Author Topic: Risk, Debt, Sleeping Easily  (Read 3320 times)

daverobev

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Risk, Debt, Sleeping Easily
« on: October 14, 2013, 06:50:28 PM »
This might end up being a ramble rather than a succinct question, but there you go.

The question I'm trying to ask is based on the fact I've just gone from having enough in the bank to cover my taxes and such, to having an extra house that should do quite well in the long run (touch wood) and a balance on a line of credit.

It's small beer - the house was $30k, the rehabbing work being done to make it nice for tenants is about another $5k including appliances.

Wonderfully, the line of credit (unsecured) is at 3% for the next few months, then returning to its normal rate of about 6%.

So - I'm in debt to the tune of $30k, after spending 2 years paying off a mortgage on another house I own. I now have an asset that should pay me nicely. I'd do it again. I'm just wondering where the line is - how much risk?

My wife has friends who are serial house purchasers - they buy, live in for a while, and convert to rent to students, making a very nice return on investment. They are probably in mortgage debt to the tune of $1m.

I'm guessing people who become rich are the ones who, in my position, would borrow more (the bank will almost certainly lend us more next year when I have enough years of self employed income). Either a second house bought with a mortgage, or with a line of credit secured against the house we live in.

I don't *need* to do any more. I can stick to the plan of paying off this LOC over the next 15-20 years, giving myself a small monthly income bump from this house I bought once it's rented. I am far, far, far from rich, but I think I have pretty much enough.

I hate debt, though, so even while looking at the numbers and the 15 year plan, I'm also going, nope, don't like this debt, I want to kill it. At the moment I'm still doing a few days self employed stuff a month for a friend which is nice, and I can (and will) throw any extra money at the LOC just because I know I'll get ~6% on it. But if I can buy another house in a few months and get 10%...

If it is generally unwise to borrow to invest in the stock market, is it also unwise to do it in real estate? Clearly not (or, rather, clearly it's possible to make *really* bad decisions, but if you've done your research...).

Next year I'm going to be SAHD, on my own from July or August time when my wife will go back to work. I don't know if I'll still be self employed then - I'm assuming not, the stuff I do is generally winding down, and while there may be a few $k next year I'm not banking on it.

Any thoughts, words of wisdom? Ideas on how to become a millionaire without a job/while being SAHD? (I guess that's a bit far off the topic).

brewer12345

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Re: Risk, Debt, Sleeping Easily
« Reply #1 on: October 14, 2013, 07:29:09 PM »
This is a risk appetite question, and a good deal of the answer will come from your own navel-gazing.  What you really want to do is a mental exercise where you consider various downside scenarios and whether you can withstand those downsides/what you can do to manage the risk.  So what can go wrong if you stay levered or increase your leverage by buying another rental on credit?  What can you do about it?

I'm not a real estate investor, so I can't help you on that account.  I am a securities aficionado.  My downside risks all revolve around a large and prolonged drop in the value of my assets, such that I can't draw enough cash out of my assets to live on without permanently impairing my portfolio for the long term.  I deal with this risk two ways:  first, I manage my portfolio to try to reduce volatility and the risk of a giant drawdown.  Second, I keep a pile of cash, CDs and I bonds that are not sensitive to market fluctuations and I keep an untapped HELOC handy.

What are your biggest risks?  What can you do to reduce those risks?  What can you do to mitigate those risks?

This_Is_My_Username

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« Reply #2 on: October 14, 2013, 07:58:47 PM »
I don't live in usa, so I can't comment specifically, but in general:


There is Bad Debt, there is Good Debt, and there is Very Good Debt.


Bad debt is debt related to items that reduce in value.  Car loan, credit cards.  Never have bad debt.


Good debt is debt related to items that increase in value.  home loan (mortgage), loan to buy shares.  Good debt is good.  e.g. a $100k mortgage loan on a $200k house is a good thing to have!

Very Good Debt is debt related to items that increase in value, AND, the interest is tax deductable against your employment income.  A 6% loan magically becomes 4%.   Very Good debt is very good.

:

My preferred (high risk) approach is to borrow as much money as I possibly can at X%.  Invest that money where the long term return is moderately above X%.  But I am young enough to ignore the short term.

Nicster

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Re: Risk, Debt, Sleeping Easily
« Reply #3 on: October 14, 2013, 08:10:10 PM »
You mention "sleeping easily," which makes me think of a reflection I heard recently that stuck with me. As brewer12345 mentioned, this is a risk question. The answer is.... Can you sleep when the wind blows?

