One of the most lucrative money-making opportunities out there is through property investing. I plan to get into the market within the next few years (if things goes well of course). In this entry, what I mean by property investment is basically the usual buy property, hold it, and enjoy the rental income strategy. I won’t be discussing about property trading, property options, property development, and etc. this time.
Recently, at uni, I attended this seminar on property development. That guy, who was a property developer (duh..), said that he prefers properties over shares because shares were too risky. Is it true?
First of all, I’d prefer properties/real estate as assets where you would obtain and keep for a long time. I prefer the strategy of buying POSITIVE CASHFLOW PROPERTY, and enjoy the rental income. As time goes by, you build up equity in those properties, unleash those equities, and buy even more properties. Equity will be discussed in another article.
What is POSITIVE CASHFLOW PROPERTY you ask? Here’s a simple illustration:
Your monthly mortgage repayment for your investment property is $1,000. Your rental income on the other hand is $1,300. After paying the monthly repayments, there will be $300 left over. This is POSITIVE CASHFLOW, thus the term POSITIVE CASHFLOW PROPERTY.
An opposite to POSITIVE CASHFLOW PROPERTY is NEGATIVELY GEARED PROPERTY. An example of negative gearing:
Your monthly mortgage repayment for your investment property is $1,000. Your rental income on the other hand is $900. You then need to supplement the mortgage repayments from your own pocket by $100. This is negative gearing.
Are negatively geared properties bad? No, they’re not. It has its own advantages as well. We’ll discuss about this at another time.
Alright, let’s get back on track. Is it true that shares are riskier? Well, you be the judge. Let’s look at the potential drawbacks of investing in properties.
DISADVANTAGES
Barriers to Entry
You need a rather big amount of capital to get started in property investments. To get a $200,000 house, you will need $20,000 (assuming 10% deposit). Apart from this, there’ll be the usual stamp duties, legal fees, insurance fees, and etc. For individuals like me, with no jobs, and still in uni, it would be hard to get hold of this amount of money (hard to get a loan as well, unless you’ve got a guarantor). True, there are other ways to raise capital, but when it comes to individuals like myself, we have limited options.
Shares on the other hand need a rather low amount of capital to begin.
Hard to Exit
One thing that I don’t like about property investing is that it doesn’t have the STOP LOSS feature, unlike share trading/investing. What is a stop loss? Stop loss is basically an automatic lever that would be automatically activated and exits you from the market if the price of the asset reaches a certain level. Have a look at my stop loss post. Having a stop loss would detach the emotions between you and your investments. How many times have we said to ourselves during asset price decline, “It’s ok, it’ll bounce back.”, when in fact, it keeps on declining?
Also, to exit from the property market, it takes a while. When you want to sell your house, it takes on average 30 to 90 days, if not more (from the point of you putting the property on the market, to the point of you getting the proceeds of sale). Shares, on the other hand, to exit, takes only minutes, or even seconds (provided there is liquidity).
Something to take note of, in the recent subprime crisis, we have seen property prices falling like crazy. I read in Australia’s Money Magazine that it fell by 48% from its January peak, causing negative equity to a lot of homeowners. For individuals with deep pockets, this wouldn’t create much problem. How about for the rest of us who has limited amount of capital to play around with?
Risk of Properties and their Potential Costs
On average, the equity in your property increases by 7% p.a. (Australia’s estimate), and rental income around 4% (??), taking note that most of the rental income goes back to paying your mortgage. True, the 7% p.a. return is leveraged but shares/business can also use leverage. The return of equity from your investment properties can only be realised by selling the asset or by refinancing the asset.
On-going Costs
Investment properties usually have on-going costs to bear. Things like property management fees, maintenance costs, Cukai Tanah (Malaysia), Cukai Pintu (Malaysia), and etc. Of course, it would be different if all these costs are borne by the tenants.
There is usually no on-going maintenance costs for shares. You only pay for the brokerage (assuming no leverage is used).
Interest Rate Rise
Interest rates change all the time in accordance to the economy. This can be a real headache to property investors. The interest rate may rise by so much that it can transform your POSITIVE CASHFLOW PROPERTY into NEGATIVELY GEARED PROPERTY. Of course, there are ways to solve this problem such as getting your interest rate fixed, and etc.
Accessibility
In terms of shares, you can easily check or do changes to your position easily by phoning your broker or even through a computer with an internet connection from anywhere in the world. They are easily accessible.
Properties however, due to them being a static asset, you or somebody else need to be personally there to check on problems or to carry out any transactions.
Other Problems
Another problem that can create a massive headache is the risk of having tenants from hell. Tenants paying late, party junkies, and etc. You get the picture.
Another bigger problem is having no tenants at all.
Shares don’t have these problems.
Alright, now let’s look at the advantages:
ADVANTAGES
Tax Deductibility
I’m not sure about Malaysia, but in Australia, expenses, and interest costs are tax deductible. Highly beneficial indeed.
Leveraged Returns
Due to the nature of property investment, your returns are leveraged. Your outlay is little but your returns are exponential. Have a look at this illustration.
You bought a $200,000 house with a $20,000 deposit. The following year, the price of the house increases by 10% or in dollar terms, $20,000. Remembering that your actual money in the game was only $20,000, you have effectively made a 100% return on your capital! Take that!
Rental Income
Another advantage of property investment is the rental income. Assuming you have a POSITIVE CASHFLOW PROPERTY, the extra money you get each time your tenants pay rent can be really useful. If you decide to buy further properties,the extra money can supplement the repayments.
Disciplined Savings Program
Let’s assume that our monthly income from our day job is $2,000. Most of us will find all sorts of excuses not to leave some money aside for savings.
Now, by having an investment property, you are obligated to pay the mortgage repayments or there will be repercussion from the bank. You haven’t got the choice to skip one month of repayments. In a way, you are now forced to save your money, which is a very good thing.
Less Volatile than Shares
Unlike shares, there are no Bursa Hartanah/Property Exchange like the Bursa KL/Australian Stock Exchange. Same properties are not usually traded on a daily basis or even every minute, unlike shares. Changes of house prices also can not be tracked as quickly as share prices. You might need to get a qualified valuer to value your investment properties to actually know how much it is worth. As such, properties are less volatile than shares. History has proven this.
Inefficient Market
Unlike the share market, the property market is an inefficient market. Prices and information are not transferable between individuals easily. There are a lot of opportunities in an inefficient market. The misjudgment of the value of a house by an individual can lead to a good opportunity to another individual. Let’s take this for example:
Mr. A is a buyer and Mr. B is a seller. Mr. A found out that this particular area will be developed soon. Mr. B didn’t know about this and thought that this is a horrible place due to no-development in the past years. Mr. B didn’t know that the area is going turned around soon. Because of this, Mr. B is prepared to sell his property 40% below market price. Obviously for Mr. A, this is an amazing deal!
Physical Asset
Another advantage is the fact that when it comes to property investing, you own a physical asset. You can actually touch and see your investment properties. It is there. Unlike shares that are only visible on your account statement or on your computer screen. Owning a physical asset do have its own merits.
My View
Personally, I don’t have a preference on one over the other. To me, I would love to have both properties and shares to be in my portfolio.
All in all, for me, my way is to accumulate capital through share trading first and then lock away my money in real estate and other quality assets for the long-term. Of course, my view could change in the future.
Anybody has an opposing view? Feel free to share your opinions as well.
P.S. The above writings are based on my own personal opinion only. It should not be treated as exhaustive or a recommendation to do anything.
(Photo courtesy of Wikipedia.com)
