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Would ever swap a productive asset for an unproductive one?


giofranchi
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I have the opportunity of purchasing a very fine piece of real estate for half the price it was worth a few years ago. It is located in a wonderful little tourist town in Liguria, northern Italy, not far from France, La Cote d’Azur. I am almost positive the price it will sell for might get back to normal, once economic conditions in Italy improve.

 

The fact, though, is I will have to sell some productive assets (stocks) to buy an unproductive one… And usually I’d hate to do that (and I never do!). It seems a great bargain, but I’d hate to see my productive capacity diminished.

 

What would you do if you were in my shoes? And for what reasons?

 

Thank you,

 

Gio

 

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Gio, it is hard to compare the two.

 

Sounds like you might have fallen in love with a beautiful object.

 

Why it might make sense: diversification, leveraged investment depending on what kind of mortgage you can get.

 

You will not have to look at prices until you sell.

 

Is it land you plan to develop since that is where the big payoff in often is?

 

Just some random thoughts.

;)

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Is it land you plan to develop since that is where the big payoff in often is?

 

No. It is just a wonderful apartment… what you might call a “beautiful object” ;)… But the fact still remains: its market price a few years ago was 13-14k Euros per square meter, and I could buy it now for 7k Euro per square meter… The location is almost unique, and it is difficult to imagine how this could be anything else than a distressed sale. Actually, I know the owner quite well, and I am aware of the fact he unfortunately needs money now…

 

Gio

 

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For me the main question would be Do I want it as an investment or to use/enjoy.

 

1. If its to use/enjoy and the price feels good then buy. Even if price is not good but you will really enjoy it then buy. Life is not all about money.

2. If its an investment then

  a. Just because it was selling for 14k/sqmtr doesn't mean it was worth that much. It could be bubble pricing.

  b. Why aren't other people interested at the 7k/sqmtr price if its so cheap?

  c. Will you be renting it out?

  d. In 10 years what will be the total value of your investment in apartment vs holding the current stocks?

      Total value needs to be adjusted for Real Estate agent fees and taxes on apartment vs only taxes on stocks.

      Lots of assumptions go into this.

      How many years till economic conditions recover? What rental income you get? What is vacancy? What will you pay some to handle rentals/maintenance etc? Which stocks will you sell? If its something like BRK would you sell the apartment and end up buying the same stocks?

      The calculations will have to be adjusted for how sure you are about the predictions you are making.  Like you are 60% sure about economic recovery vs 80% sure about your stock gains.

 

Sorry im rambling its 1:20 AM. Time to sleep. Maybe ill edit it later to clarify what I meant.

 

 

 

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  a. Just because it was selling for 14k/sqmtr doesn't mean it was worth that much. It could be bubble pricing.

 

I agree. But Italy has never been like Spain or Ireland: we have never experienced a very large real-estate bubble.

 

  b. Why aren't other people interested at the 7k/sqmtr price if its so cheap?

 

There are at least other two offers for the same price. But the owner prefers to sell his appartment to me, because we have known each other for a very long time. :)

 

Gio

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What is the gross rent/sq meter?

 

Don't know exactly… These days it might be quite depressed… In my experience with the rent you can cover all the costs associated with owning such a luxury apartment with ease… but then not much money is left to put in your pockets! ;)

 

Gio

 

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We bought a London, UK property & went through something broadly similar.

 

Options. Congratulations, your growing wealth is giving you options. You have the ability ….. but not the obligation to purchase a property.

 

Rational. Nice place, pretty locale, but if you want to visit … why would you not just rent a room or apartment during your stay. If you plan to buy & rent, then visit when the place is empty – the place must be furnished; was that part of the plan. If you are a successful renter or lessor, the place it is not going to be empty & you are not going to be visiting; was that part of the plan.

 

Trophy. If you get a huge bonus, most would use it to buy a nice house to live in, or a nice car - to mark it. This is much bigger; if you don’t intend to be a landlord & hold many apartments or houses as a business, it is really a trophy – to which there are many other options with much lower price tags; from paintings through to mistresses.

