Re: Bad Idea: Borrowing to Invest

0x143 · Post by **0x143** » Thu Jun 20, 2019 2:47 am

The comments on the article were locked but I wanted to discuss an idea I had. https://www.retirejapan.com/blog/bad-id ... to-invest/

Namely I think a regular high-dividend stock would be a bad idea for a long term loan for the same reasons the article mentions. Yet what about a REIT?

In Real Estate investing one always wants leverage. For such leverage in Japan the time frames are longer, the loans larger, and RE is of course not liquid. Yet maybe REITs are similar enough to RE to justify.

Most REITs are going to be for assets with 30-60 year depreciation, but with the Infrastructure REITs (Solar REITs) those assets are on 16-20 year schedules. Thus the depreciation better matches the loan term. Thus these REITs are returning 6-8%, of which only 2-3% is tax-able profit and the rest is return of principle. Thanks to the feed-in-tarrif system these Solar REITs should have low revenue variance. Thus their pricing should behave more like fixed income bonds. Like bonds their nominal value should go up if risk free returns go down (as they do in a recession).

Anyone else think these would be worth taking the risk for to leverage into? Of course for a fixed payment loan one would want 1.5 to 2% interest rate, otherwise one should just use margin.

Daniel

mighty58 · Post by **mighty58** » Thu Jun 20, 2019 3:18 am

I'm no expert, but I believe because the REIT itself is a financial instrument traded on the secondary markets, it is subject to price fluctuations (due to supply/demand) that may not accurately reflect the underlying assets/revenue streams. As such, the risk is that you could be hit with a big capital loss when it comes time to divest.

There is the more practical problem of where you're going to find someone offering a competitive rate for you to borrow to invest as well.

0x143 · Post by **0x143** » Thu Jun 20, 2019 3:35 am

Specifically this thread is in reply to the article on the blog where the writer was offered a decent interest rate.

Yes market prices will fluctuate, it is a exchange traded instrument after all. The question for an investor is if the variance risk is worth the upside.

There is still a slight duration mis-match, the depreciation is about 20years while the article's loan was 10 years. Thus the asset generating cash flow will be about 30% or so too little to make the full loan payments (which include principle). Yet the margin should still be juicy, as the principle gets repaid the interest bearing priciple reduces but the cashflow does not. Thus mid-way through the loan, when the NAV will have depreciated by 25% and the loan principle by 50% the cashflow should be enough to pay the full loan payments.

Thus there should only be a few years of DCA investment reduction, then a few years of net zero cashflow change, then a couple years of positive cashflow. Finally once the loan is repaid after 10 years there is still 6-10 years of the cashflow left to enjoy cost-basis free.

YouTube · Post by **RetireJapan** » Thu Jun 20, 2019 3:45 am

The slight problem is that the loan I was looking at specifically disallowed borrowing for investment purposes. You'd have to lie to get it. Not sure if they would require receipts, etc. to prove what you used it for.

Don't forget about the loan fees as well (not sure how much they will be), normally payable upfront.

0x143 · Post by **0x143** » Thu Jun 20, 2019 3:59 am

Those are good points. Loan origination fees are almost %2 or so from stuff I've seen, not cheap.

If the bank is willing to lend money to you for personal frivolous spending then there is a good chance they be willing to lend for investment if you pitched them. They 100% do not want some 40year old guy stuck in his job to take out the max amount then lose it all on FX. Meanwhile an investor with substantial assets, decent job, and a reasonable investment plan should look like an attractive borrower.

Sadly I do not have PR or citizenship yet so this is just theory-crafting for now.

ricardo · Post by **ricardo** » Thu Jun 20, 2019 7:06 am

For goodness sake, chaps.

The answer is “no.”

Believe me...

