Property is special, no doubt about it. It is tangible and real and we understand it naturally, which is powerful. It generally increases in value over time and it can produce an income in the form of rent.Property can’t usually be held in any of the main tax-wrappers like pensions and ISAs, which is an important consideration, or not residential areas.
You can hold shopping centres, car parks and office blocks inside a pension, if you’re so inclined. It’s also illiquid by definition. Wealth which is tied up in property can’t be easily realised in a short space of time, as it takes time to sell a house.
In practice this is rarely an issue for intelligent investors, as they will always keep enough money easily accessible so they don’t HAVE to sell a property. And in fact, that’s a key message for investing in any kind of asset. The last thing you want is to be forced to sell when you don’t want to, or when doing so will crystallise a paper loss into a real one.
A key benefit of investing in property is the ability to use leverage, or debt, to buy more of an asset than you might otherwise be able to. Leverage multiplies investment growth much faster than investing without it.
Understanding the Sums
Let’s say you have £100,000 to invest. You could buy a property for that amount, and ignoring all costs and tax, let’s say it increases in value by 25%, so it goes up to £125,000. Not too shabby.
But now let’s say you take your £100,000 and borrow £300,000 on a mortgage to buy a property worth £400,000. If that property goes up by the same percentage, it’ll be worth £500,000. You sell it, pay back the loan, and you’re now £100,000 in profit, not just £25,000.
Of course, there are costs involved, not least the interest you’ll have to pay, so it’s not quite that simple, but the leverage, the debt involved, actually amplifies the growth of the asset and accelerates your wealth-building as a result.
It’s relatively easy to borrow on property because of its tangible nature, and the lender understands there is a physical asset there. Worst case, the mortgage company can always repossess the property and sell it on to get their money back.
But that could result in a possible total loss for you. While potentially magnifying the returns, going into debt in order to invest also magnifies the risk. Weirdly, it is considered dangerous to borrow money to invest in the stock market, but normal to do so to invest in property.
Part of that is the somewhat flawed assumption that property always goes up in value, but a larger part is the fact that people understand property and don’t understand shares. In short, leverage is risky but potentially beneficial. Property is a great asset class, unique in its appeal, but it isn’t the panacea that many people think it is.
Looking for the previous post? Or ready for the last one in this series?
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