There are a whole host of investments out there, each with unique risk, liquidity and feasibility characteristics. I firmly believe in diversifying your portfolio, but for this post I want to share why I’m a fan of property investment and think that it’s something everyone should and can invest in. Not forgetting its an actual physical asset you can touch and feel – here are my 6 reasons;
Steady income with tax deductible expenses
The rental income you get on property investment provides a source of steady, passive income. This is unlike equity investments where not all companies pay out a dividend. In addition, you have control over the property (i.e choice of tenants, renovation, structure) whereas with equities – you have a negligible, if any influence over the strategic, operational or financial decisions of the company!
Owning a rental property is like owning a business, in that pretty much all expenses related to running the property are deductible from the rental income – which lowers your tax bill. Of course, there is no escaping property taxes but you can be smart and optimize your tax deductible expenses….legally.
Tenant pays down your mortgage
Most people take out a loan secured on their rental property, i.e. a mortgage – in order to purchase the property. As part of the loan, there will be monthly payments – which will include a mixture of loan repayment and interest. To service these payments, you rent out the property to earn rental income, and essentially this income covers the monthly mortgage payment and (hopefully) leaves a surplus/profit every month.
So basically, your tenants are paying off your mortgage. As a result, your outstanding loan reduces and the interest on that loan becomes lower (due to a lower loan balance). In time, you may increase the rent due to either a buoyant rental market or through your additional work/renovations you carried on the property.
Through this combination of lower monthly loan repayments and higher rent, your profits and cashflow increases. Eventually you want to get to a position where your rent pays off the entire mortgage, and you no longer owe the bank. This takes time, but it can be sped up with lump sum down payments where possible. T
The aim should be to get the property free of debt – making it a low risk, high return strategy in the long-run.
Property prices like most markets are subject to economic cycles and the micro-economics of supply and demand. However if you are prepared to stay invested in property for the long haul, you will find that the real returns of property are positive, i.e. after adjusted for inflation effects – the rental and capital appreciation of a property exceed the inflation rate.
This is not the case for all equities or fixed income investments. For the last 40 years both the US and UK residential property market returns have exceeded the rate of inflation. This particularly is due to the progressive increase in property prices rather than rental yields. Of course, the returns vary within regions, and that’s where location becomes a huge factor in your property investment strategy.
Sail through those economic cycles
Consider these economic scenarios that illustrate that if held over the long term, your property investment is a safe bet:
- Low interest rate environment => Cheaper to borrow/refinance mortgage => more house purchases => house prices increase. GOOD FOR LANDLORDS
- Higher interest rate environment => More expensive to borrow => fewer house purchases => mortgage payments higher => people more inclined to rent. GOOD FOR LANDLORDS
- Supply of housing exceeds demand => House prices stagnate/reduce => more purchases due to lower prices => eventually pushes up house prices. GOOD FOR LANDLORDS.
- Demand for housing exceeding supply => Can be good for house prices, rent or both. GREAT FOR LANDLORDS!
Of course, the above is just a basic implication model, and there are other factors that can contribute to the housing market, i.e. regional housing micro-structure, global credit event (i.e. Credit Crunch of 2008-2010), rental ceilings, property taxes etc.
A key feature of property investing is the ability to benefit from ‘leverage’.
For example, to buy a £200,000 property would cost you just £62,000 (assuming 25% mortgage, £5k refurb, and £2k legal costs) rather than the full £207,000.
If the property price then increased over two years to £250,000, upon selling the property you’d receive £100,000 (£250,000 – £150,000 outstanding mortgage), a phenomenal 61.2% return on cash invested, while also receiving rental income.
While this is true, the reverse also holds. If the property value declines from £200,000 the investor experiences negative equity and his/her loss on investment is also amplified due to leveraging (borrowing).
Of course, the recent stamp duty changes and tax laws introduced by the UK Government on buy-to-let property has significantly reduced cashflow for landlords. As a result, investors have become less incentivized to acquire further properties fulfilling the Government’s intentions. Despite this, there are still many property investment strategies available to investors, including;
- ‘Flipping’ (developing and selling the property in the short term)
- House in Multiple Occupation (HMO)
- Short-term lets including Air-BnB
- REITs (Real Estate Investment Trusts)
- Crowdfunding (see below)
On a budget…try Crowdfunding
Owning properties is great, but with the higher deposit requirement for buy-to-lets or rental properties, it means you can have a lot of capital tied into one property…not forgetting the taxes and any refurbishment costs.
Real estate crowdfunding allows you to invest in real estate along with other investors, usually through a platform that will propose real estate deals and take care of all the work, like listing deals, doing all the legal work, and then managing the property. This allows you to invest as little as £1,000 into a residential or commercial real estate project for potentially 8 – 13% annual returns based off historical data.
This beats the return from £1000 in your savings account! With real estate crowdfunding investing, there’s also physical asset that’s backing your investment – similar to direct investing.
In addition, crowdfunding is great for people who want the hassle of tenants or renovations and essentially want a ‘hands off’ approach once the investment is made.
Essentially, it allows an investor to invest in a variety of property deals (residential, commercial, industrial) with a much lower capital injection. Click here for a list of recommended crowdfunding platforms.
What about the recession?
The last recession in 2008 onwards was driven by irresponsible lending to house buyers, complex credit products and greed. On top of that, the banks and lenders had rubbish capital buffers and so suffered wild losses – and had to be bailed out, severely affecting the markets, economy and consumer confidence. This time around there is more regulatory scrutiny over financial products, lending and bank capital adequacy. In other words, we are unlikely to see large corrections in house prices – although that’s not to say they won’t be affected.
Consumer confidence is hit in a recession and people are less likely to spend and invest, which reduces house prices. And the property investor needs to be prepared to ride these out – especially if s/he doesn’t have a need to sell. Note that a recessionary environment also provides opportunity to purchase assets at a discount!
I would always recommend investing in property for the above reasons. Refer to Global Property Guide for a useful source on property trends, statistics and news across the world. As mentioned at the top of this article, rental properties should form part of a diversified portfolio thus aiming to spread risk. Of course, all investments should be entered with a thorough due diligence.
Property investment is a great way to generate a passive income. Another way is through a profitable, online business. If you are keen to learn about setting up an online presence, developing unique digital marketing skills and generating an impressive income online, click here to get started!
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