 

Diversification. This is really a reserve asset that diversifies earnings; if your life goes to hell tomorrow, this is the nest egg to get you back on your feet. The local property market needs to be reasonably liquid, even in the bad times.

 

We chose London, because of its liquid property market, and the place is unfurnished. We bought because the price was exceptionally low. We treat the property as a trophy asset, & kept the equity investment to less than 20% of total net assets. The mortgage is used to absorb any surplus operating cash that we may have, as the before tax return is well above what we might earn on a gilt.

 

The property has 8 years to go on a 10 year lease, and has appreciated 65% over the short period that we have held it.

 

SD

 

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What is the gross rent/sq meter?

 

Don't know exactly… These days it might be quite depressed… In my experience with the rent you can cover all the costs associated with owning such a luxury apartment with ease… but then not much money is left to put in your pockets! ;)

 

Gio

 

So it sounds like 0. In that case I suggest you price it the way you would a good cigar or a good bottle of scotch!  ;D

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We bought a London, UK property & went through something broadly similar.

 

Options. Congratulations, your growing wealth is giving you options. You have the ability ….. but not the obligation to purchase a property.

 

Rational. Nice place, pretty locale, but if you want to visit … why would you not just rent a room or apartment during your stay. If you plan to buy & rent, then visit when the place is empty – the place must be furnished; was that part of the plan. If you are a successful renter or lessor, the place it is not going to be empty & you are not going to be visiting; was that part of the plan.

 

Trophy. If you get a huge bonus, most would use it to buy a nice house to live in, or a nice car - to mark it. This is much bigger; if you don’t intend to be a landlord & hold many apartments or houses as a business, it is really a trophy – to which there are many other options with much lower price tags; from paintings through to mistresses.

 

Diversification. This is really a reserve asset that diversifies earnings; if your life goes to hell tomorrow, this is the nest egg to get you back on your feet. The local property market needs to be reasonably liquid, even in the bad times.

 

We chose London, because of its liquid property market, and the place is unfurnished. We bought because the price was exceptionally low. We treat the property as a trophy asset, & kept the equity investment to less than 20% of total net assets. The mortgage is used to absorb any surplus operating cash that we may have, as the before tax return is well above what we might earn on a gilt.

 

The property has 8 years to go on a 10 year lease, and has appreciated 65% over the short period that we have held it.

 

SD

 

Interesting.  Many buyers are cautious about buying properties on a short lease.  How much certainty over renewal costs do you have and how will you fund them?  I guess you could now remortgage?

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Interesting.  Many buyers are cautious about buying properties on a short lease.  How much certainty over renewal costs do you have and how will you fund them?  I guess you could now remortgage?

The remaining term of our lease is 57 years, & we are subleasing in 5-10 year chunks. At the end of 57 years the value of the lease will be zero, so at each sublease expiry we will formally reappraise. Sell the lease & buy another - do nothing or roll up/down or out/in via a sale and repurchase. We do not intend to hold the property forever.

 

In market parlance we have prepaid 57 years of premium on an at-the-money call on a specific property in a desirable location, with the years option decay (all else equal) equal to the years premium. We do not know what the premiums will be (the greeks are constantly changing), and we cannot determine what the current years premium was until the year has expired (ending - beginning value). We can exit the option at any time, by simply reselling the property into the liquid market.

 

Short subleases allow us to arbitrage the option decay. Our sublease is to a PLC & we are prepaid the annual rent at the start of the year. Realized CF against unrealized decay loss on our underlying lease. The primary greek is volatility, not interest rate; our increase in MV is primarily because of volatility reset. We think it will reset again before interest rate starts to move in any significant way.

 

We don't need a mortgage; we took one out primarily to exploit the current incentives, & give us a higher paying option on our surplus cash - than a straight gilt would do. The proceeds are in high quality prefs with dividend flow applied against interest. We could pay out the mortgage at any time.

 

The UK is unique to this type of ownership, & its part of the culture. We would have preferred a simpler arrangement. If you understand options (Eric) this is no big deal, but if not - its a bad place to be.

