June 20, 2018
“Liquor, ladies, and leverage” are often quoted by Warren Buffet and Charlie Munger as the only three ways a smart person can go broke.
Let’s add a 4th L-word: Lodging.
I am about to do the unthinkable – buy a condo using leverage, or in other words, take a loan on my equity at Interactive Brokers as a pseudo-mortgage to buy a condo in Bangkok. Leverage can be dangerous to your financial health. Property in Thailand can be deadly. I’m usually risk-adverse when it comes to investing. So, why am I not following the advice of the great Oracle of Omaha?
One Million Baht Down the Drain
Three weeks ago, I realized I have been renting my condo in the center of Bangkok for almost four years. I spend over 250,000B per year on rent (8,000 USD), so in four years I have thrown away over 1,000,000B (30,000 USD). That might not be a lot of money to some people, but I would rather avoid spending 1 million of any currency with nothing to show for it.
If the condo owner said I could pay 1 million Baht up front for four years when I first saw it, I would have realized how expensive it was long-term. I had never thought of rent as an annual expense before. I always thought if your rent is a reasonable percentage of your monthly salary you are fine. Many people think it’s normal to spend 25-30% of your salary on rent. At 25%, you spend one year’s salary every four years. At 30%, it’s one year every three years!
And 1 million Baht is how much I have spent in only the last four years. I have been renting for more than 25 years. I’m not going to calculate the total amount I’ve spent on rent for fear the result may shorten my lifespan.
There are advantages to renting though, especially in Thailand. Most importantly, it’s less risky than buying. You can easily move at any time if you change jobs or have noisy neighbors. Walking away is trivial if Thailand doesn’t work out for you. It’s much simpler than navigating foreign ownership rules. Foreigners are not allowed to own land and there are restrictions on buying condos. Local mortgages for foreigners are almost impossible to get, as I was about to find out.
Mission Impossible: A Mortgage
I had enjoyed the flexibility of renting for long enough and it was time to stop wasting money. Condos in my area cost around 4-5 million Baht (140,000 USD) for a 1-bedroom unit. I don’t have that kind of cash sitting around, so I went looking for a mortgage. I have a friend whose wife doesn’t work, but a local bank easily gave them a 5 million Baht mortgage with 0% down at 2% interest. Interest rates are only going up to control inflation these days, so I was eager to get the process started. With 0% down, what could wrong?
The first bank I went to was Krungsri. I pictured myself as their perfect customer applying for a mortgage – the same job for close to 15 years, millions of baht (tens of thousands of dollars) of investments with them, and a Krungsri credit card for over 5 years with a perfect credit history. Anxious to start the first property purchase of my life, I couldn’t wait for the electronic voice to call my queue number. My hands were sweating as I sat down in front of the loan officer. The conversation that transpired bewildered me.
Quite often when a Thai person becomes uncomfortable in a conversation with a foreigner they will pretend to all of a sudden lose the ability to speak English. Even though Krungsri took over HSBC’s Thailand operations, the loan officer appeared to only know one sentence, “We don’t give mortgage to foreigner.” I got the same reply to everything I said. It took under one minute for me to leave, completely demeaned.
I’m not easily discouraged, so I went to UOB since I also have investments and a credit card with them. They were more welcoming. They took down my contact information and said someone from the head office would call me. I had to go back twice over the next week before I actually received a call.
Mission Impossible 2: UOB
The lady who called me was friendly and positive. She spoke perfect English and explained they give loans to foreigners through their branch in Singapore. She sent me the terms and conditions by email and it was easy to see they were not favorable. I had to give a down payment of 30-40%. The interest rate was close to 8%. I also had to pay lawyer fees every year and get life insurance. There were even premiums to cover their exchange rate risk. I met her in person to figure out why I was having so much trouble getting a mortgage when my friend didn’t have any problems.
She explained since the Thai government requires foreigners bring in all the money to buy a condo from abroad, banks are unable to give mortgages to foreigners from any of their Thai branches. That’s why I was instantly denied at Krungsri. I knew special documents were required when you brought money in from abroad to buy a condo, but I thought that was just for tourists. Equally important, foreigners can only own up to 49% of the units in any building. Maybe I was naive, but I didn’t realize those rules also apply to foreigners who live and work in Thailand.
The condo my friend bought isn’t in his name. It’s in his wife’s name and he has guaranteed her mortgage. Using my Western logic, I asked, “What’s the difference between giving a mortgage to a Thai person who doesn’t work that is guaranteed by a foreigner and just giving a mortgage directly to a foreigner in the first place?” It’s all about ownership. If I want the condo to be in my name, all the money must come from abroad. Local mortgages are not allowed unless you have permanent residency. No exceptions.
I talked in detail with the UOB loan manager about mortgages for Thai people, not because I wanted to promote the stereotype of a difficult falang who thinks too much, but because I wanted to understand the system. In contrast to being denied instantly despite working here for almost 15 years and having investments along with a perfect credit history, Thai people just need a middle-class job.
To increase profits, banks have deliberately made mortgages strikingly easy to get for the largest segment of Thai society. If a Thai person has a minimum monthly salary of 20,000B (600 USD) they qualify for a 0% down mortgage at 2% interest. But the 2% interest rate is an advertising gimmick than only lasts for the first few years. After that, it goes up to about 7%, which is 5.5% higher than the current Bank of Thailand policy rate of 1.5%! This explains why banks are making a ton of money. They provide easily accessible mortgages for the growing middle class and then make a killing charging 7% interest over 30 years. With those conditions, a 5 million Baht condo would end up costing 12 million.
