The direct purchase of real estate generally for the purpose of letting out to generate an income and ideally an increase in the capital value. The old cliché of location, location, location is very important here and often determines the demand for a property due to employment, facilities and amenities in an area. In the right locations supply tends to be restricted due to land being a limited commodity and, therefore, if there is a strong demand then prices tend to increase. Similar to shares, the return tends to 6-8% per annum but the big differentiating factor with property is the ability for finance over the long term at low interest rates and that lenders have no ability to call in the loan until the end of the period.
You may be thinking that property investment is only for people with money or wealthy fat cat landlords and I don’t blame you as that is what I thought before getting involved. This chapter of Financial Freedom Explained will provide a summary of how the average “mum and dad” investor which we define as a person or couple living the average UK family life that are generally between the ages of 30 to 50, can achieve success using this asset class. If you’re interested in replacing your employment income with passive income generating from your investments with little effort from you, the holy grail of investing, then Property Investment is for you.
The returns generated from leveraged buy to let property over the past 20 years have been quite incredible. The average return on funds invested in a buy to let with 75% leverage over 20 years to 2013 was 16.1% per annum. Which greatly exceeds the returns generated by other popular investment asset classes. A strong contributing factor to these returns and the major advantage the property holds is the ability to borrow money at high loan to value rate, low interest rates and for long periods of time without taking too much risk. To borrow to invest in shares, there is quite a bit of risk as, generally, the highest loan to value is approximately 60% (40% of your own cash invested), rates at the time of writing range up from 6% and if the value of your shares fall below an accepted level then you either must sell or contribute more funds. This often results in people selling at the worst possible time and losing money simply because market sentiment is low. This being said, even as a cash purchase, property has outperformed the FTSE All Share index consistently.
It’s important to note that without the prudent use of investment debt it is very difficult for the vast majority of people to achieve their lifestyle and financial goals. Even if they saved most of their income they still would not have enough funds to retire and passively generate the income that they need. So it is important to assess the best use of your resources and make investments that not only fit with your risk vs reward profile, but also align with your target timeframe and current resources.
Since 1926, house prices in the UK have, on average, more than quadrupled every 20 years. Compared with the share market, the FTSE 100 is lower today than it was in 1999.
The current average rental yield available on UK property is approximately 5%. This means that you are able to achieve approximately £1 per £10,000 investment per week. E.g. a £100,000 property will rent for approximately £100 a week. The average growth in rental yield has been 4.2% per annum which is versus a historical inflation rate of 2% which means that rents are growing at a much faster rate than people’s incomes. Therefore as opposed to many other investment types, at current interest rates of 2-3% it actually makes sense to borrow for income. This is due to the yield being higher than the cost of borrowing which accelerates your returns. For example a property that is yielding 7% (2% higher than the UK average but very achievable in the right areas) a 75% mortgage will often provide a return on cash invested up 12-15% per annum after all expenses and excluding any potential growth. Rental demand and growth is very much determined by demand and therefore so long as you invest in the right areas with strong reasons for people to want to live there, then you can have confidence in rental demand regardless of the state of the economy.
Comparing this to shares, the average dividend form the FTSE 100 is 4.2% and interest rates are 6%+. Given the interest rate is higher than the yield, it doesn’t make any sense to borrow to invest in shares if your main goal is to generate income. Even if you invested in higher yielding types of shares where the yield was 6%+, the gap would be minimal and therefore the cash flow wouldn’t be far above neutral. Average dividend growth in the FTSE 100 has been 3% but the risk with dividends is that they can drop at the whim of management or if the company or market isn’t performing well.
This is a sample taken from the chapter Buy to Let Property in the book Financial Freedom Explained. The author of this chapter is Paul Mahoney who has over a decade of experience in financial planning and property investment. His formal qualifications include a bachelor of business majoring in Financial Planning, a diploma of financial services, a certificate in mortgage advice and practice (Cemap) and he has studied the better part of an executive MBA.
To read the rest of this chapter, pick up a copy of Financial Freedom Explained from Voila Success. Ebook price: $12.00