Why is property good?

Posted by admin in Property Investment | October 12th 2004

TEAMWORK.

I realise from our own experience now that investing as a team we are doing better than if we were trying to achieve results on our own. That does not mean that we have syndicated our properties. Each investor in our team owns his own property or properties and all rights over those properties are his, just as your farm in Macheke or Stellenbosch is your own, or your home in Wiltshire. However association with like minded people with similar goals opens up opportunities for mutual benefits. Benefits which are aimed at achieving higher returns with less risk, and the use of other people’s money (being the Bank’s)

I apologise once, at the beginning of this paper to those who have bought properties for cash. I believe in borrowing as much as possible to buy property – not cars or TV’s or furniture or any other deteriorating asset – and certainly not shares, but property. And those who have paid cash for theirs can very easily reverse their decision to do so if they are convinced by my arguments, so please bear with me and accept that this is not a criticism of your decision, just a viewpoint.

WHY IS PROPERTY GOOD?

If you had $100 to invest you could buy exactly $100 worth of stock, but you can buy a lot more than $100 worth of property.
If you asked a bank to lend you money to buy stocks I think you might politely be shown the door. But the same bank is eager to lend money to buy property. Not only that – the interest rate on property loans is lower than the interest rate charged on loans for almost any other form of business venture. The reason is simply that banks consider property a safer investment. Lower interest for lower risk.

This advantage of being able to access easy credit to buy property is commonly called “Leverage”. What does it do for you?
If your $100 worth of stock went up 10% you would have made $10 on your investment, but if you have bought $200 worth of property with $100 invested (a 50% mortgage), the same 10% increase will have made you $20. 100% more on your capital invested. No rocket science there.

When you buy $100 worth of stock it is worth exactly $100.
When you buy your $200 property using $100 what is it worth? Anything. If you have chosen badly, perhaps less than $200 – you’ve been taken to the cleaners. But that is unlikely to happen because before they lend you the $100 which is their contribution, the bank will send their own assessors to value the place. They don’t generally lend on bad deals.
However it is quite possible that it is immediately worth a lot more than $200, because you have bought a bargain. It happens all the time.

Why would someone sell below the value of the property?
A host of reasons.
A slow thinking owner, or a poor agent.
Divorce – sadly people can’t wait to sell the property and split the proceeds and get on with their lives. No preparation of the property for sale, and instant results.
People will “save” the expense of getting a proper valuation – and price it according to what they think it’s worth, and what they paid for it years ago, plus a bit.
Like divorce, the quick liquidation of a deceased estate in order to split the proceeds between beneficiaries, who often live far away. Nobody on the spot.
Foreclosures. The bank is only interested in getting it’s mortgage back, not true market value.

When you buy your property what can you do to improve it’s value?
Paint it. It increases the value by a great deal more than the value of the paint and the labour. People don’t like buying a scruffy dirty place, and they tend to believe that there are all sorts of things wrong with it beyond the fact that it is “yeuk”!
The same property a few weeks later, with a coat of paint, some tasteful furnishing and the lawn trimmed suddenly looks fantastic, especially if there are flowers in a vase and the lovely smell of freshly baking bread permeating the house. Perception becomes reality.
There is so much that can be done to enhance the value of a property that costs relatively little – new gutters and down pipes always look great, air-conditioning, curtaining, a modern bathroom and/or kitchen, painting the roof, installing an alarm system, shiny doorknobs throughout, cleaning carpets, etc. etc. etc.

Get a new bank valuation once you’ve done the improvements, and refinance. It is a non-taxable increase in value if you don’t sell the property, and the difference can be invested in another property if you want, or taken in cash if you need it.

So what have you got then?
An investment that offers the possibility of tremendous leverage, and you can shop around and buy properties at below their true value. You can increase their value beyond the cost of expenditure on improvements, and increase their value without having to sell them, or pay tax on the increase. It is not taxable because it is not income, and as you have not sold the property it is not subject to capital gains tax.

Can property go down in value?
If the market goes down then the downside of leverage will be just as marked as the upside was.
However, have you ever known of any property (except for a farm in Zimbabwe – and even that may come right in time) which has lost great chunks of value the way shares can lose value – 60%, 90%, 100%?
On the other hand, have you ever walked around your home district, or down the beachfront at Umhlanga, and said “Wow, if only my Dad had bought a few acres of that when it was only R1 000 an acre”?

Comparisons of investment vehicles should be fair.
When analysts say that house prices increased by 7% last year, and money market funds by 5% and that the FTSE lost 7%, they are not comparing apples with apples. They are not telling us how they compare relative to the amount of money put in. Investments in the money market or stocks require the $100 investment for $100 value, and property does not. Advisors saying that property is not great should compare the results from $100 invested in one investment to the same $100 invested in another, and leverage greatly changes the reality. If the stock market goes up 15% and the property market by 5%, the property investor with a 70% mortgage will have done better than his friend in stocks!

He will also not have been subject to the wild swings up and down – from tech.stock downs to pharmaceutical highs, airline lows and oil busts, that the stock market is subject to all the time. Trends are slow in property, with little deviation from the average. The suburb, city or region with high growth this year is likely to be at or near the top again next year and the year after. If 500 properties in Cape Town increased in value by 5% on average this year, the chances are very strong that each individual property will also have increased by about 5%. Trends are stable and therefore pretty predictable. If on the other hand 500 stocks increased by 5% on average, some individual stocks may have gone up by 1000% and others crashed out of existence.

