British Expat Money

The day you became a better investor in property

james@britishexpatmoney

Today could be the day you became a better property investor.

Even experienced pros might learn or thing or two by the end of this article.

It all started when I found myself arguing with a good friend of mine recently over property.

He sees himself as a highly accomplished property investor. And to be sure it’s hard for me to argue.

After all, he’s got more properties than me. A lot more. That’s not hard, though. I don’t have many.

He’s also got a lot more experience than me. And to be fair. That’s not hard either. I get everything done via a management company. He does everything himself.

In other words, he’s a real landlord. A landlord with experience. A landlord with a large portfolio. And a landlord that makes a lot of money from property.

But here’s the thing. I’m pretty sure he does all this without understanding some basic investment principles.

During our tête-à-tête he confidentially rattled off numerous reasons why I needed to join the world of serious UK property investors, and stop messing around with index tracking ETFs.

So in this article I’m going to run through a few key investing principles that I think he is missing.

And I don’t think he is alone.

Do property prices always go up?

The first mistake he made was explaining that property prices have always gone up.

To be fair to him, he’s not the only one who thinks that. But the truth is, that’s not the case at all.

You see there’s strong argument to say average house prices haven’t gone up for most people because they are ignoring three critical financial truths which we’ll come to shortly.

Now my friend was quoting a property guru who shall remain nameless that pointed out that from Jan 2008 to Jan 2023 average UK house prices have increased from £186K to £272K.

The guru in question was making the argument that even if you’d bought at the top of the market in 2008 you’d still have made lots of money on house price growth alone.

At first glance, that looks like a true statement.

In fact it’s an £86K increase, which equates to 46%.

No wonder the property guru mentioned it multiple times in an interview.

The problem is, it fails to take account of three elements that are key to property investment.

  1. MORTGAGES – Most people buy properties with a mortgage and this so called house price increase totally ignores the fact you have to pay the interest back as well as the amount you borrowed. In other words you don’t pay the asking price for a property, you pay a lot more than the asking price if you use a mortgage. (& most investors use mortgages because you don’t get the big returns without them)
  2. INFLATION – Inflation means the costs of goods and services increases which in turn means you need more money today to buy the same things that you could buy for less money in the past. Just because a property is worth more in pounds than it was when you bought it doesn’t mean its really worth more in terms of the goods and services you need to buy or even other types of investment.
  3. DOLLARS – The world we live in is priced in the dollar. 80% of things that companies import around the world are priced in the dollar so you need to price investment assets in dollars.

Each of these points is critical to understand, when you are considering how good or bad an investment property is.

This is particularly true nowadays because unlike in the past everybody now has access to all kinds of alternatives.

Without further ado lets get into it.

How mortgages juice returns for an investor in property

A serious investor in property uses a mortgage to juice returns. Some people call this leverage, others gearing, but most of us just plain borrowing money.

Any house price increase can be magnified using a mortgage. Let me explain.

A £100K property increasing in price by 10% gives you £10K.

Not bad, but what if you borrowed £300K from the bank to buy a £400K property?

A 10% increase in that case would give you £40K.

And remember that you still only invested £100K of your own money so that £40K is a 40% return on your money. Nice work.

No wonder UK property investors like mortgages.

What’s not to like?

Well, there are three things to be aware of when you borrow money to buy property.

Now, whilst many people do have a basic understanding of the first two, its point three that seems to cause people trouble.

So I think it’s worth unpacking that because in many cases it changes the game entirely.

Why mortgage interest changes the game

Most people understand that when you take out a mortgage you need to pay interest. However, they fail to comprehend the impact that has on the price you end up paying for your property.

Let’s say you used a mortgage to buy a house back in 2008 at the average price of £186K.

Typically you can borrow 75% of the price so that would be £139.5K. Leaving you with a £46.5K deposit to find.

Most people understand that banks don’t lend you money for free and that you need to pay interest.

But after that, in my experience things start to get a little hazy.

