There are 2 main asset classes that work for long term wealth-building. One is the stockmarket and the other is property.
Everyone has a different take on these and you are allowed to have your own views.
My own view is that the (unleveraged) returns from the stockmarket have historically been better than the returns from property (marginally better in the UK, much better in the USA) and that stockmarket investing is ridiculously easy, arguably safer and is much less effort and hassle than property (no voids or broken boilers to worry about!).
But here’s the thing. Financial Independence is a movement that is much bigger than the experience of any one person. There is not just One True Path.
When I cover a subject outside my own circle of knowledge, I find someone that knows what they are talking about. Someone with skin in the game who has demonstrated success and done it themselves. So when I met Rob (who co-founded a property business) in the real world, I asked him to write me a guest post.
I’ve been a saver since I had my first newspaper round aged 11, but it took me until my mid-twenties to accumulate enough money to worry about doing anything with it.
My flat ended up littered with books about the stockmarket by the likes of Ben Graham and Jim Slater, but ultimately it all felt a bit abstract and arcane.
So I left them to gather dust, and did what a lot of people do: I went to see a mortgage broker, and put down a deposit on the only flat I could afford within a half-hour distance of where I lived.
I got lucky: this was in 2009, when memories of the crash were still fresh, London property was on sale, and yields were strong. But I didn’t know any of that. Property just seemed like something easy to understand…and anyway, it always goes up in value doesn’t it?
There are many stories like this, and over the last 20 years most of them have ended happily because the market has been so kind. But even though property is tangible and easy to understand, is taking all your capital and putting it into one illiquid investment (propped up with a pile of debt) really such a good idea?
Is property overrated?
Buying a single property is similar to buying shares in a single company. You make income from the monthly rent after costs (the equivalent of a dividend), and hope for its capital value to increase over time.
It doesn’t take an investment genius to know that owning shares in just one company is a risky move. For that reason, hardly anyone does. But because property is so much more expensive, 55% of landlords only own one and only 1% own ten or more.
There are other drawbacks too. If you decide to sell, it’s not just a case of clicking a button: you have to embark on a months-long process that buries you in paperwork, racks up thousands of pounds in fees, and brings you into contact with (shudder) estate agents.
Even if you have someone manage your property for you, it will always be less passive than just owning shares. And then there are the tax disadvantages: you can’t hold residential property in an ISA or pension, and property investors have been clobbered with extra taxes since George Osbourne brought in some major changes in 2015.
So is the simplicity and tangibility of property leading us astray? Is property too loved as an asset class?
Not necessarily – because it has some unique advantages too.
The joy of debt
The biggest is leverage, AKA borrowing money in the form of mortgages. Yes, you can do it with other assets, but not as readily or as cheaply. And it can really work wonders for your returns.
It’s very common to borrow 75% of the purchase price of a property, and only put in 25% yourself. That means that with any given amount of money, you end up with an investment portfolio four times bigger than you’d have if you just put it into an unleveraged portfolio of shares.
So if you assume that a typical net yield on a property portfolio (equivalent to its dividend) is 3% per year, you can multiply that by four to get a 12% return on the funds you personally put in. It’s not actually so simple because you need to deduct the cost of borrowing the money, but knocking on the door of double-digit returns is far from unrealistic.
Leverage also magnifies your capital gains. If a £400,000 all cash portfolio goes up by 10%, you’ve made a 10% return. But if you only put in £100,000 to acquire that portfolio (the rest being debt), you’ve actually made a 40% return on your own money.
Now, leverage also magnifies your losses. If you put in a 25% deposit and the market falls by 25%, that’s 100% of your investment wiped out. Even then, you can’t just walk away: even if the bank repossesses the property and sells it at a loss, you’re still personally on the hook for the remaining debt.
In practice this extreme scenario rarely happens: as we found out in 2008, the last thing a bank wants is to take on the management of thousands of houses then crystallise a loss. The cyclical nature of property means that after prices fall, they’ll eventually come back.
Even so, seeing a large part of your equity wiped out by forces beyond your control isn’t fun. That’s why planning is so important – which we’ll come to later…
The invisible helping hand
Another advantage that property has in its favour is something that nobody thinks about enough: inflation. Rents are based on people’s wages, and people’s wages tend to rise with inflation. So while you might not decide to (or be able to) increase the rent every year, over the long-term you’ve got a broadly inflation-linked income stream.
And because property values are ultimately determined by rents, this means you’d expect the value of the property to rise with inflation too – while it simultaneously erodes the real value of your mortgage debt.
