Borrowing to invest raises risk

BY MARY HOLM

Q: I wish I could be a fly on the wall in your letterbox and await and read the howls of protest from property investors over my letter to you in last week's column.

In reality, I have no objection to property, just the failure of others to recognise the risks taken on and the perception that returns are better than they actually are, particularly when gearing or negative gearing is used.

I've got only one minor issue with your response, and that probably arises as a result of a need to make a point in limited space.

Contrary to your statement, I did not point out that if your earlier correspondent had not borrowed, the return would be only 3.5 per cent per year.

This was the return actually achieved in this case, after deducting costs, as all of the rental income went on expenses and interest. Hence my conclusion that the return did not justify the risk.

If he had not borrowed, and had $105,000 to invest, the return would have been increased by the rental income.

The total return may well have been reasonable for the risk then taken on, particularly as there would be no borrowings.

The return would then have been 3.5 per cent per year plus the rental less much reduced expenses. Unfortunately, your correspondent had only $40,000.

You would have been a bored fly.

Nevertheless, I want to run your letter to put the record straight. I did, indeed, get it wrong about the 3.5 per cent return. Too much haste. Sorry.

Would it be churlish to add that you have made a minor error, above, too?

The value of the man's rental property has grown from $105,000 to $120,000.

In the meantime, he has paid $5000 off his mortgage, so his equity has grown by $20,000. A gain of $20,000 on $105,000 over five years comes to 3.5 per cent a year.

But if the man had not borrowed, he would not have paid off the $5000, so his equity would have grown only $15,000.

That gain on $105,000 over five years comes to 2.7 per cent a year. Then, as you say, he would add the rental income minus expenses.

Your excuse can be that you probably didn't have the original letter in front of you, so you forgot about equity paid off the mortgage.

Anyway, enough of all this detail. The main point - on which we agree - is that borrowing to invest in property, or anything else, raises risk.

* Mary Holm is a freelance journalist and author of "Investing Made Simple". Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@pl.net. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.