.

Is it worth it.

you decide.


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## Beej (22 January 2012)

McLovin said:


> Like this...




If you plot that chart on a log scale  - as you should for something with the sort of time period you are looking at there, you would notice that the current situation has occurred at least 2-3 times in the past to a similar magnitude and for a similar period of time ( look at the 70s and the late 80s for example). By that I mean look at the magnitude in % terms by which one line has "over-shot" another etc. The linear scale just makes things look worse now than they have been in the past - in fact this is the leading "confidence trick" of much of the analysis of the housing market / debt situation that is floating around at the moment.

The other point I would make is that looking at the price of anything and adjusting it to CPI doesn't really tell you much - it is quite possible that the price of assets may rise at a rate well above the price change of a selected "basket of goods" indefinitely, or certainly for very long periods of time. Ie, there is no guarantee of a relationship between the value of land < 10kms from a city CBD and the weighted price index of banana's, bread, milk, TVs and so on.

Finally to address the OP question, I'm with the "it is better to pay down your debt ASAP and take the 10-13% risk free return" crowd on this point. The only exception would be if you are really hell bent on taking the "high risk / fast track" road to wealth creation - as long as you really understand the risk that entails - ie you could end with nothing, or be far worse off than the alternative.


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## McLovin (22 January 2012)

Beej said:


> If you plot that chart on a log scale  - as you should for something with the sort of time period you are looking at there, you would notice that the current situation has occurred at least 2-3 times in the past to a similar magnitude and for a similar period of time ( look at the 70s and the late 80s for example).




And then prices went nowhere for many years...


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## Beej (22 January 2012)

McLovin said:


> And then prices went nowhere for many years...




Well, they went nowhere only relative to CPI growth. For example, in the 70s, house prices increased by a huge amount, even though they grew at a rate less than CPI for that period on your chart. The thing is, you have to buy assets in nominal $, not some imaginary "CPI adjusted real $". So during that period in the 70s for example, owning a house was one of the best things you could have done - high inflation "inflated away" your debt, meanwhile your wages were growing rapidly. Of course no-one was getting ahead in real terms, that's the problem with a high inflation environment, but those who deliberately delayed asset purchases in such periods were punished even more for their decision.


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## McLovin (22 January 2012)

Beej said:


> Well, they went nowhere only relative to CPI growth. For example, in the 70s, house prices increased by a huge amount, even though they grew at a rate less than CPI for that period on your chart. The thing is, you have to buy assets in nominal $, not some imaginary "CPI adjusted real $". So during that period in the 70s for example, owning a house was one of the best things you could have done - high inflation "inflated away" your debt, meanwhile your wages were growing rapidly. Of course no-one was getting ahead in real terms, that's the problem with a high inflation environment, but those who deliberately delayed asset purchases in such periods were punished even more for their decision.




Look, the point was to show the link between wages and house prices. I don't think prices will collapse American style (unless something severe happens to the economy) but I do think that over the long run house price growth is linked to wage growth more than any other asset class.

Anyway, I've said all I need to in this thread.


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## Beej (25 January 2012)

McLovin said:


> Look, the point was to show the link between wages and house prices. I don't think prices will collapse American style (unless something severe happens to the economy) but I do think that over the long run house price growth is linked to wage growth more than any other asset class.
> 
> Anyway, I've said all I need to in this thread.




Fair enough - I don't disagree with your general outlook by the way. Just wanted to show that some of those charts floating around are designed to make things look worse now than they actually are relative to past periods and market cycles.


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## odds-on (25 January 2012)

McLovin said:


> Look, the point was to show the link between wages and house prices. I don't think prices will collapse American style (unless something severe happens to the economy) but I do think that over the long run house price growth is linked to wage growth more than any other asset class.
> 
> Anyway, I've said all I need to in this thread.




McLovin,

I agree with you. House price to income is the key. 

Interesting website below.

http://www.interest.co.nz/property/house-price-income-multiples

Key point being:-

"The house-price-to-income multiple is a simplified, yet internationally recognised measure of housing affordability. It is covered in Agenda 21, Chapter 7 of the United Nations Framework and it is defined as the ratio between median house price and median annual household income, otherwise known as the median multiple. The World Bank also says this ratio is "possibly the most important summary measure of housing market performance, indicating not only the degree to which housing is affordable by the population, but also the presence of market distortions"."

Cheers

Oddson


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## Tysonboss1 (25 January 2012)

odds-on said:


> McLovin,
> 
> I agree with you. House price to income is the key.
> 
> ...




Agreed,

As long as the "House price" part of the calculation includes the entire spectrum of dwelling ie. apartments.

As I said earlier, Actuall houses on land will increase faster than wages generally in a growing  city, due to population growing while the number of houses on land is decreasing.


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## odds-on (25 January 2012)

Tysonboss1 said:


> Agreed,
> 
> As long as the "House price" part of the calculation includes the entire spectrum of dwelling ie. apartments.
> 
> As I said earlier, Actuall houses on land will increase faster than wages generally in a growing  city, due to population growing while the number of houses on land is decreasing.




I agree it is crude but it is a useful tool for anybody interested in property investment. It is equivalent to using the percentage of total market cap relative to the GNP as a stock market valuation tool. If the property market is overvalued then to make decent returns one has to allocate serious capital to buy the right house in the right street in the right suburb  – similar to picking the right stock in an overvalued stockmarket. I personally feel way more comfortable sticking $100k in a microcaps than taking out a $400k loan (assume $100k equity) to buy a $500k property in an overvalued property market.

Cheers

Oddson


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## Tysonboss1 (25 January 2012)

odds-on said:


> I agree it is crude but it is a useful tool for anybody interested in property investment. It is equivalent to using the percentage of total market cap relative to the GNP as a stock market valuation tool. If the property market is overvalued then to make decent returns one has to allocate serious capital to buy the right house in the right street in the right suburb  – similar to picking the right stock in an overvalued stockmarket. I personally feel way more comfortable sticking $100k in a microcaps than taking out a $400k loan (assume $100k equity) to buy a $500k property in an overvalued property market.
> 
> Cheers
> 
> Oddson




I prefer to use a P/E ratio of various property options, Making a comparison of the earning power of the rental return over time to justify a price i am willing to pay for a property, As well as making various judgements as to what a property has in the way of options for the future, eg development.

Just like the equity security investments I make, I pay much closer attention to each indiviual situation of each opprtunity than I do to macro economics.


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