Companies come and go, but the buildings they worked out of and the homes the workers lived in tend to stay around.

When companies go under there is nothing you as an investor can do about it. Insurance against it, if it were available, would be prohibitive. Property on the other hand rarely goes under, (fire, earthquake….), and as a result insurance is cheap and is the norm.

More tax considerations.
Property is very tax friendly.
We are allowed to claim depreciation at around 2 or 2.5 % per annum on property – and yet it goes up in value! This is because it is government policy to encourage average people to own and provide housing because the government can not afford to house everyone. It becomes very significant when you put numbers to it. Say your $200 property generates $20 income for the year, of which $15 is accounted for in deductible expenses like electricity, mortgage interest, taxes, etc. You have a net profit of $5 which would be taxable except that the 2.5% depreciation on the value of your $200 property accounts for it. You don’t pay any tax on your $5 profit, and the depreciation has cost you nothing.

Beating the averages.
I don’t know how you beat the average on the stock market any more than in the casino. It’s about all one can hope for just to stay with the average I think, and hence the popularity a few years ago (and lack of it now!) of investing in “index trackers”. If the index went up your stock increased, and as it normally went up you normally made money. Simple.

However in South Africa Cape Town is known to have a high growth relative to most of the rest of the country. No wonder. It has a lovely climate and scenery, the sea, lots to do and is a very nice place to live. So demand for property in Cape Town is high, and prices have increased at a higher rate than they have elsewhere in the country.

Cannes is the same where Europe is concerned, with all the advantages listed for Cape Town, relative to much of the rest of Europe, and the highly developed conference facilities just add some cream. Worldwide, growth in the value of property is also highest by the sea, and in the case of Europe, where it is warmer. Cannes has all those things.

People are still obsessed with buying in their home town or country, but if you want to beat the averages you don’t have to. It is possible fairly easily to decide where to go to do better, by focusing your investments on those areas where it can be shown statistically that growth is consistently higher than the national average. We have the freedom to invest where we want to.

Yes, but…
I have enjoyed reading Dolf De Roos (a New Zealander!) recently, and I quote from one of his writings:

“….because that is how many people typically think. Every time I write a new article or column on some aspect of real estate, or share a recent experience with property, I get a flurry of letters and e-mails from the “Yes, but…” brigade, who seem to relish pointing out circumstances where what I say may not apply. It is as if they go out of their way to find a reason why it will not work. I guess for them, more often than not it doesn’t.”

He continues a little later:

“Having fears when considering investing in real estate is natural. But letting that fear drive you is not productive. Developing the financial intelligence to be able to discern a good deal from a mediocre one, on the other hand, is wise.
With sufficient financial intelligence, you gain the confidence to do really well. And with that confidence comes daring. And when you dare to try, you practice. And
through practice, you develop ability. And the more you exercise this newfound ability, the more your financial intelligence will go up as you learn new techniques, or nuances of old techniques. It becomes a positively reinforcing circle. You get better and better at it. At believing real estate is good, at finding great deals, at negotiating them, acquiring them, managing them, and watching them grow.
One day you may even wake up, realise that you are making more from property than from your regular “job”, and quit your job to work full-time on investing in real estate.”

He also speaks of what he calls his 100 : 10 : 3 : 1 rule.
If you look at 100 properties, put offers in on 10, and try to arrange financing on 3, you may end up buying 1.
We are certainly finding those figures to be not far out in our experience – good buys are not just there for the picking. Look at a lot, and you will find some gems. Look at a few, and you will find evidence to support the theory that all the good ones have been taken! Also look at a lot, and you will recognise a property worth investing in when you see it, because you will know the area, and you will know what is the norm.

The “Yes, but….” that must not be forgotten is that after transfer of the property to your name, the monthly mortgage repayment and other costs start immediately, and there is not necessarily the immediate income to cover them. You must have access to enough cash to pay those costs for a few months, or whatever the period of time is that you estimate will be required before the generated income from the property covers those costs.

Summary.
• You don’t need much of the purchase price in cash to buy the property you want.
• You can buy property worth far more than you are paying for.
• You can often increase the value of the property you buy significantly without spending much on it.
• You don’t have to sell the property to reap the benefits of your growth.
• You don’t have to monitor your properties closely from day to day because the market is not volatile.
• Property prices tend to increase smoothly and consistently.
• Property has exceptional tax advantages.
• Fluctuations of any one property relative to the average for any area are very slight.
• It is not difficult to locate an area where you are going to do better than the national average.
• It is a relatively simple, reliable and consistent investment, with great cash and wealth building potential.

I promised that this would only be a few pages, and I could go on and on, but I hope you see where I am coming from.
A year ago, after the loss of our farm and home, Vicky and I were filled with fear, but thankfully not to the point of paralysis. Are we glad that we researched property in general, Europe and France in particular, and Cannes specifically to invest in? Oh yes! But the first step is always the hardest, and rather terrifying.

Where to now?
• You have been waiting and watching – start something on your own or pool resources with a friend or family member of like mind.
• You have bought something using mortgage finance. Start looking at buying another property – refinance or get a revaluation on the one you’ve got, and explore the ways and means available. They are not always all that obvious, and not always all that expensive either.
• You have bought something for cash. Mortgage the property and buy another one or two without putting in any more cash! Increase the value of your property portfolio without spending anything more, and increase your wealth while you are at it.

I do not mean to trivialise what are after all huge decisions, but I can not avoid the logic.

My very best regards, and from Vicky too,

Guy.

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