Summer Financial Reflections

I'll get to my Good, Better, Best post in a while. I've completed the outline and want to spend more time that usual putting my logic together to "make my case".

===

I've been mulling over a few things this year and watching the major economies -- from a distance, on a weekly basis through the Economist, FT and Wall Street Journal. I've also been reading a selection of research that some pals send over from time-to-time.

Interest rates -- globally, I've watched every central bank tighten throughout the year. This time last year there were some outstanding long term swap rates around -- oil prices, inflation fears, a more rational outlook and easing global expectations have made those disappear.

Housing -- despite rates moving up just about everywhere, prime housing is surprisingly robust. Within our portfolio (Prime Scottish Residential), we continue to see 10% per annum growth. The high end, in most places I go, is performing very well.

Inflation -- everyone talks about how we live in a low inflation environment. I simply don't see that. Now my life is quite a bit different that most folks -- my largest single expenditure is airfares. and -- following that -- rental accommodation. Step back from me, though...

What is the largest single expenditure that most people will make in their lives? Think about it relative to personal NAV at the time.

Housing.

Now if you "own" your house then you've likely seen fantastic growth in your equity over the last six years. You may have also moved up the housing ladder possibly by increasing your personal leverage. I know many folks that have done that.

Consider your debt service obligations as a percentage of total family expenditure -- how have these changed over the last six years?

If you don't own then consider rent as a percentage of total expenditure -- how has that changed?

One of the things that I learned when working in venture capital was sensitivity analysis. Basically, we would dream up scenarios to see how our investments would fare under various outcomes. We also wanted to see what would blow out the banking covenants and/or leave us bust.

Here's one that I've been mulling --
***Knock 20% off the value of your real estate investments
***Set all your asset backed debt service costs to 10%
***Set all your unsecured debt service costs to 15%

Are you still solvent?
Lose your job -- how many months until you lose your house?

If you are under 30 then this scenario may seem far too drastic.
If you are over 50 then you'd merely call this a recession.

This table is great -- outside of the US, you get even wilder historical interest rate data. It's worth looking at the prime rate across your business career -- then look at across your parents' careers.

If you have a similar spread to my peers then you'll see why so many of our parents' generation were hammered in the late 70s/early 80s. The only experience they had was similar to our own. Now they had their parents' memories of the Great Depression but that was ancient history and they were in a new era...

Most of my adult friends have very little direct personal experience with the combination of asset deflation/wealth destruction and high interest rates. There are vague memories but times have been so good, for so long and their investments are so blue chip... that they simply can't fathom anything other than continued asset inflation.

===

It will be interesting to see where we are a year from now.

War in the Middle East -- high energy costs -- terrorism -- a contraction in consumer demand driven by negative wealth effects -- tightening global monetary policy...

Now there is a lot of very good news out there. Most of my peers continue to do very well -- the people that purchase and rent our properties are continuing to do well.

It's just that I can't help but run my scenarios -- and I sense that much of this feel good factor is being driven by the massive run up in global real estate values. Nothing warms the heart quite like our own home increasing in value. It seems so "real".

What drove these values so high, I wonder?
***Rapid monetary growth driven by low central bank rates
***Increasing loan to value ratios
***Increasing loan to salary ratios

Leave everything the same as it is right now -- assume no further inflation, no deflation -- merely a benign scenario where we all move sideways for a while. If you aren't too leveraged then not a big deal for a few years. However, if you are highly leveraged on low yielding assets then there could be a liquidity squeeze.

Who knows what's going to happen. I certainly don't.

I've simply beeing watching (from a distance) global liquidity as well as risk. I have the benefit of moving around the world quite a bit so I get a feel of what things are like in many different regions. While successful property investing is very "local", the concepts that I have outlined above are pretty much universal from my travels in Asia, America and Europe.

I read all the articles on the US Dollar being overvalued but in terms of purchasing power, the States leads all of the "first world" places that I've visited (France, UK, Canada).

New Zealand still has a value-for-money edge over the States but that's driven mainly by a lower housing cost than an equivalent US city. I'm spending all of December in Australia and will enjoy having a look around there.

So that's what I mull over when riding long and not thinking about triathlon training. A rather long winded way to say that you might want to check your room-for-error with your personal leverage situation.