There is a seemingly endless stream of articles wailing about how difficulties facing 20 somethings. How could anyone afford to buy a property or start property investing?
The same stories were being written 20 years ago. Mortgage payments as a proportion of income had increased by nearly 30% over the the preceding 3 years. The horror! How could anyone afford to buy a property?
And 20 years before that. Interest rates were in the mid teens. How could anyone afford to buy a property?
In fact I’m certain that, at the time, it has never felt easy.
There is an Chinese proverb that says:
“The best time to plant a tree was 20 years ago. The second best time is now.”
The same is true of investing.
Living location is a lifestyle choice
Where you choose to live is a lifestyle decision, determined what you like and enjoy.
It could be a house in the suburbs, a flat in the city centre, a canal boat, a caravan near the beach, etc.
Whether you choose to buy or rent where you live is an investment decision. Run the numbers to determine the optimal outcome for your personal circumstance.
These are two vastly different decisions, and should not be confused or conflated.
An investment property does not need to be in the same city or country that you choose to live in.
Property as an asset class
As an asset class property investing has a lot going for it.
Direct property owners have the ability to create value as a result of their own actions. Examples including extending, subdividing, redeveloping, zoning changes, planning approvals, and so on. That is something that is not possible with stock market investments or REITs.
Generally (but not always!) property tends to be less volatile than shares, moving at a slower pace.
This makes it possible to secure a medium to long term mortgage over a property, and unlike margin lending against shares there are no margin calls to worry about before the loan becomes due.
Never forget that property should be evaluated as an investment. You don’t have to live there!
This is liberating. It doesn’t matter if you personally like the colour scheme, layout, or location providing there is a reliable supply of tenants who will.
The purchasing decision should be driven by the numbers.
You don’t have to afford to live there
You can probably purchase a better located investment property, that will be paid for by tenants, than you could ever hope to fund were you to occupy it yourself.
Providing you get your numbers right, a good investment property will be self funding.
You will need to be able to cover holding costs during void periods between tenancies. That is not the same thing as having to pay every mortgage payment over a 25 year mortgage yourself, unless something goes horribly wrong!
You must also cover maintenance costs whenever these occur. Your numbers should factor in a reasonable level of maintenance. It may not be possible to know ahead of time precisely what will go wrong, but it is a certainty that at frequent though random times things will need fixing or replacing.
The power of leverage
As the owner of a property you get to enjoy any capital gains that may result from rising property prices.
To illustrate consider the table below highlighting four different funding models for the same property.
The judicious use of leverage can significantly increase your return on investment.
Note the negative impact the servicing of that leverage has on cash flow.
Higher borrowing levels reduce the investor’s safety margin.
Interest rate rises or falling market rents will really ruin the day of a highly leveraged owner.
If you have analysed thoroughly then you should be able to obtain a self-funding, positive cash flow generating investment property.
If you have researched well then over time that property’s value should grow, increasing your equity.
In time it should become possible to extract some of that accumulated equity, while ensuring the property remains self-funding.
Use that extracted equity as the deposit for your next self funding investment.
Passive income pays for financial freedom
Over time your passive income steams should increase and your wealth will compound.
Once your portfolio contains sufficient accumulated equity, consolidate. Sell off some investments to clear the debts over the remainder of your portfolio.
If things have gone well you will have achieved the same goal those folks with 25 year owner occupier mortgages strove for. You should have a sufficiently sized portfolio that you could own outright one (or more) properties should you choose to. The big difference is you will have been living where you choose, rather than where you could afford to buy,
With a bit of luck the passive income generated by your portfolio will cover your own living costs, buying you financial freedom. If you are really luck you lived in a locale where the mortgage interest was tax deductible!
- Evaluate whether renting or buying in your own locale makes more financial sense.
- Consider property investing as a means of generating wealth.
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