When we are discussing the pros and cons of investing in stocks and shares versus property we are also, in essence, discussing the pros and cons of investing in traditional pensions versus property as‘most traditional pensions are invested in global stock markets’.
While these days analysts will often accept that property was the better investment in a given year than stocks and shares, a distorted picture is still often given (generally unintentionally) to the detriment of property investment as they do not take into account or explain some of the major advantages that property investment has over stocks and shares.
Here’s an example of what an analyst might say: –
Analyst: Well last year (Year X) average property prices increased 5% and the stock market was up 10% so stocks and shares performed better – this year (Year Y) property prices increased 10% and the stock market was up 5% so property clearly performed better.
While what is being said is true it can also be quite misleading. You can understand why many people when glancing at the figures would think that in Year X they should (in general) have been investing in stocks and shares and that in Year Y they should (in general) have been investing in property. This is wrong.
The Return on Investment or ROI from property in both cases will have easily been higher. Why? Well because you can borrow money from a bank or similar institution to buy property and have that loan secured against the property that is being purchased and you can’t do this with shares.
Banks will not have shares as security since they are, by nature, quite volatile … not only can they go down in value as well as up but, they can in certain instances lose virtually ALL their value overnight….and whether overnight literally means overnight or whether it means a few days, a month or even a year, they (the banks) would probably find it impossible to react to protect their lending position. Companies can quickly disappear due to bad management, strong competition, abnormal market conditions, corruption, new technology introductions etc. The Northern Rock situation is a good (if ironic) example of this happening.
In any case the result of this is that property investors can benefit from gearing or leverage on their investment whilst investors in stocks & shares cannot. So here’s an example of what that means and the effects on the Holy Grail of the investor, Return on Investment:-
In order to buy £100,000 worth of shares you need £100,000 but in order to buy a £100,000 property you might typically only need £20,000 … you borrow the rest from the helpful banks who agree with you that secured on the property being purchased their money is safe as houses – at the end of the day their thoughts are that people will always need somewhere to live and, historically, it can be seen, that property prices have doubled every 7 to 10 years – even after taking into account (in the UK for instance), a couple of major property price crashes.
Once a property is purchased and a mortgage is in place the icing on the cake is that you can then rent out property to pay not only for its upkeep but also for the cost of the loan, the interest payable on the amount borrowed to part fund its purchase. This means that as opposed to what you might read in the papers, actual comparative Return on Investment for an actual typical investor for Years X & Y would be as follows:
|Year X||Value Held||% Increase Over Year||Profit|
|Stocks & Shares||£20,000||10%||£2,000|
|Year Y||Value Held||% Increase Over Year||Profit|
|Stocks & Shares||£20,000||5%||£1,000|
Property is a clear winner in both years – it can be seen that even in a year when the stock market outperformed the property market by 2:1 ‘property ROI’ actually outperformed ‘stocks and shares ROI’ by 2.5 : 1. It is this Return on Investment that investors are concerned with not overall market movements. With the market situations reversed the ROI from property massively outperformed the ROI from stocks and shares by 10:1, and clearly we’re not talking about fantasy situations here – it’s no coincidence that the majority of the world’s richest people have the bulk of their fortune in property.
(Side Note: The exact situation above clearly isn’t always the case. In property markets that are seeing exceptional property value growth (capital growth) we are often prepared to take a ‘hit’ on rental income in order to purchase in places showing exceptional capital growth.
In these areas, everyone is trying to buy in order to take advantage of the situation and few actually want to rent…the result of this is that rental returns tend to be lower meaning that mortgage payments may well not be fully met by rental income, although this should be more than made up for by the handsome increase in value of the property. This is also a function of the fact that rental returns in any case lag behind the increase in property values by a few years, so if large price increases are seen in a property market it takes rents a few years to catch up. A good example of these situations is to contrast Germany with Poland….Germany good rental returns, virtually no capital growth for 10 years (!), Poland not great rental returns but exceptional capital growth. In time the rents in Poland will also catch up with the higher property prices.)
The idea behind smart property investment is to use other people’s money, (from banks and from people renting the property) to fund YOUR property investment.
Not everyone is happy or comfortable with taking on high levels of debt in order to fund property purchases and that’s fine, it’s horses for courses and quite frankly it doesn’t suit everyone’s position. We wouldn’t advise it for elderly people for instance as if there was a short term downturn in the market (‘gearing’ or ‘leverage’ magnifies the downside as well as the upside) it would be more difficult for them to ride out a difficult period waiting for values to bounce back….as they always have…. A good thing about property is that when a slump in values does occur it has a (but again delayed)knock on effect on rents as they then rise, and rental yields rise even more to reflect lower property values. There’s always a silver lining!
Returning to the debt issue we don’t see some types of debt as a bad thing. Our view is that debt to pay for exotic holidays, or depreciating assets such as sports cars (that you can’t really afford!) really is a bad thing, however debt taken on in order to secure assets that will appreciate in value and that therefore make very substantial on-going profits is a very good thing!
After owning the property for a period of time it’s often possible to refinance the property and take out the initial 20% of own funds invested whilst still having the FULL benefit of the property investment and it’s subsequent increases in value, for instance doubling every seven to ten years in the UK or perhaps achieving even greater growth in some of the new markets currently opening up in Europe and further afield.
This is another major advantage to investing in property; after the property has gone up in value you can then refinance or take out a bigger mortgage. The increased rents available some years after the original purchase will continue to pay for the increased mortgage and the mortgage is still fully and well secured by the increased property value … so the bank is still (very) happy as they are, after all, in business to lend as much money as possible that is well secured. The bonus for the property owner or property investor is that money taken out in such a fashion is NOT taxable in any way as it’s not income and it’s not a capital gain. Again this method of accessing increases in value in a tax free manner is not possible with stocks and shares. To realize the increase in value of stocks and shares they must be sold and then tax becomes payable on the gain.
Lastly property doesn’t need such constant attention as it won’t disappear in value overnight. With shares an expensive fund manager will otherwise be needed and clearly, from the performance of our own pension funds in years gone by and the wide press coverage, these fund managers seem just as prone to errors and market misjudgments’ as everyone else!
Please call H&G for Professional Property Investment advice, paying for good advice is much cheaper than learning from your mistakes.
Tel 01832 864020 (Switch-Board).
Lincoln 01522 526413.