Why Property? - Chapter 1

Your Life in Property - Chapter 1

You will no doubt have your own ideas about why to choose property over other forms of investment to generate a cash flow or to provide an asset you can use at some future point in your life. You would not be reading this book otherwise I suspect. So what would be on your list as to why to choose property? After all, property can rise and fall in value as dramatically as the stock market (OK, perhaps at the speed of months not in minutes as on the Stock Market on occasion.) Property can also be a hassle. Roofs leak, heating boilers stop working (always at the weekend) and carpets need renewing. What about your beloved customer the rent-paying tenant of your property? Tenants can cause damage to your property through neglect and sometimes wilful damage. And what about the mortgage? That can rocket at a moment's notice and leave you way out of pocket. So why are you choosing to take the responsibility of property on at all? Why not join the growing band of carefree tenants and kickback and let someone else have the hassle? Well, that just isn't you is it? I suspect our lists will look fairly similar, but there could be some new ideas:

1 There is No Opt-Out.
It's an obvious point but perhaps the most compelling reason to choose property. After food and water, the provision of shelter is the most basic of needs. People will live in property, as an owner or a tenant, or they will live in the park under a newspaper. This gives a constant and steady demand for housing which other assets don't have. You can opt in or out of shares in Apple at a whim, for example. One bad decision from the CEO or a change in the market, and the shares can be sold until they drop to zero. There is no such opt-out with housing, and demand to live under a roof only really varies with population levels and some social factors (such as levels of divorce creating more one-parent households for example).

2 Property = Wealth.
The ownership of land and property has historically made the difference between those who live hand-to-mouth (tenants or tenant farmers) and the lord of the land (Landlord) who uses the asset to his advantage, generating wealth from this asset which can be used to support his life and then be passed on to future generations. Most people on the Times Rich List made it through property and land. The other lucky ones who had good business ideas and exploited those ideas to create fortunes have probably exchanged or will exchange their new wealth into property and land in some way or another as a method of retaining and building their wealth. The point of note here is that these wealthy people often buy and hold land and property for generations and so do not rely on the release of the capital value to support their lifestyle (although I am sure it helps their credit rating!). Wealthy people clearly exploit the property or land by charging people to use it and then give it back to them, in the same condition. It is this money, or rental yield that provides for them and supports their lifestyle.

3 Property is just another Business.
This is true and a useful idea. You as a landlord will be the "CEO" if you like of your own business. This idea helps to think of other landlords as competitive businesses and makes you good at what you do. Not all Landlords think in this way and are actually very poor at what they do in my experience. However, the big point here is that the business of property is fragmented like no other. There are millions of property "businesses". Most people in the property "business", the private buyers and sellers of houses don't even consider themselves to be in business and quite right too. They buy and sell their homes according to circumstance and sentiment. Without these drivers, you as a property professional have a distinct advantage and can take opportunities as they arise, not just when you need to move. Equally, the business of property rental is hugely fragmented with no one player (other than the council or social rented sector). Most Landlords have less than 5 properties and many only have one. You as a property professional can exert your knowledge and motivation to create a competitive advantage over these property "part-timers", even if you only have one property yourself.

4 Use of Other People's Money
. It is often sighted as the most important aspect of property investment. You can use other people's money, usually a bank, to increase or leverage the effect of your own wealth. It is common practice, when banking times are stable, to be offered 80% of the price of an investment property by the bank and you as an investor must find 20%. This increases by 5-fold the price of a property you can purchase. This sets property apart from other assets where you would usually require the full purchase price to buy a stock or bond. Sounds good? Well it is, particularly if you are reading this book and do not have access to huge amounts of money but can prove to the bank that you are solvent and a good risk. The typically conservative banks only make this exception with property as it has been the route to the banks riches also over the centuries and is a safe bet. The only point to make is that although your potential profits are greatly increased through the use of someone else's money, so is your exposure to making much bigger losses (there had to be a downside!). Profits and losses are only generated when a property is bought and sold and the timing of this will be discussed later in the book.

5 Property Goes Up in Value.
Because of the scarcity of property and the reason that it cannot be opted out of, property tends to increase in value at least in line with the rise of incomes over time. This is certainly true in areas where the ability to build on new land is limited and the population is stable or increasing (and the property is of good building construction that will last). Over the last 30 years, property in UK for example has increased, in real terms over inflation at around 2.5% per year¹ .

There are huge fluctuations of course in values as the graph shows, for example buyers around 1988 needed to wait around 12 years before the real value of their house returned to the original price they paid. Those who purchased in the summer of 2007 may have to wait a similar period of time, just to break even. So purchasing purely for expected short term rises in prices can be foolhardy in the extreme. In this book we will focus on the long-term performance of property and the monthly returns from rentals that you will receive. MONTHLY CASHFLOW IS KING. It is the ability to time the (fairly transparent) property market and treat it like a business that will ensure you minimise your exposure to the downward market trends and make a profit each month. This is what this book will focus on.

1 Latest statistics for UK are produced at Nationwide.co.uk

Okay, so we get a list. We could add more reasons. The point is to look at the list, make your own list, and then understand and exploit each point as far as you can. If these are the reasons to choose property then taking each reason to the limit will maximise how good you get at this business. Equally, making a list of reasons not to buy property, and then hedge against them is an equally useful exercise. Let's do an example:

Is Property a Gamble?

The conceptual idea I developed was that I, as a property investor, was living the life of a professional gambler sitting in a high-class casino playing roulette. Just like the roulette wheel stopping on red or black so property prices rise and fall and I am taking that risk. Sure, in property there tend to be more uptimes than down, but still like roulette. Perhaps I should stay in my job! But then I thought about the gambling stakes and who was providing the "chips" for each spin of the wheel. It wasn't me, it was my tenant. Every "spin of the wheel" costs one mortgage payment but the rent my tenant paid bought me enough "chips" for each spin of the wheel. Indeed, when I got it right, the tenant paid me much more than was required for "the chips" and there was money left over to buy "drinks at the casino bar". I could now afford to just keep spinning the roulette wheel as the tenant was paying for the table and also my drinks.

The risk of capital value increases and decreases had therefore been removed and, eventually, I was content to leave my job although I could have had the confidence to do it years early if I had read a book like this. For those versed in investment, okay the above is a long-winded metaphor for what a cash-positive investment looks like – sorry! Maybe thinking of the principles in this abstract form rather than numbers on a spreadsheet can be helpful though in focusing your energies, giving confidence or helping to explain your way of life to others. We will pick up on the idea here throughout this book.

Activity 1

My suggestion at this point is for you to make a list of the advantages and disadvantages with property ownership, to whatever level of detail you find useful. Then, consider what you can do for each advantage to maximise you benefit from it and minimise your exposure to all your listed disadvantages. I would then keep this list with you when property hunting. It is very easy to get carried away when viewing a property but does it meet the fundamental criteria you have? These should not be compromised.

Next Chapter - What do you want to achieve?