Let’s go back to basics.
You’re reading Your Investment Property because you’re interested in … ta da! ... investing in property!
But do you still have a million and one questions on your mind like: Is investing in property right for me? Will it help me achieve my goals?
It’s good to ask (and answer) the ‘why property’ question, so that you can be crystal clear in your own mind that you’re heading down a path that’s right for you and your family.
If this was a debate, while I’m forever focused on risk, I’m only ever going to be on the ‘pro-property’ side because I’m what you’d call a true believer! Property investment has been instrumental in helping me achieve my financial and lifestyle goals, and of course, it also represents the core of my business, OpenCorp.
The case for property
So, in this article, I’m going to put forth a case for investing in property, and why I think it should form the foundation of your plan for financial independence.
For me, investing in property has always made sense.
From when I was a teenager - black AC/DC t-shirt, tight jeans and a mullet that would make the youth of today jealous - I knew I wanted a wealth-building strategy that had reasonably low risk but could still provide excellent returns, and property investing (done well) certainly ticks these boxes.
But my interest in property was sparked at an even earlier age.
Here’s one stat I heard from my Dad when I was about eight years old, and I’ve never forgotten it: over 90 per cent of the world’s millionaires made their first million from property. This is still the case today.
Consider the term ‘old money’ for a moment. Old money is wealth that has been passed down through generations. In nearly every case study that I’ve looked at, old money has the same single foundation.
That foundation is land.
The British royal family is a perfect ‘financial’ example. They have amassed huge wealth, simply because they owned all the land and collected rent from everyone who lived on that land.
Risk v Return
Smart investors know that if you want to assess an investment opportunity, you must consider what’s known as a ‘Risk v Return’ ratio. The following table is a standard risk matrix; it’s a very basic example of how Risk v Return should be assessed.
Property investment, done well, falls in the ‘high return/low risk’ category.
Unfortunately, most investment opportunities fall either into the ‘low risk/low return’ or ‘high risk/high return’ quadrants. This doesn’t mean they shouldn’t be considered. It just means that you need to do your research to try to understand the risks so that you can manage them. In other words, you need to maintain control, and compensate for the risk.
With the risk vs return equation out of the way, here are three big reasons why I choose property over any other investment.
My first big reason for choosing property as an investment vehicle is leverage.
If you compare the main two investing vehicles - shares versus property - you could argue that shares outperform property over time, or at the very least are very close to property as far as a return is concerned.
But the reality is we don't invest dollar for dollar. We take our money, and we go to the bank and we get some of their money, then we combine the funds and put it into whichever market we think is going to work for us - shares or property.
The reality is banks deem shares nearly twice the risk of property in terms of the amount of leverage they'll allow. In other words, what they’ll lend you. On average you’ll get a 50 per cent ‘loan to value ratio’ (LVR) or thereabouts on shares; sometimes this figure will be a little higher, sometimes a little lower.
Personally, I wouldn't take any more than 50 per cent debt on shares based on the fact that in the Global Financial Crisis, the share market dropped 45 per cent. This was enough to trigger the dreaded margin call. If you leveraged out higher than that, you would have been required to tip in extra money to keep the investment afloat, otherwise the bank would have made you sell the shares so they could get their money back.
Compared to property, however, you can borrow up to 80-95 per cent, depending on the market and the lender's appetite. This is nearly double the leverage of shares.
When we consider the difference in the amount of money you can put into each market, based on the leverage you're able to get out of the banks, property wins hands down.
Here’s a really basic example of what that looks like: If you were to take $50,000 and get a 50 per cent LVR on shares and invest that into the market over a 20-year period, compounding the amount, the $100,000 you put into the sharemarket ($50,000 of your money, $50,000 of the bank’s money) in total would be about $670,000 after two decades. That's at a 10% compounding growth rate.
Now, if I give a property an 8 per cent compounding growth rate - I take my $50,000 and, together with borrowings of $450,000 (equating to a 90 per cent LVR), I invest in property over the same time period, after 20 years my investment would be around $2.1 million.
It’s very easy to see how leverage is a key reason why property beats other investments, in this case, the share market.
The second reason I choose property is control.
When I invest in property, I get to choose the finance structure. I get to choose the investment criteria. I select the property, do all my due diligence over that property. I get to select a tenant. I have control of each step of the way, which in turn reduces my exposure to risk.
By comparison, if I invest in shares or other investments, I limit the amount of control I have. If we think most people, when they invest in shares, they tend to diversify across a fund management portfolio.
As Warren Buffet says, "Diversification is for people who don't understand investment."
If I invest in shares of a company, I need to understand a lot of things if I’m to regain some semblance of control. I need to understand how to read balance sheets, P&Ls, cashflow statements. I need to understand the management team within that business, what their product lines are like, what their research and development teams are like, what markets, what competitors they have, what sort of growth they're likely to get, and the stability of that business. Gaining that depth of understanding will give me greater control over my investment. But it also takes a heap of time, skill and knowledge. The majority of people won’t do that level of research when investing in shares. They take a punt. Control allows you to reduce risk in your investment.
3. Low cost to hold
The third reason why I choose property is because of the very low cost to hold the investment, thanks to tenants and taxation benefits. Tenants pay a large portion of the holding costs and then taxation benefits cover a large portion of the rest, that is until the property increases in rental yield to the point where it covers itself.
As a property investor, for the first number of years I'd take advantage of negative gearing. Then following increases in rents, over time the property becomes cashflow positive. Of course, this is the ideal position to be in, provided of course you pick the right investment property in the right market, and hold for a long period of time.
So, there you have it. Leverage, control and low cost to hold, along with the potential for high returns but low risk: these are the chief reasons why the bulk of my investments are in property.
Director of OpenCorp, Cam McLellan is committed to sharing his passion and property investment knowledge with everyday Australians.
Cam started investing in real estate at a young age and quickly mastered the art of building sustainable wealth. He has used the same wealth building strategy to develop a multi-million dollar business, sharing his knowledge and skill with ordinary Australians. Cam has personally bought, sold and developed numerous properties and has an extensive residential and commercial investment portfolio.
Read more Expert Advice from Cam here!
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.