Why real estate or why property, some people ask when looking for an investment. Well, as far as I am concerned, real estate/property investment is, and always has been, the most powerful type of investment for building wealth. It has been said that over 90% of the world’s millionaires got there by owning property. The reason property is such a powerful way to build wealth is due to one key concept: leverage.
Once I realised this, I didn’t look back. Now, if you are an experienced investor this may be obvious, but for the benefit of those who haven’t seen the light, let me explain…leverage is your ability to magnify your returns by using other peoples’ money (in this case, it’s usually the bank’s money). To give a clear example, say you have GBP20,000 to invest. This can be a lump sum or by releasing equity in your main residency.
So what is the best way of investing this money?Option 1
Considered by some the safest option: “at least you can’t lose it, and you get some guaranteed increase in value” usually goes the argument.
Money in the Bank – assumed return: 4%
Now GBP20,000 1 Year GBP20,800 5 Years GBP24,333 10 Years GBP29,605
As you can see, after 10 years, you’ve made virtually no progress at all, especially when you consider the effects of tax and inflation.
Stocks and Shares
Now over the last 10 years, although admittedly not in the last 4 years, the stock market has been very popular. However I cannot accept it is a better bet. When I read that the stock market is a better bet over the next 2 years as it will go up by 15% a year, as opposed to the property market that may go up by 5% a year, this does not take leverage into account and so paints a very distorted picture!!
I will show you why. It’s hard to say what sort of return you might get on the stockmarket, but let’s say you get 12% a year for the next 10 years – very unlikely, but let’s just go with this. So, if you could beat the odds and get a 12% return every year…
Money in the Stockmarket – assumed return: 12%
Now GBP20,000 1 Year GBP22,400 5 Years GBP35,247 10 Years GBP62,117
Now that’s a big increase on sticking the money in the bank, but clearly is not guaranteed. But can you do better?? I think you know what I’m going to say?!
One of the great things about property is it enables you to leverage the GBP20,000 to purchase a GBP100,000 investment property (in other words, borrow the remaining GBP80,000 from the bank). Now, say the property market slows down to an average of only 6% return for the next 10 years. This would probably be a fair estimate in the UK, although there are plenty of markets which are growing more rapidly, lets concentrate on the UK for this example.
Money in Property – assumed return: 6%
Now GBP20,000 (GBP100,000 property value GBP80,000 mortgage) 1 Year GBP26,000 (GBP106,000 property value GBP80,000 mortgage) 5 Years GBP53,823 (GBP133,823 property value GBP80,000 mortgage) 10 Years GBP99,085 (GBP179,085 property value GBP80,000 mortgage)
Make sense? So you make 6% increase on the full value of the property, not just the GBP20,000 which you initially had. This is the power of leverage. In effect you have increased your initial investment 5 fold in 10 years! So even if the stock market increases by twice as much per annum as the property market over the next 10 years, you can make far more money from property.
For simplification, I have not included lawyers’ fees, agents’ fees or stamp duty. Admittedly buying a property has more additional costs than buying shares, but this would not make a significant difference on your profits – around 4% in the UK, higher overseas.
One thing to point out is that in the short term you have greatly increased your potential loss i.e. if the property went down by 10% in value, you would lose more of your initial investment, because the property value would go down to GBP90,000, you still owe the bank GBP80,000, so you now have GBP10,000. In comparison if the stock market dropped by 10%, your investment would be worth GBP18,000, as you only lose 10% of GBP20,000.
However, over a length of time, using leverage to good effect and using all the other skills you need when buying property, property is by far the best investment for the majority of individuals.
The figures I have used have been very conservative, many individuals are making far more than this on property.