Property as an investment or not is what we are going to discuss in today’s post!
We’ll go through why properties as an investment might be a great way to financial wealth and financial freedom. But, we’ll also have a look at the other side of the coin since we all like to make well founded decisions.
The pros of property investment
Some argue that properties have been or even is the greatest wealth builder of all times and to some extent I agree. There are for sure good reasons why most, if not all, millionaires and billionaires invest in properties and it’s not just for fun!
The list of pros of investing in properties can be quite extensive but as a start I would like to focus on a few of the aspects I personally find very attractive with property investment.
Easy to leverage
If you want to use financial leverage (borrowed money) to invest in any shape or form, the easiest and cheapest way is likely to be investing in properties and use the property as collateral. Most lenders see properties as very safe and the value is rather transparent (lots of statistics readily available). That means it’s a competitive world for lenders which leads to low borrowing costs for investors (low interest rate on the loan).
To understand the importance of this aspect when making a property investment let’s have a look at an example.
Let us assume I can buy a property worth 1 million USD today and let’s just say that in 10 years it has doubled in value (might be extremely unlikely but this is just an example!). For simplicity we won’t take any costs into consideration, only two ways of buying this property. One is with cash only and the other is using a mortgage and hence borrowing 80% of the capital.
Ten years down the line we have a property valued at 2 million USD, so the value is the same.
If we assume I bought it with cash, my 1 million USD would have doubled to 2 million USD which would have been very good. A 1 million paper profit!
Had you bought it with a mortgage, you would also have an asset worth 2 million USD, BUT as you only invested 200k of your own money, your money actually grew five fold! From 200k to 1 million USD!
Well if we both started with 1 million USD and I bought one property I would have the 1 million USD paper profit.
But let’s say that you understood the value of using leverage wisely so you used your 1 million USD to buy FIVE properties, putting 200k down on each one of them. Maybe you decided to live in one and rent the other four to generate cash-flow and let them pay for themselves.
After those 10 years, your paper profit would have been 1 million on EACH property = 5 million USD!
That is what leverage can do for you if you use it wisely. Of course, if you don’t use it wisely it can go the other way around as well so you have to know what you are doing!
By being smart and using leverage wisely, you can make your journey to Financial Independence so much faster and again, property investment might be the easiest way to get that leverage!
To put food on your table you will need cash-flow, we all do. By investing and owning properties and renting them out, you will generate cash-flow. As most of us want to make sure we have a roof over our head, paying rent is a high priority. This means that property as an asset over time is relatively stable (not the price fluctuation one can experience in the stock market) even if they at times can be moving a lot in value.
Even if the value might fluctuate more during certain periods (likely to happen now after Covid-19 and the following unemployment…) rent is still something most will prioritize paying as they don’t want to end up in the streets.
Cash-flow from property investment, if done well, is very stable over time. If you only have one or a few properties then you could be “unlucky” and have bad tenants who can’t or won’t pay but if you diversify well and build a portfolio, you should be doing very well over time.
So if you are looking for cash-flow, property investment might be one way to go. It for sure isn’t passive but you can make it passive if you build a portfolio and put systems in place so that it works without you interfering on a daily basis. Just don’t buy into the bs that it’s completely passive and hands off… If it is, you are paying for it and your returns will be lower (which might be ok but just be aware!).
Inflation hedge or value appreciation
This is the other very appealing part of property investment. They tend to go up in value over time and at least in line with inflation (the overall level of price increases). When investing in properties, you will often hear the word appreciation or appreciate in value. That just means that property prices are going up in value!
The cool thing with a combination of leverage and price appreciation is that your mortgage will be the same dollar amount even if the value of that dollar amount is being eroded because of inflation. If that was a mouthful, just think about this. Wouldn’t it be easier for you to pay back a mortgage of 1 million USD in twenty years rather than today? Most likely your salary will have increased over that time frame, partly due to inflation and fingers crossed mainly because of the value you are adding to the market place.
More pros with investing in properties
Below is a list with some additional benefits of investing in properties but the ones mentioned above are really the important ones in my view:
- Transparency (in most countries)
- Easy to find partners
- Low volatility (compared to other assets)
- Easy to get started – low barriers to enter
- Loads of different strategies available
- Improvements – the possibility to add value to a property in various ways
- tax breaks and deduction – country specific but can be very advantageous
- Diversification – I hope you invest in other asset classes as well!
Depending on your circumstances and what your goal is when starting to invest in property, you might value some reasons differently to me and that is a good thing!
