Why Should I Invest in Property?

Why property ? Many people ask when looking for an investment. Well, in our opinion, property investment is, and always has been, a serious contender for being the most powerful type of investment for building wealth. It has been said that over 90% of the world’s millionaires got there by owning property. The reason property is such a powerful way to build wealth is due to one key concept - leverage.

If you are an experienced investor this may be obvious but, for the benefit of those who are less experienced and contemplating their first property investment, let us explain ... Leverage is your ability to magnify your returns by using other peoples’ money (in this case, usually a mortgage provider).

The example below looks at the different ways to invest a lump sum of £30,000. This £30,000 could be savings or it could be equity released from your main residence.

Option 1 - Bank

Open a deposit account at your local bank. Many consider this to be the safest option, "at least you can’t lose it, and you get a guaranteed increase" is usually the argument.

Money in the Bank - assumed return: 5% gross per annum

Now £30,000
1 Year £31,500
5 Years £38,288
10 Years £48,867

As you can see, after 10 years, you’ve made relatively little progress, especially when you consider the effects of tax and inflation.

Option 2 - Stocks and Shares

During the last 10 years, although admittedly not during the period 2000-2004, the stock market has been very popular. However it may not be a better option despite some expectations that the stock market may go up by 15% a year over the next two years, as opposed to the property market that may go up by 5% a year. However this does not take leverage into account and so may provide a very distorted picture.

Let us show you why. It’s hard to say what sort of return you might get on the stockmarket but, although not very likely, let’s assume 10% a year for the next 10 years. ......

Money in the Stockmarket - assumed return: 10% gross per annum

Now £30,000
1 Year £33,000
5 Years £48,315
10 Years £77,812

Now that’s a big increase on investing in the bank, but your money is not guaranteed and the value of your investment can go down as well as up. But is there a better place to invest??

Option 3 - Property

One of the great things about property is it enables you to leverage the £30,000 to purchase a £100,000 investment property (in other words, borrow the remaining £70,000 from the bank). Let us assume that the property market slows down to an average growth rate of only 6% per annum for the next 10 years.

Money in Property - assumed return: 6% gross per annum

Now £30,000 (£100,000 property value £70,000 mortgage)
1 Year £36,000 (£106,000 property value £70,000 mortgage)
5 Years £63,823 (£133,823 property value £70,000 mortgage)
10 Years £109,085 (£179,085 property value £70,000 mortgage)

As you can see the 6% return is on the full value of the property, not just the £30,000 initially invested. This is the power of leverage. In effect you have increased your initial investment nearly fourfold in 10 years! So even if the stock market increases by nearly twice as much per annum as the property market, the latter could still provide you with a higher overall return from your investment.

It must be noted that none of the above examples have taken into account dealing costs, professional fees etc. Admittedly buying a property has more additional costs (eg. solicitor’s and estate agent’s fees, stamp duty etc.) than buying shares but it is debatable as to whether such fees would make a significant reduction in the overall return. Also please note that the above example does not take into account the rent payable during the 10 year period quoted which is usually enough to cover any mortgage, insurances and taxes. In fact in many instances there is also a profit on the rent.

The figures used in the examples are conservative but the above clearly illustrates how leverage works and why property should be considered as an essential and major element of a person’s investment portfolio. Many investors are achieving gains which are far higher than the figures quoted.

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