Reflection:
Years ago a farmer owned land along the Atlantic seacoast. He constantly advertised for hired hands. Most people were reluctant to work on farms along the Atlantic. They dreaded the awful storms that raged across the Atlantic, wreaking havoc on the buildings and crops. As the farmer interviewed applicants for the job, he received a steady stream of refusals. Finally, a short, thin man, well past middle age, approached the farmer. "Are you a good farm hand?" the farmer asked him. "Well, I can sleep when the wind blows," answered the little man. Although puzzled by this answer, the farmer, desperate for help, hired him. The little man worked well around the farm, busy from dawn to dusk, and the farmer felt satisfied with the man's work. Then one night the wind howled loudly in from offshore. Jumping out of bed, the farmer grabbed a lantern and rushed next door to the hired hand's sleeping quarters. He shook the little man and yelled, "Get up! A storm is coming! Tie things down before they blow away!" The little man rolled over in bed and said firmly, "No sir. I told you, I can sleep when the wind blows." Enraged by the response, the farmer was tempted to fire him on the spot. Instead, he hurried outside to prepare for the storm. To his amazement, he discovered that all of the haystacks had been covered with tarpaulins. The cows were in the barn, the chickens were in the coops, and the doors were barred. The shutters were tightly secured. Everything was tied down. Nothing could blow away. The farmer then understood what his hired hand meant, so he returned to his bed to also sleep while the wind blew. -

(Even though the roots so this story are religious, I'm not. Just thought it is a good way to think about risk.)

aj_yooper

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Re: Risk, Debt, Sleeping Easily
« Reply #4 on: October 14, 2013, 08:24:25 PM »
Brewer makes a good point.  He uses ample fixed income to dampen the risks of stocks, but cash, CDs, Ibonds, etc can also be used to diversify or balance out real estate risks.  Having an excellent tenant should help you sleep better so work very hard on matching a tenant to your asset; that should help.  Consider building a separate ample fund of cash, CDs, etc. to diversify your real estate risk.  You could work to pay off the rental mortgage, but then you lose the leverage of your investment, which is at the heart of land lording.

daverobev

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Re: Risk, Debt, Sleeping Easily
« Reply #5 on: October 15, 2013, 09:00:41 AM »
Thanks all.

I'm in Canada, have one rental in the UK (used to live in it, paid it off), just bought this house in the US on a floating-rate ("prime" which is currently 3% + 2.9% unsecured) line of credit - borrowed here in Canada. We also have a modest house in Canada ($150k - half the price of a 'normal' house - but perhaps a little small in the long term, not sure - but obviously 4-5x the price of this rental house in the US, and not as nice!).

I also have some money in stocks split between stuff in the UK not tax sheltered, and stuff in Canada sheltered. Relatively small amounts. The large asset I have is the house in the UK, it's worth more than everything else put together.

So, risks: Interest rate (6% on the LOC could easily become 10% in a few years; I'm guessing it won't move for a couple of years, though).

Currency fluctuations: If the US$ weakens significantly vs the CAD$ it'd be medium-bad as my borrowing is in CAD$.

Vacancy: Not too fussed here as the running costs for the house are low.

On the whole I'm perfectly comfortable with where it all is, logically. I can't see into the future, obviously, but hey many people have more in a car loan than I do for this house...

But that's what I'm wondering - when next year comes round, 'should I' be looking for further investments? Something much riskier.. well, no not riskier... just larger. Same risk *level* but more of it.

I have my eye on a couple of stocks now where I have positions already but I can really make more sense of the valuation - wishing, of course, that I'd picked up more when they were cheap - but at least in theory I will have more sense if there is a buying op in the future.

I don't want to go back to an office job, 9-5. I hated it, don't miss it.

daverobev

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Re: Risk, Debt, Sleeping Easily
« Reply #6 on: October 15, 2013, 09:33:34 AM »
I guess I should be looking at the Smith Manoeuvre next year, when we are able to get a HELOC.. that'd be the lowest risk but still significant way to increase our investments through leveraging cheaply.

tooqk4u22

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Re: Risk, Debt, Sleeping Easily
« Reply #7 on: October 15, 2013, 10:30:43 AM »
Some thoughts....

1. Risk appetite is an individual choice, what keeps you up at night or what would if it happened?
2. Ignoring or not understanding the risks is stupid,
3. Leverage magnifies returns and risks, (its not that leverage is bad on stocks its more that margin calls happen, whereas on a rental your debt typically can't be called on a moments notice if you lose a tenant or the value drops precipitously)


What does it all mean....know the risk, spread them out, and setup your (finances/life/etc) such that no one risk can bring you down....and if you do take a big risk like that then the upside better be equally large as well.