 

Oddly, the optionality produces a result not that different to what you might see around a junior mining coy. Part of the reason why our stakes in ALS & ADV do not particularly bother us.

 

SD

 

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Is it land you plan to develop since that is where the big payoff in often is?

 

No. It is just a wonderful apartment… what you might call a “beautiful object” ;)… But the fact still remains: its market price a few years ago was 13-14k Euros per square meter, and I could buy it now for 7k Euro per square meter… The location is almost unique, and it is difficult to imagine how this could be anything else than a distressed sale. Actually, I know the owner quite well, and I am aware of the fact he unfortunately needs money now…

 

Gio

 

Why is it an "unproductive" asset?  I first figured you meant raw land, but if it's been developed (an apartment) then it doesn't sound unproductive.  You can rent it to produce income.

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Why is it an "unproductive" asset?  I first figured you meant raw land, but if it's been developed (an apartment) then it doesn't sound unproductive.  You can rent it to produce income.

 

Yeah! But in my experience (and I already have another apartment in the same town!) it is just like MrB has said:

So it sounds like 0.

 

Gio

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Why is it an "unproductive" asset?  I first figured you meant raw land, but if it's been developed (an apartment) then it doesn't sound unproductive.  You can rent it to produce income.

 

Yeah! But in my experience (and I already have another apartment in the same town!) it is just like MrB has said:

So it sounds like 0.

 

Gio

 

MrB's reply was great -- thanks for pointing me to it.

 

I'm familiar with exceptional real estate being priced like a good bottle of Scotch.  Or a fine cigar.  Neither are valued on their cash flow, as they don't produce any.

 

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Interesting.  Many buyers are cautious about buying properties on a short lease.  How much certainty over renewal costs do you have and how will you fund them?  I guess you could now remortgage?

The remaining term of our lease is 57 years, & we are subleasing in 5-10 year chunks. At the end of 57 years the value of the lease will be zero, so at each sublease expiry we will formally reappraise. Sell the lease & buy another - do nothing or roll up/down or out/in via a sale and repurchase. We do not intend to hold the property forever.

 

In market parlance we have prepaid 57 years of premium on an at-the-money call on a specific property in a desirable location, with the years option decay (all else equal) equal to the years premium. We do not know what the premiums will be (the greeks are constantly changing), and we cannot determine what the current years premium was until the year has expired (ending - beginning value). We can exit the option at any time, by simply reselling the property into the liquid market.

 

Short subleases allow us to arbitrage the option decay. Our sublease is to a PLC & we are prepaid the annual rent at the start of the year. Realized CF against unrealized decay loss on our underlying lease. The primary greek is volatility, not interest rate; our increase in MV is primarily because of volatility reset. We think it will reset again before interest rate starts to move in any significant way.

 

We don't need a mortgage; we took one out primarily to exploit the current incentives, & give us a higher paying option on our surplus cash - that a straight gilt would do. The proceeds are in high quality prefs with dividend flow applied against interest. We could pay out the mortgage at any time.

 

The UK is unique to this type of ownership, & its part of the culture. We would have preferred a simpler arrangement. If you understand options (Eric) this is no big deal, but if not - its a bad place to be.

 

Oddly, the optionality produces a result not that different to what you might see around a junior mining coy. Part of the reason why our stakes in ALS & ADV do not particularly bother us.

 

SD

 

Just be aware that 57 years is unusually short - surprised you got a mortgage on that - and that it will get less and less liquid the shorter it gets.

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I have the opportunity of purchasing a very fine piece of real estate for half the price it was worth a few years ago. It is located in a wonderful little tourist town in Liguria, northern Italy, not far from France, La Cote d’Azur.

sounds horrible  ;D go for it if it doesn't hurt too much and it would make you happy. in my opinion this depends on % of total assets and how it compares with what you already own.

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I have a crazy rule - when times are hard, I spend money. When times are easy, I save money.

While this may be against the grain, the reasoning is that in hard times you do best to focus inward and ignore the noise while waiting for things to turn, and when times are good, you best to be cautious. Not sure if this helps with your situation but I would almost always go for my own thing than the "default position" available in the general ocean of stocks.

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