What is it about property that makes it work as an investment?
The media is full of articles trying to compare the returns from property and the share market, in a bid to gain some glory for one or the other and change our behaviour. It is really much simpler than that, leverage amplifies our returns.
Most of us have bought our own home. Many of us have paid off a large chunk of the mortgage. We know that it gets easier and easier to make those payments so we are not afraid of debt. Most of us have also had the value of our home, and those of our friends and family, go up over time. While this has been very pleasing, it has also demonstrated the way capital growth works. We have faith that property will continue to increase in value over time.
Because of this intimate knowledge of debt and the increasing value of our home we feel confident to invest in property.
In comparison most of us have had limited exposure to the share market. We haven’t learnt enough to know why it goes up and down. It seems very technical and we aren’t sure we want to know more. The idea of relying on someone else for our strategy is OK for our superannuation but that is probably enough exposure.
When it comes to borrowing money to invest the banks are happy to give us a loan of up to 90% of the value of an investment property (90% LVR). If we were to invest in shares we would be more likely to get a 50% loan (50% LVR). This also endorses our greater confidence about property.
So what is it that makes property work?
It is the leverage, putting our money down and completing with borrowed funds.
If we had an investment property valued at $500,000 and it went up 10% in one year, it would now be worth $550,000. This represents a 10% return on our $500,000 invested.
If we had leveraged by borrowing 50% of the value, or $250,000, our return would be 20% on our money. If we borrowed 80% of the funds and invested $100,000 we would have a 50% return on our money.
Leverage is the driver behind wealth creation. We can spread our money across multiple properties and have stronger returns using borrowed money. The key is to either know how to plan and execute a strategy for yourself or alternatively seek the services of a professional who can do it for you.
Forrester Cohen International