Property is cyclical – prone to booms and crashes – which obscures this fact. At the moment, prices are flat or falling – partially because of Brexit uncertainty. When it’s eventually resolved, it seems likely to me that the pent-up demand will create another boom…which will inevitably tip over into the next crash.
But when you zoom out to a multi-decade view, this smoothes out. Without you even noticing, the silent force of inflation along with the magnifier of leverage combine to give property investment a boost that’s hard for anything else to match.
That’s the work that the underlying economic forces do silently, but there’s also work that you can do. While the employees at your local Tesco would be unimpressed if you bought a few shares then waltzed in and started trying to re-design the store, you can use your skills and knowledge to make improvements to a property. You need to be realistic and account for the cost of your own time, but you only need to have watched a bit of daytime TV to know that the right improvements or alterations to a property can yield great returns.
Fluking my way to freedom
I got very lucky with my first investment. Decide my lack of research, because I’d flukily bought in the right place at the right time it doubled in value over the next decade – which, because of leverage, meant far more than a 100% return to me.
I put the profits, along with more savings, into expanding my property portfolio. Thanks to leverage boosting my rental return too, by the time I owned a few properties I had enough month-to-month income to take a chance and leave a job I didn’t enjoy. My wife and I spent a few years travelling non-stop while re-establishing ourselves as freelancers: a risk we could only take because our property income meant we wouldn’t be living off baked beans if we had a bad month.
Although property has done wonderful things for me, I don’t think it’s sensible for it to make up 100% of a portfolio. I’m now boosting my allocation of savings towards shares to bring my portfolio back into balance – but because I can’t give that my focus, I’m doing it totally passively.
When it comes to property, I’ve made plenty of mistakes along the way. I’ve missed problems that have cost thousands of pounds to put right. I’ve had a tenant not pay rent for months on end, then trash the place before leaving. Even now I own a couple of properties that in retrospect I shouldn’t have bought, and will sell when the market is right.
But somewhere along the way, I got obsessed. I started researching property endlessly, which led to me starting a blog to share what I’d learnt. That led to me co-presenting a popular property podcast, which in turn led to me co-founding a company that provides education and advice to property investors.
That weird career arc has brought me into contact with hundreds of investors. I’ve seen people achieve monumentally life-changing things through property, and I’ve seen the aftermath of some horrendous mistakes.
So if you’re interested in having property as part of your portfolio, I can tell you that these steps will radically boost your chances of success:
- Be realistic about how much time you want to put in, and what proportion of your portfolio you want property to make up. Learning enough to make sensible investments is a lot of effort, and it might not be worth it if you only plan to acquire one or two. If you still want some exposure, property-backed lending or crowdfunding (both of which have their own risks, and don’t offer FSCS protection but are FCA regulated) might make more sense to explore.
- Put a plan together. Get clear on where you are now, where you want to get to, and what contribution you want property to make towards bridging the gap. This will help you work out which type of property to buy: just like with shares, different properties can be geared to either income or growth, and will have different risks and opportunities.
- Run the numbers. Put together a simple spreadsheet and plug in the numbers for potential investments – with realistic/pessimistic assumptions for costs like mortgage interest, repairs, periods when the property is empty, management fees, and so on.
- Get professional mortgage and tax advice. Your personal circumstances will dictate how many mortgage options you have and at what rates, so it’s worth finding out early. And being structured correctly for tax will save you tens of thousands of pounds over your investing lifetime.
- Keep it simple. You don’t have to buy in your own town, but stick to a market you understand for your first purchase. I hear endless horror stories of people who bought into “bargain” off-plan developments abroad, which never got built. (I even know one chap who bought in Albania, lost all his money, then bought again in Serbia and had exactly the same thing happen again. Apparently “once bitten” isn’t always enough.)
- Keep learning… If you’re actively investing in anything you need to make it your business to learn everything you can about that subject. Property is no exception. Luckily, there are now endless free resources online to help you.
- …but don’t forget the doing. I’ve seen many people succumb to “analysis paralysis”, and get endlessly trapped in the research stage. Set yourself a deadline to have done your research by, at which point you have to either start trying to invest or decide property isn’t right for you.
Property isn’t the perfect asset class: there’s no such thing. But I’ve seen it change lots of people’s lives, including mine. Getting it right does involve a lot of hard work – but if you’re lucky enough to get obsessed like I did, it can be an extremely profitable hobby.
Rob is the co-founder of propertyhub.net