What to Invest in, Part IV—Property
Episode #6 of the course Investing money for beginners by Maureen McGuinness
The home you own is a place to live and not an investment. Any other property you own that generates income is an asset. When people invest in property, they often do so by renting it out.
Buy to Let
This means to buy a property and rent it out for a number of years before selling it, in the hopes that the value of the house will have also increased during that period. Speak to any baby boomer, and you’ll likely be told that the best investment is “bricks and mortar.”
Baby boomers were born in the years after the Second World War, when there was a marked increase in the birth rate. They may often suggest that young people need to make more sacrifices in order to get on the housing ladder, but what they don’t realize is that we’re faced with much more expensive housing costs than they faced in their 20s. A recent study revealed that millennials are spending three times more of their income on housing than their grandparents yet are often living in worse accommodation. So, buy to let isn’t as accessible now as it was during the last century.
With buy-to-let investment property, you can get income and profit from the value of the property if it grows during your investment term. Unlike other investment products, property also allows you to gain from an increase in value without having to sell your property. Since many investors purchase buy-to-let properties using a buy-to-let mortgage (which requires almost double up front as a down payment compared to a standard mortgage), you can remortgage your property when it grows in value and releases equity (money) that you can invest elsewhere or spend as you wish. Many investors use the released equity as a deposit on another buy-to-let property, which means you can build your portfolio without selling any of your properties. This approach is known as leveraging.
Rental Yield
Take the example of the property I currently rent in London. The landlord purchased the property in 2002. If I were to purchase the property from him today, it would cost me at least three times what he paid for it 15 years ago.
To work out your return, you take the monthly rental income, multiply it by twelve, and then divide that by the price you paid for the property. Here’s an example:
Purchase Price: $300,000
Annual Rent: $12,000
Annual Rent divided by Purchase Price x 100 = 4% rental yield
As many of us won’t have $300,000 to buy the property outright, we’ll need to use a buy-to-let mortgage and make a downpayment of 30-40% of the Purchase Price. For this property, you’d need at least $90,000 for the downpayment. You’d also need another $10k to cover the costs of purchasing a property, such as lawyer’s fees, survey fees, mortgage fees, and furnishing the property.
For anyone trying to use property as their main investment vehicle, consider the following:
• Large initial capital required—tens, if not hundreds, of thousands of dollars to start
• Minimum of five years—to make back money spent for solicitor’s fees and taxes
• Associated dependencies—you need good tenants to look after the place and pay the rent on time; you also may need a good managing agent to help if you’re not nearby
• Potentially low yield and no guarantee for capital growth—if you’re buying in London, Sydney, Tokyo, or Vancouver, you may only be able to earn around 3-4% on your investment (is it really worth all the work?)
• Lack of liquidity—it’s not always easy to sell your property; if you need to sell quickly, you may sell for less than it’s worth or the price you purchased it for
Property can act as a lucrative part of your investment portfolio. The main problem is that in order to start investing in property, you need a significant amount of money, which may mean putting all your eggs in one basket.
Tomorrow, we’ll discuss where to put your investments. Since bonds, stocks, and peer-to-peer lending aren’t always accessible through traditional banks, we’ll look at where to keep your investments.
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