Debt Signals

Q: How can you tell if someone has an investment property?

A: Don't worry, they'll tell you.

Private debt as status symbol

Friends tell me they could sell an investment property and pay off their house, so good/insane has COVID made the real estate market lately.

I benefit on paper from rising prices too, but I don't like talk without walk. Or maybe I don't like others to be successful. Whatever. I'm a work in progress.

"Nananana Debt-man!"

Anyway, I call it out, like, "Then do it. Sell. Pull the trigger already." After all, holding an asset debt-free beats holding an asset encumbered. (Amirite?)

Man, the backflip gives me a nosebleed.

Mumble mumble, "Nah the debt is serviceable," mumble mumble.

Debt? Weren't we talking about the underlying asset, the property?

OK so I got another anecdote. Bear with me.

My dad likes to tell two stories about a frugal surgeon friend of his:

• How this rich motherf*cker has so many investment properties.
• How this poor motherf*cker keeps working (three months after a cardiac arrest).

Am I supposed to feel bad that I do neither? That somehow it's a virtue to not enjoy vast wealth?

But then I realised: that sh*t doesn't add up.

If I was in a position to have the federal government as a tenant, ain't no way I'm punching a clock.

My dad, like other dudes of his generation, often turns gossip into shirtsleeves-to-shirtsleeves fables, and this one is no different. The good doc apparently does what he does to (1) provide for his super-accomplished kids, (2) keep bailing out the same super-moronic kids.

That also doesn't stack. I know his kids. We used to game. They not big-ballers, but they doin' a'ight.

Then I have a Damascene moment.

"I'll tell you why he keeps slaving away. It's not that he loves a job that almost killed him. It's not that his kids are losers. He's up to his eyeballs in debt! Repayments, baby!"

Again, the real story isn't about the underlying asset, but the underlying debt.

"You see gross! You don't see net!"

For better or worse, my dad is hard of hearing, and thus shielded from my truth-bombs.

It's also true (but widely known therefore not a bomb) that Australian households carry a lot of debt, a lot of which is associated with housing.

Property is unique in that most people have to borrow to buy one. A lot of other investments are chopped up and securitised so you can buy a share of the whole. Not houses.

Does that mean residential property is such a great investment that you should gear up and buy in?

Answer 1: Once you account for transaction and holding costs, No.

Answer 2: In specific locales, under specific conditions, yes. Do the calculations yourself.

You'd expect bias in articles from brokerages or realtors, but what of a bank that deals in both? From Westpac:

A recent paper dubbed “the rate of return on everything” by The Federal Reserve Bank of San Francisco found anyone investing in Australian shares between 1980 and 2015 would have accrued annual returns of 8.7 per cent, compared with just over 7 per cent for housing.

What this tells me is that property could have matched shares as an investment if you geared up to buy in.

But why bother?

Why do all that legwork just to concentrate into one property in one suburb in one city?

Why go to the trouble arranging debt and injecting risk, just to pace a diversified portfolio bought outright?

You wouldn't unless ... it's about the debt, not the asset.

The financial rewards of debt

Let's say you've consulted a retirement calculator, and given the assets you hold, the computer says expected returns will grow them enough to entirely self-fund your retirement, with no social welfare payments at all.

Go you.

But what if you, like the majority of Australians, do not hold that level of assets?

If you want them, you have to borrow to buy them.

However, if you were really hungry for outsize returns you'd gear into businesses or shares, not property. You're supposed to borrow small and bet big, not the other way around.

Yet investment housing borrowing is the well-trodden path, notwithstanding that tax breaks for property are the same for shares and that cheaper housing debt can be recycled to create low-interest portfolio loans.

This inconsistent caution hints that borrowing for investment may often look like greed, while actually being driven by fear.

Disclosure: I have direct property. But I'm one and done. I don't know if I'd go back in time and do it again, and I'm damn sure I don't want to do more of it. Especially given its risk concentration and lack of out-performance.

But what if you felt you were falling so far behind that you could only achieve the gains you needed through debt? 

I would go so far as to say that the only reason for investment property is because you need the debt to make up for what you haven't saved.

Again, the asset is secondary to the debt.

Yeah, yeah. I sound like some sort of leverage-Jeremiah, railing against debt. Well, we moralise everything else, so why not borrowing?

And actually, we do moralise debt. Just not like I do.

Here, I frame private debt as the consequences of a bet made before you had the means to make it.

However, it is now more commonly framed as confidence in future success. As something you do to give family members the best chance in life.

Which brings me to ...

The social rewards of debt

In case you missed the link above, the Reserve Bank of Australia (RBA) had this to say about the drivers of household debt:

... higher real incomes and lower real interest rates or inflation are all associated with increased indebtedness of households, as is the deregulation of the financial sector since the 1980s. 

Higher income means higher debt.

So why hang on to debt?

Because higher debt signals higher income.

Friend number one was 100% correct about serviceability being the issue. But it isn't about whether the underlying asset was worth servicing debt on.

I could also argue that also isn't about what size of debt is sustainable, because while debt may be sustainable, it is not - at least in my books - desirable.

Actually, 'serviceability' symbolises the creditworthiness of the income doing the servicing.

Remember in the early 2000s when we humble-bragged about how 'busy' we were? We'd refer to our Blackberries as our 'leashes'. My, what sweet innocent summer-children we were.

Now as then it is considered vulgar to plonk your payslip on the table. One must subtly hint at one's means.

Once you sit through enough Zoom parties where smug posers moan about how much they had to borrow to buy into the postcode they wanted, it may occur to you that indebted-ness is the new busy-ness.

You're not meant to question their purchase, whether they paid a fair price, or whether it was worth it. Because it's not about the asset.

You're not meant to question the debt, or whether it was necessary. Because it's not about the debt either.

If you want to be invited back to that Zoom room, you're meant to be impressed if not envious that a lender thought their prospects sunny enough to lend them five times income. 

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Q: How can you tell if someone has a good job?

A: They'll tell you about their property debt.