Why Property? Catherine and I don't have a traditional pension fund and for us, property is our retirement plan. Has an elderly person ever told you stories about how much they bought their first house for? I have a great aunt who bought her house in Cornwall 60 odd years ago for about £400. That same house today is worth around £250,000. What if she had bought 3 or 4 houses? She would own assets worth roughly £1,000,000. What if she was able to buy more? what if back then, she knew why property is such a good investment?
At the end of 2005 Catherine, my Wife, and I were fortunate enough to buy our first property and get onto the property ladder. It is a 1 bedroom semi detached house in Bedfordshire England. The house was on the market for £112,000 and we made a successful offer of £106,000. Now, just over 1 year later, all the 1 bed semi detached houses in this area are on the market for between £125,000 and £130,000. That’s about £24,000 increase in 1 year. By the end of 2007 we will have re-mortgaged this property into a buy-to-let and we will have bought a second, slightly larger house for us.
Below is a summerised chapter extract from “Real Estate Riches” by Dolf De Roos, Ph.D. This extract goes a long way to explaining why property investment has such advantages over investing money in the stock exchange and why property excites him so much.
Four Magic Questions
Let me in the next few paragraphs show you, in my oppinion, why property is so much better than other investments out there. Imagine you have a lump of money to invest. It does not matter whether you have $5,000, $10,000, $100,000, or $1 million, as the same principles apply in each case. So let's assume that you have $100,000 cash to invest. Let's also assume that you are considering investing your funds either in the stock market or in property. Finally, for the sake of simplicity, let's ignore all brokerage fees and commissions. I will simply pose four questions...
How many dollars' worth of stock can you buy with $100,000 cash?
For most people, when you have $100,000 of cash to invest in the stock market, you can buy exactly $100,000 worth of stock.
Let's compare this with investing in real estate.
How many dollars' worth of property can you buy with $100,000 cash?
Well, clearly, you could buy a $100,000 property. But you could also buy a $200,000 property, by taking out a mortgage for 50 percent of the property's purchase price. You could also buy a $300,000 property by taking out a 66 percent mortgage. In fact, you could buy a $1 million property by taking out a 90 percent mortgage.
The answer is that if you did buy a $1 million property with $100,000 cash, you would have an asset worth $1 million that would generate rental income for you. If you had bought wisely, then the rent would more than cover your expenses.
The point is that when you buy stocks, you generally have to put up the entire purchase price in cash. When you buy property, you generally have banks and other lending institutions falling over themselves to give you money.
The moment you buy your $100,000 worth of stock using your $100,000 cash, how much is your stock worth?
By definition, at any point in time, a stock is worth that price at which willing buyers and willing sellers agree to transact a parcel of shares. Thus, the moment you buy $100,000 worth of stock using your $100,000 cash, it is worth exactly $100,000.
The moment you buy your $1 million property using your $100,000 cash and a mortgage of $900,000, how much is your property worth?
Is it not possible that the property for which you just paid $1 million using your $100,000 cash and a mortgage of $900,000 is only worth $650,000, and that some fast-talking owner or agent talked you into paying too much for it? Is it not possible that you bought a lemon? Of course it is! It happens all the time.
By the same token, is it not possible that the property for which you just paid $1 million using your $100,000 cash and a mortgage of $900,000 is worth $1.5 million, and that some slow-thinking owner or agent let you get away with paying too little for it? Is it not possible that you bought a phenomenal bargain? Of course it is! It happens every day of the week. In fact, it is much easier to buy a bargain than a lemon for the simple reason that even if you sign a contract (subject to finance) to buy a lemon, the bank will not lend you money on it, as the appraisal will reflect its true value and not the contract price. Bingo! An instant and invisible lemon-avoidance algorithm.
The most common reason why properties are sold at way below their true value is, unfortunately, divorce. When people are blissfully married they can reason lovingly and at length, but when things go awry, the battlers want instant results. So if it is agreed to sell a jointly owned home, the owners generally want each other out of their hair as soon as possible, and they therefore want their money out fast. There is no time to prepare the property for a good sale, and sometimes even no time to get an updated appraisal. Let's just sell the property NOW, split the proceeds, and never talk to each other again.
So far, we have asked two of our four magic questions. We have seen that when you invest $100,000 in the stock market, you get exactly $100,000 worth of stocks that are worth exactly $100,000 the moment you buy them. Conversely, when you invest $100,000 in property, you can buy $1.5 million worth of property for a contracted price of $1 million using a $900,000 mortgage. Let's move on to the third question.