The cons with property investment
All of the pros of investing could of course become cons in some shape or form. I will just focus on a few of the biggest cons (or risks) as I see it and they are:
As mentioned earlier, leverage can work both ways. When you are investing using leverage (other people’s or financial institutions’ money) all numbers involved get bigger. Still this is for sure the most common route. Investing in properties using saved cash only would be very difficult for most and on top of that it takes a lot of time to accumulate.
If you invest in a property using leverage and the deal goes south; maybe your tenants are not paying, maybe there’s big leak or whatever it might be, it can become very expensive. Unless you have the financial resources to handle it, it can become very burdensome. It’s even likely that you have given a personal guarantee on that mortgage/loan and if things go really sour you will be personally liable with all the consequences that brings.
Leverage is a beautiful thing when used wisely as it can make the journey to Financial Freedom so much faster but again, if you try going too fast using too much leverage (or the wrong type of leverage) it can become a devastating lesson!
So make sure you understand what you are doing and have back-up plans because things will happen along the way, they always do.
Properties can fall in value!
Not really a paradox to what I discussed before as over time, in most locations, properties have increased in value. Still there are areas and situations when properties have fallen in value. This point has a few things in common with the point on leverage as your lender might require more capital from you if the value of your property (their collateral) falls below a certain level. Make sure you understand your loan documentation and what your lenders can do in case they believe the value of your property (their collateral) has fallen in value.
Besides from the possible risk that your lender might require you to put in more capital if values fall, you might take a hit if you have to sell (never want to be a forced seller…) or if you are using a strategy which includes lots of buying and selling.
One example would be if you buy a property and intend to renovate and then sell. What happens if the market is down 20% once you have renovated? Will you sell anyway, how was it financed, can it be extended etc…? More on this when we go through different investments strategies.
Do you really know what you are buying?
I guess we all think we know what we are buying and that we have assessed the risks. Still, this might be one of the bigger risks. We haste into a transaction thinking it’s a great deal, “too good to be missed” so we are not doing a proper due diligence on the property.
This can be devastating, especially if you have limited financing and you face something major like structural issues. You could be facing both large costs and a no cash-flow situation as the property might be inhabitable until the structural problems have been solved. Not only will you then have to pay for the works of correcting the building but you also have to cover all the running costs whilst no money in!
Make sure you do your homework!
When you own properties in your own name or via your own company, it will still mean some management has to be done. It won’t be passive during the early stages at least not until it has grown large enough so that you can outsource most tasks. Basically don’t go into property investment thinking it will be all passive and you won’t have to do anything but watch the money roll in.
Properties are similar to cars in the sense that there is always something that either needs to be fixed or should be taken care of in the near term!
Well, it’s not my business to persuade you to change your life for the better but as you are reading this content I do believe you are looking for a change in your life and this might be one interesting avenue for you to look into!
The above might only outline a few of the pros and cons about investing in properties. However, building a long term portfolio means cash-flow and cash-flow is what we all live off. The only question really is where that cash-flow is coming from and for most people it’s from their day jobs. As of lately and with the Covid-19 situation, many have unfortunately realized that those might not be that safe to depend upon after all.
Personally, my main reasons for investing in properties are to create a base of wealth that will support me and my family in infinity and at the same time be supporting families and helping them find quality homes with great landlords. When I think about the asset class as such, I honestly find it hard to think about any other asset which can accomplish this as well as being easily available to everyone of us!
You must find your own why as to why you want to invest in properties. As with everything in life, if you have a big enough why, you will make it happen and the journey will for sure be worth it! Just close your eyes and think about this for a couple of moments: When you have built a portfolio of properties generating enough cash-flow for you and your family to live off, you never have to “work” another day in your life. If you knew this to be true for you and your family, how would that make you feel? Stick with that feeling for a while…
Now, is that knowledge and that feeling not a good enough reason for you to start moving forward?? Knowing you have the capacity to create financial freedom for you and kids, how awesome is that! I know you are a go-getter, else you wouldn’t even be reading this so I’m confident you can do it.
Every journey starts with that first step and as long as you keep moving forward, those steps will add up. In this case to a property portfolio!
How to get started?
Good question. I would actually suggest you start reading my series on the property I bought and have listed on Airbnb as that could possibly be a good way to dip your toes into properties. You can find the first one here: Buying a property part 1 – why, what and where?
Also, Coach Carsson has some amazing content on his blog so I would really suggest you have a look there too. Most of the information in there is relevant regardless of where you live even if the blog is based on the US market. We live in a global world so there really aren’t that many differences between countries besides from regulations and taxes.
Actions to take:
- Know your WHY – Burning Desire
- Property investing – Where, Why and where?
- Why I decided on starting a property company abroad!
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