If property is so good, why aren’t more people promoting it as an investment vehicle? Dolf de Roos looks at the benefits of property investments and why we should be buying more!
Although direct investment in property continues to be one of the best investment options available today, there are very few people openly enthusiastic about its merits.
This is largely because few people (other than property investors themselves) benefit from property acquisitions. In Australia, even real estate agents get their commissions from the vendors and not the purchasers (as they do in many other parts of the world).
Looking at investment yields
The lack of recommendation for property is also partly the result of incomplete knowledge about how property investments work. This lack of understanding manifests itself when yields on properties are quoted and compared to the returns on fixed investments. Almost without exception the yields quoted are income yields and do not take into account other factors that can dramatically affect the net returns such as depreciation provisions on improvements and chattels. Similarly, many people not involved with property are quick to point out the management ‘burden’ of property, but fail to fully appreciate the tremendous benefits.
Rather than consider the yield, we need to look at the Internal Rate of Return (IRR). Although accountants have a complex text-book definition of the IRR, the concept is really quite simple. Calculating the IRR for a property is complex, but software easily takes care of that. And when the IRR of a property is compared to that of other investments, suddenly it becomes apparent why property investors are such fervent practitioners of their trade.
And benefits there are, relative both to property investment in other parts of the world and to other investment vehicles. Of all the benefits, there is one in particular that sets property apart from most other investments…
Why banks like property investments
Imagine going to a bank manager and saying, “I really think that gold and silver are going to go up in value and I am quite bullish on diamonds as well. Furthermore, my friends assure me that antiques and paintings are truly sound investments and my third cousin twice removed has complete faith in platinum, so please Mr Bank Manager will you lend me some money so that I may invest in these things?”
The response of the banker will be the same the world over
On the other hand, all over the world banks and financial institutions are falling over themselves to lend you money so that you may buy property (be it for investment purposes or other reasons). That tells us two very pertinent things about property: firstly, it is still perceived to be an exceptionally secure investment; and secondly (and more importantly), you don’t even need to have the required money to buy property.
Whenever I mention these points at a seminar there is always someone whose comfort zone does not yet encompass property who says something like, “Now hang on a minute, one bank has just changed its lending rules from advancing 90 per cent of the property’s valuation to only advancing 80 per cent, which proves property is out of favour, so don’t tell me they are falling over themselves to lend us money”.
The answer is simply that even if one bank reduces its exposure from 90 per cent to 80 per cent, that is still 80 per cent more than any bank will advance on almost any other asset in which you may care to invest.
As to the “falling over themselves” part, I stand by the wording. Recently, one bank was offering mortgage applicants six chances to win $10,000 simply by arranging a mortgage with that bank. Another bank got on the bandwagon and offered a free trip to Tahiti just for taking out a mortgage with them. Others replaced their standard 1 per cent application fee with a $1 fee, or waived it altogether “for this month only”.
At one seminar an attendee pointed out that banks don’t just lend against property. His bank had been more than willing to advance 100 per cent of the money he needed to buy unit trusts, so surely everything I had been saying was biased. When I asked him what the bank had required as security for the loan, he admitted that he had offered his home as collateral. So even in this situation it is property that provided the security – not the unit trusts. Try asking a banker whether he would let you mortgage unit trusts to enable you to buy a property!
This willingness on the part of banks to finance your properties is a delightful situation – banks have the money needed to buy a property but do not wish to own it, whereas you want to own the property but don’t have the money. So it is not surprising that a synergistic if not symbiotic relationship arises.