When you buy your $100,000 worth of stock for a purchase price of $100,000 (and the moment you buy it, it is in fact worth exactly $100,000), what can you personally do to increase the value of your stock portfolio?
"Pray!" I hear you say. How about writing a letter to the directors of the company wishing them well? Or how about going out and buying as much and as many of the products or services that the company provides as you can afford? I think you will agree that your options are limited.
When you buy your $1.5 million property for a contract price of $1 million using your $100,000 cash and a mortgage of $900,000, what can you personally do to increase the value of your property?
Wow! Where do we start?
You could paint the property. You may increase the value of your property by replacing the rusted gutters and downspouts on the front, by putting in a new heating/cooling system, by changing the curtains or drapes, by modernizing the bathroom, by putting in a new kitchen, by painting the roof, by erecting or replacing a fence, by installing an alarm system, by fitting new doorknobs throughout, by changing the window shades, by adding a swimming pool, by removing an old shed, by cleaning the carpets, or by paving the driveway.
With most other investments there is little you can do to increase the value of the investment, with property you are only limited by your imagination.
This brings us to our fourth and final question for this section... Part of the reason why we invest is in the anticipation that things will go up in value. So, let's assume that all invested assets have doubled in value. (I am not specifying a time frame here-it may happen in a year or over a period of many years.) That means that the $100,000 stock portfolio has doubled to $200,000, and that the $1.5 million property has doubled to $3 million.
You bought $100,000 worth of stock with $100,000 cash that was worth $100,000 the moment you bought it. It has doubled in value to $200,000. What must you do to enjoy some of the increased value?
Well, for most investors, the simple answer is: "Sell!" You could sell the entire portfolio, and thereby get your original $100,000 investment back plus $100,000 profit, or you could sell a portion of it. Either way, depending on the tax jurisdiction you are in, you will be up for capital gains tax, which will take some of the wind out of your windfall. What's more, by selling part of the portfolio, you are reducing the amount that is left that can earn further profits for you. Something sounds counter productive!
You bought $1.5 million worth of property for a contract price of $1 million using $100,000 cash and a mortgage of $900,000. It has doubled in value to $3 million. What must you do to enjoy some of the profit?
Sell it? Selling the property would probably be the dumbest thing you could do! Why sell it? After all, you own an asset, the value of which is indexed for inflation. It is generating a passive rental income that is similarly indexed for inflation. As time goes on, both the value of the property and the income it generates will continue to creep up. What's more, if you were silly enough to sell, you may have to pay capital gains tax on the profit.
But, I can hear some of you say, if you don't sell, how will you ever access the increase in value?
The answer is simply to refinance. You get a new appraisal (this time for $3 million) and go back to the bank and ask for a new mortgage. At the 90 percent loan-value ratio, you would get $2.7 million in your hands. After paying off the original $900,000 mortgage, you would still have $1.8 million left over of surplus new cash in your hands.
And ask yourself this question: Is the $1.8 million taxable? Of course not! Why would it be taxable? It is not income, so there would be no income tax due. Similarly, you have not sold the property, so there can be no talk of a capital gains tax.
You could use this $1.8 million as a 10 percent deposit on a further $18 million worth of property, which, combined with the $3 million you already own, makes your total portfolio worth $21 million.
At this stage, if property values were to go up a mere 1 percent, you would have made $210,000 (1 percent of $21 million). And the surplus passive rental income cash flow would be very handsome. If the property were to go up by 10 percent (perhaps in one year, or perhaps over a period of, say, five years), then you would have made a further $2.1 million (10 percent of $21 million). At this stage you could again re-finance, pull some more money out, and invest in more property, or you could buy anything else such as an airplane (tax-deductible if you use it to fly around inspecting your expanding empire).
My aim in writing this chapter is to share with you why I think property is not just as good as other investments, not just a little bit better than other investments, and not even just much better than other investments, but tens and even hundreds of times better than other investments.
Taken one at a time, the advantages just mentioned illistrate why property is a phenomenally powerful investment vehicle. However, when considered in unison, when these advantages work together, the effects compound each other, and, as we have seen, an investment of a mere $100,000 may give you access to $18 million without much effort at all. Even if it were only half as good, the resulting $9 million would still be phenomenal! Even if it were only one tenth as good, the $1.8 million would still be spectacular! Even if it were only one hundredth as good ($180,000), that is still, in my biased view, wildly better than the results of investing the same original starting capital of $100,000 in something that does not offer the advantages discussed in this chapter.That is why property.
Copyright © 2001 by Dolf de Roos, Ph.D