[m-rev.] Property Investing

[Investment Opportunity]

Why Property?

It has been said that over 90% of the world's millionaires got there by owning property. 

One of the key reasons property is such a powerful way to build wealth is due to one simple fact: Leverage. 

Leverage is the ability to magnify your returns by building your wealth using other people's money (in this case, it's usually the bank's money).
 
Consider the following example, if you have $40,000 to invest. (Don't be concerned if you don't have $40,000 - you can use the equity in your existing property and purchase an investment property for very little out-of-pocket expenses).

One option would be to put this money in the bank - say a term deposit - or a superannuation scheme.

Money in the bank (assumed return 4%)
Now   		One Year   	Five Years   	Ten Years
40,000   	41,600   	48,666   	59,210

As you can see, after 10 years, you've got basically no-where, especially when you consider the ravaging effects of tax and inflation. 

Alternatively, you might put this money in the share market, as a great many people do. We've been generous here, assuming you are able to produce consistent returns of 15%, year after year. 

Money in the Sharemarket (assumed return: 15%)
Now   		One Year   	Five Years   	Ten Years
40,000   	46,000   	80,454   	161,822

This is better ... so long as you can get 15% consistently (also see Note 1 below).

Better still, though, would be if you leverage the $40,000 to purchase a $200,000 investment property (in other words, borrow the remaining $160,000 from the bank which is an 80% lend and one that most banks go to providing you meet their other lending criteria).

Money in Investment Property (assumed return: 8%)
Now   		One Year   	Five Years   	Ten Years
200,00   	216,00   	293,586   	421,785
-(160,000)   -(160,000)   -(160,000)   -(160,000)
40,000   	56,000   	133,865   	271,785

What has happened here is that after 1 year, the $200,000 property has risen by 8%.

In other words, you get the 8% gain on the entire $200,000, not just the $40,000. 

8% of $200,000 is $16,000, bringing the total asset after 1 year to $216,000. 
Subtracting the $160,000 you still owe to the bank leaves you with $56,000. 
(We've assumed that the tax benefits and rent you receive pay the interest on the bank-loan, as often happens).

Note the advantage of compounding after 10 years. You now have increased your $40,000 investment to $271,785. (In practise, you can also borrow this $40,000 against your existing home, achieving returns similar to the above using little or no money from your pocket, whether for initial outlay or for monthly outgoings.

This is a little simplified for ease of explanation, but gives you a good idea of the power of leverage. 

The real key to leverage, though, is to use the equity in one property to buy another, then another, and so on, so that over a 15-20 year period you may be able to accumulate a large portfolio of investment properties, all providing you with an inflation-adjusted income for as long as you keep them. This is a key point, and a much better alternative to a lump-sum "nest-egg" that dwindles away over time through inflation and taxes.
 
NOTE 1:
The following is an example of using your $40,000 which, at a rate of 50% margin lending (most banks will consider this), allows you to buy $80,000 worth of shares.

Money in the share market (assumed return 15%) With margin lend of 50%

Now   		One Year   	Five Years   	Ten Years
80,000   	92,000   	160,908   	323,644
-(40,000)   	-(52,000)   	-(40,000)   	-(40,000)
40,000   	40,000   	120,908   	283,844

Even though this has produced a better return than property, the following cannot be excluded from the overall analysis.

There is an inherent risk with margin lending in that if the value of your share portfolio falls below a certain level (set by the lender) then they can ask for a margin call. This is where you either have to sell some of your shares to reduce your loan or input more money from an external source to cover the shortfall, generally within 48 hours.

Also to be noted is the performance of, say, balanced share funds. With the following being reported in "The Australian Financial Review" on Wednesday 22nd May 2002

   			3 Months %   	1 Year %   	3 Years %
Tyndall   		1.4   		7.6   		6.9
Maple-Brown Abbott   1.0   		9.0   		9.4

With these being the top two performers for the March quarter 2002.

Another pitfall is that you would be taxed at your marginal tax rate when you sell your shares. Also by decreasing your pool of available funds, you are further decreasing your returns in the future whereas with property you can "harvest" the property growth tax-free. History shows that property outpaces inflation by 2% to 4% so your returns are more assured than the stock market which can go through massive ups and downs.

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Disclaimer
Please read this disclaimer carefully.
Information in the above article should not be regarded as a substitute for professional, legal, financial or real estate advice. Because every investor's needs and financial situations are different, the information in the article 
is intended as a guide only. 
 
The author responsible for this article, believes that all information contained within this article is correct. However, no warranty is made as to the accuracy or reliability of the information contained herein. The author disclaims all liability and responsibility for any direct or indirect loss or damage which may be suffered by any recipient through relying on anything contained in or omitted from the article. 
 
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