TokyoWart · Post by **TokyoWart** » Thu Jun 20, 2019 8:00 am

Regarding the general question, I would strongly recommend against borrowing to invest. I agree that a lot of direct real estate investment is structured that way and it can make sense if you have protections from the loan being called in (which would happen at the worst possible moment for you) but loans taken for financial investment (margin loans, bank loan to buy a stock, etc.) are not going to have that protection. I am not sure how margin loans are regulated in Japan, but margin requirements in the US are set by the Federal Reserve which can and does suddenly change those requirements to remove market liquidity (i.e. they know their move is wiping out some investors but make the move anyway because it provides market discipline).

The more specific question on whether margin might be safer for a solar utility REIT because it has guaranteed cash flows due to the feed-in tariff system, I would say this is actually one of the riskiest of cash flows because the law can be changed at any time. In general utilities do not like those tariffs (they do not tend to be economically well-structured for the utility) so you have one powerful force constantly working against you.

I used margin in the early part of my investing career. It really boosts returns when times are good and has the same effect in reverse when times are bad. In 2006 I made moves to remove any trace of margin from my investing and by 2008 I realized that if I had not, I could easily have been wiped out because of how aggressive brokerages had to be on margin calls (if they can't reach you they just liquidate your positions). Seeing how close I had been to disaster convinced me to remove every way in which I was borrowing for investment, including paying off my mortgage, using no options, having cash a year or more in advance for major purchases, etc.

0x143 · Post by **0x143** » Thu Jun 20, 2019 9:58 am

TokyoWart wrote: ↑Thu Jun 20, 2019 8:00 am The more specific question on whether margin might be safer for a solar utility REIT because it has guaranteed cash flows due to the feed-in tariff system, I would say this is actually one of the riskiest of cash flows because the law can be changed at any time. In general utilities do not like those tariffs (they do not tend to be economically well-structured for the utility) so you have one powerful force constantly working against you.

The law can be changed for new projects, but existing contracts cannot be changed without someone convincing the government to introducing a law breaking said contracts.

Personally I agree that TIF was a poorly designed system, but the government has already been pulling back with new projects. Thus I do not see a scenario where TIF gets broken enough for the government to break existing contracts.

What risk exists is when the Power Companies can curtail production. So far curtailments have been minor, and presumably would stay so provided mega solar does not expand too fast.

TokyoWart · Post by **TokyoWart** » Thu Jun 20, 2019 1:22 pm

The law can be changed for new projects, but existing contracts cannot be changed without someone convincing the government to introducing a law breaking said contracts.

I didn't realize you had read the existing contracts and knew how long they extend.

Although there are already articles about the feed-in tariff being reduced by half which only brings them down to the generous levels typical in the EU (https://www.japantimes.co.jp/news/2018/ ... QuHv6-P6M8).

I have no idea where solar REIT's are heading as an investment. I tried doing some online searches and was surprised to learn that for legal reasons they are hard to create in the US. In general an investment that is returning 6-8% each year is pretty good but not so if all but 2-3% of that is return of principle. I think the point I would like to drive home is that when you invest with borrowed money (or when you short a financial asset) you need to be much more sure that you are right about your investment thesis and have considered every way in which events could turn against you. I would not stand on my soapbox and say no one should buy a solar REIT, but I would stand on that soapbox and say no one should borrow to invest in a financial asset and that includes solar REITS.

mighty58 · Post by **mighty58** » Thu Jun 20, 2019 1:24 pm

Yes market prices will fluctuate, it is a exchange traded instrument after all. The question for an investor is if the variance risk is worth the upside.

You've obviously given this some thought and you seem to know your stuff (certainly better than I), but all the calculations in the world will not help in predicting the future NAV value, and I feel the rate of return is certainly not as rock-solid as you make it out to be.

However, even if you turn out to be correct in all your assumptions, the loan offer being referenced is only for 10mil yen max, which at the end of the day doesn't offer much significant upside. At 1.7% (+fees), that puts a very solid (low) cap on the upside potential, while still exposing you to a large (i.e. the full amount) downside potential. If you could borrow a couple mil DOLLARS at those rates, the upside potential might get more interesting, but at these levels, the upside is too small to be even be worth considering.