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Other People's Money

So far as I and many other property advisors are concerned, real estate/property investment is, and always has been, 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:

Using Other People's Money – or in banking terms - leverage.

Now if you are an experienced investor this may be obvious, but for the benefit of those who haven’t seen the light, let me explain ... Leverage is your ability to magnify your returns by using other people's money in this case, money provided by banks or building societies.

To give an example, say you have £20,000 to invest. This can be a lump sum or you can raise it by releasing equity in your main residency.

So what is the best way of investing this money?

Option 1 – The Bank

Stick it in your local bank - by some considered the safest option, "at least you can’t lose it, and you get some guaranteed increase in value" usually goes the argument.

Invest Your Money in the Bank - assumed return: 4%

As you can see, after 10 years, you’ve made virtually no progress at all, especially when you consider the effects of tax and inflation which could pretty well wipe the profit out.

Option 2 - Stocks and Shares

Over the last 10 years or so the stock market has been very popular, this despite some problems 4 or 5 years ago. However when I read that some financial "experts" say that the stock market is going to be a better bet over the next 2 years as they reckon that it will go up by 15% a year* as opposed to the property market that may go up by 5%** a year I have to wonder at their financial acumen. Even if it were to be true (see below) it doesn’t take leverage into account and so paints a very distorted picture! Let me show you why.

Now its hard to say what sort of return you might get on the stock market, but lets say you get 12% a year for the next 10 years – very, very unlikely, but lets just go with this. So if you could beat the odds and get a 12% return every year what return would you get?

Now that’s a big increase on sticking the money in the bank, but clearly is not guaranteed. But you can do better.

Option 3 - Property

One of the great things about property is it enables you to use other peoples money by way of leverage. With your £20,000 you can purchase a £100,000 investment property by borrowing £80,000 from the bank.

Now say the property market slows down to an average of only 6% return for the next 10 years. Remember over the last 70 years it has averaged 11%. This would probably be a fair estimate in the UK, and even though there are plenty of markets in Europe that are growing more rapidly, lets concentrate on UK for this example.

Your investment of £20,000 + £80,000 interest only mortgage

There’s no competition is there? Banks are safe. Stocks and shares are risky (remember the crashes in May and June this year) even if the stock market increases by twice as much per annum as the property market over the next 10 years, you can make far more money from property. Imagine what you could achieve with even greater return; say 7, 8 or 9% on property?

So what about the mortgage? Easy – the rental income from your property will cover your interest payments, insurance, ground rent etc. That’s how it is structured from day 1 but as rental rates rise you will start to make a nice profit and can even release some equity if you like without affecting the capital return.

For the purposes of this illustration I have not included lawyers’ fees, agents’ fees or stamp duty. But then I’ve not included rental income either. Admittedly buying a property has more additional costs than buying shares, but this will not make a significant difference on your profits. The figures I have used have been very conservative, many individuals are making far more than this on property.

So there you have it. Over a length of time, using leverage to good effect and using all the other skills you need when buying property, property is by far the best investment, for the majority of individuals. So, what “other skills” am I talking about? Knowing where to buy, what sort of properties will rent easily, and buying at a discount. Don’t worry if you don’t feel you have these – James Green & Co will advise you and guide you. Click here for more information on investing via the stock market.

* On 12th May 2006 the Stock Market crashed. Speculators love this as they make profits whether the market goes up (a "bull" market) or comes down (a "bear" market). Stockbrokers make money whether you are buying or selling. Investors who need to cash in stocks now will loose massively. Since then although there have been some recoveries the market remains volatile and the general movement is down. If you had invested your £20,000 2 years ago it would now be worth £18,600, a loss of £1,400. The same £20,000 in property, leveraged using other peoples money would have shown a gain of £31,300.

** Some "experts" have said that UK property prices will rise by between 3% and 5% in 2006. As of June this year the official rise is running at 5.2%. Of course these figures are averages and typical buy to let properties are doing better with over 7% increase so far this year. Remember that it 7% on the value of the property - but you have only paid for 20% of it!

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