Anyone who remembers the 2008 financial crisis should be drawing similarities between Thai mortgages and NINJA (No Income, No Job or Assets) sub-prime mortgages that fueled the property bubble in the US. While not as risky as NINJA loans, zero-down Thai mortgages for the new middle class are fueling inflated property prices in Bangkok and driving new developments. The 77-floor MahaNakhon Tower, which can only be described as excessive, is a good example. Any property market that has almost no barriers to entry for a rapidly expanding population will likely become a bubble.
It goes without saying, these expensive mortgages will keep people in debt most of their lives. Not realizing the consequences of 7% compounding interest over decades is financial suicide to me. Spontaneous combustion of any FIRE lifestyle plans will be the result.
Leverage and Lodging
It didn’t take long to decide against a long-term mortgage of millions of Baht at 8% interest with UOB in Singapore. My thoughts shifted to buying a cheaper condo on the outskirts of Bangkok with cash. I’ve been spoiled living in the city center for years. It’s never been part of my personality to pay extra to be in the middle of the action. I don’t drink or go with ladies of the night. If I take at least some of Warren Buffet’s advice and avoid liquor and ladies, maybe I can indulge in a bit of leverage without too much damage to my overall well-being.
A lot of my tax-deductible investments are now eligible for redemption and I could sell some of my overseas investments as well. But instead of selling investments to buy a condo, a friend suggested I get a loan on my equity from Standard Chartered in Singapore. They have a program where you can withdraw in cash up to 70% of the value of qualified investments. That way, I could remain fully invested while still financing a condo.
I had a normal Reg T margin account with Interactive Brokers that allowed a 50% margin loan on equities, but I contacted them to see if they have anything similar to what Standard Chartered offers. And they do – a portfolio margin account. With portfolio margin, in theory, you can withdraw up to 85% of your net liquidation value. Like Standard Chartered, not all investments qualify. Many of the investment trusts I held have 100% margin requirements, so I sold most of them and bought equivalent exchange-traded-funds that have 15% margin requirements.
Advantages of a FIRE Condo
I found a new condo development within walking distance of the Skytrain. It’s about half the size of what I have now and it’s 20 minutes further from the center of the city, but those are sacrifices I am willing to make. Most importantly, I can pay off the margin loan in just a few years, even while still putting 30% of my salary (the maximum allowable) into tax-deductible investments. Tax-deductible investments will always be my number one financial priority because I get almost an extra month’s salary every year just from the tax savings.
I did some calculations to determine the opportunity cost of paying off the margin loan instead of putting that money into investments. My total amount invested will be lower while paying off the loan and for a few years afterward. But, my total equity will quickly catch up once it’s paid off because the money I used to waste on rent will then go to investments. About eight years after buying the condo, my total equity (not including the condo) will surpass what it would have been had I not bought it. If I continue to work until 60 years old, my total wealth will be much greater.
Even in the absolute worst case where I am unable to sell or rent out the condo in the future, I will still be ahead financially eight years after purchasing it as long as I can live in it. That’s an acceptable risk to me.
Financial Independence is Near
In addition to having greater total wealth by buying the condo, my living expenses will drop. In fact, not paying rent will allow me to become financially independent based on the 4% rule as soon as it is paid off! That is a major milestone for anyone following FIRE. I never thought I could become financially independent in my mid-40’s!
At the same time, my savings rate will jump to 75%!
The verdict is clear. By living below my means and sacrificing a bit on accommodation instead of financing millions of Baht for decades at high interest rates, I will have more wealth and be able to FIRE sooner.
The above calculations are based on my current living expenses and don’t include getting married or putting kids through school. So I won’t quit working as soon as possible. I’ll continue at least until my early or mid-50’s to give myself more of a buffer and to pay for an international school for at least one kid.
Margin and leverage come with many risks. In the worst case scenario of a market crash, your broker could force you to sell at large losses to cover the loan. It’s possible to get completely wiped out. That’s why I would never take anywhere near 85% as a loan on equity. Market crashes of 30, 40, and even 50% or more are common throughout history so I will limit my margin loan to 20-30% at most. That will give a large safety cushion in the event of a market crash.
Another downside to leverage, often emphasized by Warren Buffet, is your losses are amplified which can lead to poor decisions. Spur-of-the-moment decisions made while under the stress of large losses will not be in your financial best interest. Luckily, I have some experience with market crashes. I survived 30% drops in the Thai stock exchange in 2013 and 2015, and more recently, I’ve watched bitcoin lose close to 75% of its peak value. I didn’t panic those times, and I most likely won’t in the future.
If the equity in my Interactive Brokers account starts getting too close for comfort my backup plan is to redeem some of my tax-deductible investments in Thailand. Then I could top-up my Interactive Brokers account with the proceeds. Yes, I will most likely be selling at a loss in the event of a market crash, which is what you normally want to avoid doing, but emerging markets and Thailand exchange-traded-funds available on Interactive Brokers will also be down. It would be similar to transferring investments from one broker to another.
Exchange Rate Risk
Exchange rate risk is very real. I can take the margin loan in any currency Interactive Brokers offers. Some currencies like British Pounds and Euro Dollars have a 1.5% interest rate at the moment. Singapore Dollars is about 2.9%. History has shown exchange rate risk is far greater than the difference in interest rates. Exchange rates can move 10-20% or more in a single year. It’s best to choose a currency like Singapore Dollars that is more likely to move with the Thai Baht, rather than chase the lowest interest rate. Using Singapore Dollars also gives me the same exchange rate risk as if I took a mortgage with UOB.
My condo will be ready to move into around January 2019. I’ve paid the booking fee and 15% is due within 30 days, and another 15% within 60 days. The final 70% is due on ownership transfer.
I’ll write a future post about the buying process.
*Please read the Disclaimer. I don’t recommend anyone use margin, especially to buy property in Thailand.