Safe as Houses – The Upsides of Property Investment

With
No Comment

Central London

This article looks at the reasons you should invest in property, overlooking some costs/risks to simplify the picture.
In the next article we will review this in more detail and explain the reasons that you perhaps shouldn’t invest in property.

Investing in property has widely been seen as a smart move for the past half century. Indeed if you asked 10 people on the street, 9 of them would probably tell you that buying property is one of the smartest things you can do with your money.

An ongoing boom in property prices in the west has seen many of the Generation X and Baby Boomer generation generate substantial wealth, and the idea of “owning your own home” has been the cornerstone of the “American Dream.”



Provided propriety prices continue to go up each year, then an investment in property would seem to be a good idea. Even a modest 2% increase on a property worth $500k would represent an increase of $10k.
At time of writing, the average house price in the UK is £272k ($441k) and grew at a rate of 11.7% in the trailing twelve months.[source]

The average rental price in the UK, at time of writing, is £761 ($1,240) giving an annual rental income of $14,880.[source]
This would give a rental yield of $14,880 over the property price of $441,000, or 3.37%
If we were to blindly assume that the same rate of growth will be seen in the following twelve months, then the numbers would stack up as follows:

A CAGR(Compounding Annual Growth Rate) of 11.7% can be expressed as a monthly increase of 0.93%:

((111.7/100)^(1/12))-1 = 0.93

Assuming that the rental price grows in line with property price, the 12 months would look as follows:

Month Property Price Monthly Rent Rent Incr.
0 $441,000 $1,240
1 $445,085 $1,251 $11
2 $449,208 $1,263 $12
3 $453,369 $1,275 $12
4 $457,569 $1,287 $12
5 $461,807 $1,299 $12
6 $466,085 $1,311 $12
7 $470,402 $1,323 $12
8 $474,760 $1,335 $12
9 $479,158 $1,347 $12
10 $483,596 $1,360 $12
11 $488,076 $1,372 $13
12 $492,597 $1,385 $13
Subtotal $51,597 $15,807
 Combined Return  Percent Return
TOTAL $67,404 15.28%

With number like this, it’s not hard to see why many people extol property investments as a vehicle for growing your wealth.

  • $441,000 Investment
  • Growth @ 11.7% = $51,597
  • Rental Yield @ 3.37% = $15,807
  • Combined Total  = $67,404
  • 15.28% Return on Investment

However, most people do not have $441,000 in cash lying around to invest.

This leads us on to the most important aspect of property investments.. the power of leverage..

Leverage

Assuming that you do not have $441k in cash down the back of your sofa, the idea of buying a property might seem unreachable.
Or even if you do have $441k down the back of your sofa, you might think that sinking all of it into one property is not a smart idea.

This is where the large power of real estate investments manifest themselves.

If we say, for example, that you have $50k in cash that you wish to invest into a real estate investment.

We will make a lot of assumptions here and simplify a lot of things to make it easier to follow…

Say you find a property for $441k that you wish to buy, that you know will pay 3.37% in rental yield and will continue grow in value by 11.7% per year.

Assuming that you can find a “buy-to-let” mortgage at 4.5% [source] with a deposit of 10%.

A mortgage at 4.5% would be 0.375% per month:
((104.5/100)^(1/12))-1 = 0.375

Taking the mortgage as an “interest only” mortgage, your monthly repayments would be  ($441,000-$44,100) * 0.375%
= $1,488

Buy purchasing the property with only a 10% deposit, you effectively give yourself 10 times leverage which is an incredibly powerful tool.

Let’s update the chart above to see how these figures look:

Month Property Price Monthly Rent Ammt. Invested
0 $441,000 $1,240 $44,100
1 $445,085 $1,251 $1,488
2 $449,208 $1,263 $1,488
3 $453,369 $1,275 $1,488
4 $457,569 $1,287 $1,488
5 $461,807 $1,299 $1,488
6 $466,085 $1,311 $1,488
7 $470,402 $1,323 $1,488
8 $474,760 $1,335 $1,488
9 $479,158 $1,347 $1,488
10 $483,596 $1,360 $1,488
11 $488,076 $1,372 $1,488
12 $492,597 $1,385 $1,488
Subtotal $51,597 $15,807 $61,956
 Combined Return  Percent Return  Combined Invested
TOTAL $67,404 79.99%  $61,956

As we can see, by using the power of leverage we are able to massively ramp up the rate of return on our investment!

  • $41,000 Investment
  • -($17,856) Interest Payments
  • Property Price Growth @ 11.7% = $51,597
  • Rental Yield @ 3.37% = $15,807
  • Combined Total  = $49,548
  • 79.99% Return on Investment

By purchasing the property with 10x leverage we have managed to realize a return of almost 80% and be on course to double your investment in the space of 15 months.

Even in the scenario that property prices rise by a mere 3%, the return on investment in this case would be a staggering 16.99%

In the event that you had the $441k in cash to invest in the first place, by purchasing a property outright, assuming the 11.7% growth as above, you would have returned the following:

  • Invested $441,000
  • Property Price Growth @ 11.7% = $51,597
  • Rental Yield @ 3.37% = $15,807
  • Combined Total = $67,404

If you had taken the $441k and used it to purchase 7 properties, the numbers would be as follows:

  • Invested $44,100 x 7 = $308,700
  • Interest Payments x 7 = -($124,992)
  • 7 x Property Price Growth @ 11.7% = $361,179
  • 7 x Rental Yield @ 3.37% = $110,650
  • $441,000 – $431,217 = $7,302 Cash
  • Combined Total = $354,139

By using the leverage to invest in 7 properties, rather than one, the return is as follows:

  • Invested in One Property. Return  = $67,404
  • Invested in Seven Properties. Return = $354,139
  • Difference = $479,131 – $67,404
  • Difference = $286,735

Such is the power of leverage.

This is the very rosy picture of property investment and shows what can happen in the best case scenario and the reasons that you should invest in property.

However this fails to take into account the plethora of fees and other issues that you expose yourself too when buying real estate.

In the next article we will talk about the reasons why you shouldn’t invest in real estate.

Tags: , , , ,

Leave a comment

(*) Required, Your email will not be published