Sunday, 25 February 2018

Failing to Borrow

Am I missing out on opportunities to borrow, and thus make leveraged investments, because I bought shares instead of property?

After all, banks charge lower interest rates for loans on homes (5.94%*) and investment properties (5.36%*) than for margin loans (6.63%*). You could say that borrowing for shares is 24% more expensive than borrowing for property.

Furthermore, banks reputedly allow higher LVRs for property.

So if I can borrow more on a house and pay a lower rate, would not doing so multiply my leveraged returns?

When my friend asked me this, I flubbed by saying something like, "In an efficient marketplace the risk-adjusted returns would be roughly the same..." (blah blah self-loathing blah.)

Clearly, I want to give a more considered response.

Why do banks treat these two asset classes so differently? Common opinion is that it's because shares are riskier.

ABS Res. Price Index 2008-2017 Quarterly STDEV
Sydney 4.22
Melbourne 4.05
Brisbane 3.17
Adelaide 2.68
Perth 3.08
Hobart 3.33
Darwin 3.4
Canberra 3.14
8 Cap. City Weighted Avg 3.31
ASX 200 Index
(Rolling quarterly) 4.82

But just because property is low-risk, doesn't mean it's no-risk. With volatility of the ASX 200 being roughly 45% greater than Australian property as a whole, (but merely 14% more volatile than Sydney), the 24% premium margin loans rates have above investment property loan rates - let's call it a risk-adjusted cost - can be seen in a new context.

Second, banks lending less on shares than on houses is only partially correct. Select blue-chips attract the same LVR (around 80%) as houses. I could use either a $100,000 house or $100,000 in CBA shares to borrow $80,000.

I've written before that leverage is only useful if the asset's rate of return is greater than your rate of interest. With Australian property growth on the whole consistently lower than the loan rates at similar points in time, lower volatility reduces the chance of breakout gains. Borrowing for property investment may still not clear its lower hurdle for profitability. I believe this should be considered before the future ability to access cheaper credit (on the back of a potentially underperforming asset).

My persistent guilt about investing without leveraging does not have rational roots. Rather, its source is a yearning for approval, even if it comes from a bank officer, and a desire to be considered a sound investment. It is less about securing than it is insecurity.

So perhaps my strategy should be reminding myself that leverage opportunities are not wholly closed off to me, and that I need not feel so bad about neglecting them.

I should rather fail to borrow than borrow to fail.

*CBA comparison variable rates at time of writing.

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