Bond Investment Strategies 6: Revealing Hidden Capital | Harris Fraser
Wealth Planning
4 November, 2020
Bond Investment Strategies 6: Revealing Hidden Capital

As mentioned in the previous article, taking advantage of the low interest rate environment and high property prices, carry arbitrage via mortgage financing is one of the wealth appreciation strategies. Rising property prices increase the amount of capital available to us, while low interest rates reduce borrowing costs and increase room for carry.

Mortgage refinancing can be used like a magic tool to unlock the hidden capital that don't usually come across investors' mind. Utilizing it for either investment or purchasing properties can give investors more opportunities for wealth appreciation.

Envisioning “Passive Income”

One of the more popular terms we hear these days is ''passive income''. Not sure if everyone has a different understanding of the term, but “passive income” should mean income that doesn't require any effort or time on your part, something so simple and mindless that you can sit at home, and watch your bank account balance grow by the day. Sounds good, so how does it work out?

Getting the money to work with

Given there is room for carry and passive income generation, we can construct the passive income generating engine. First and foremost, everything requires capital. Where does the capital come from? In Hong Kong, often complain that they don't have enough capital, but the truth is, many Hong Kongers' assets are held up in real estate. You can release the capital with mortgage financing, it doesn't matter if your property is fully paid up or if you are still paying off your mortgage, you can always organize a carry trade with your asset in hand.

Building the engine

We’ll take an example of mortgage refinance carry to illustrate it better. If your property is valued at $7 million, under the current HKMA guidelines, you can take out a mortgage of up to 60%, which means that you get a refinanced mortgage of $4.2 million at if it is fully paid up, which can be used in the carry arbitrage trade. Of course the mortgage will be smaller if you are still in the midst of paying off, but the whole process is the same except the value being proportional to the net value of the property.

The arbitrage carry can be self sustaining

For mortgage terms, on average, a person aged 45 or below could typically apply for a 30-year repayment period. Based on the highest reference mortgage rate of 2.625%, the $4.2 million mortgage shall be repaid over 30 years, and the monthly repayment would only be $16,869. If the entirety of the $4.2 million is invested with an annual return of 6%, the monthly gains of $21,000 will be sufficient to cover the monthly mortgage payments. Bear in mind that mortgage payments also include repayment of the principal, the actual income actually reaches an estimated total carry potential as much as HK$11,000 per month.

To sum up, that’s how a passive income engine could be constructed in a very simplified way. As for the investment part, what is the most suitable investment for such a carry trade? We will discuss this in the next article.

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