When I ask people how much they paid for a house, they always tell me the price that was agreed with the seller and estate agent. In other words, the amount that changed hands on point of sale.

So let’s say the house was on the market for £195K, but you bargained it down to £186K. On point of sale your solicitor will wire £186K to the seller. This is the number people have in their mind, but in reality this isn’t the amount you paid for house at all.

That’s because you have to pay back the money you borrowed to the bank and you have to pay interest too.

This is true with both repayment and interest only mortgages. The only difference with interest only is that you are expected to pay off the money you borrowed at the end of the loan period rather than monthly as with a repayment mortgage.

The fact that most people use a mortgage to buy property and that the loan has interest attached means that you end up paying far more than the asking price.

Think about this for a moment. Whilst UK property investors have been enjoying some of the lowest rates in history since 2008, most experts agree those days are long gone.

Right now borrowers can expect to pay somewhere between 4 and 5% for a fixed rate mortgage.

That’s a different kettle of fish entirely to what people have been paying in recent years.

And unfortunately for today’s budding investors, it will totally change the game in terms of how much of a good investment property actually is.

How much did you really pay for your house?

If we were looking at buying a house right now with a mortgage we’d be looking at an interest rate of around 4.5%.

Sticking with buying a £186K property and assuming a similar growth in the future to what we have in the past we can crunch a few numbers.

To buy our £186K property, typically you’d borrow £139.5K and put down £46.5K deposit. (You borrow 75% and deposit 25%.)

So far so good but then you have to make monthly interest payments to the bank no matter whether you are using a repayment or interest only mortgage.

This means you don’t just pay back the £139,500 that you borrowed. Over a typical mortgage period of 25 years, you’d end up paying over £93K in interest.

Can you see where I’m going with this?

In actual fact you would end up paying £232K back to the bank. The £139.5K you borrowed and £93K interest. (Even interest only mortgages need the money paying back somewhere down the line).

Not to mention the fact when you bought the house you put down a £46,500 deposit so in total you paid £278.5K.

And we’ve not even talked about buying fees yet. These are typically 10% of the asking price ie £18.6K in this case.

So in fact you end up paying £297K for that £186K house!

If you ask somebody how much they paid for their house do you think they’ll give the first of those numbers or the second?

In my experience most people have absolutely no idea they paid so much for their house.

Often times people think they’ve made a killing in property when in actual fact they’ve lost money.

If we get the same growth that was had in the past then that £186K increases to £272K.

So in our example, your house is now worth £272K but you paid £297K for it.

After 15 years your house is worth less than you paid for it. Ouch!

How inflation impacts property investment

Inflation is the increase in price of goods and services over time. It is a nasty little critter that eats away at the value of money.

Now lots of property gurus will point to the fact that inflation can be a good thing when you borrow to buy a house. This is because a loan say fifteen years ago is worth less today than it was back then due to inflation.

Whilst there is some truth to that here’s another way of looking at the impact of inflation on property investment. Let me explain.

The price of goods and services has increased by 3.8% a year over the last 15 years.

Now, that’s according to official government figures, which as everybody knows, is lower than the real figure. But let’s give them the benefit of the doubt and work with that number.

What this means is you’d need a lot more money today to buy the same amount of stuff than you would have needed back in 2008.

The equivalent today of that £297K you spent on your property is £520K.

In other words you’d need £520K to buy the same stuff you could have bought in 2008 for £297K.

Ouch again! Because this means again that house has lost you a tonne of money in real terms.

But would you believe it gets worse?

And that’s because there’s a final concept that most people fail to grasp.

What’s the $ got to do with the price of fish?
investor in property vs fish

There’s a basic piece of economic reality that gets lost on many people.

THE WORLD IS DENOMINATED IN DOLLARS.

What’s the dollar got to do with me, you may ask?

I get paid in pounds. I spend pounds. I’ll always spend pounds etc etc etc.

The problem is even though you pay pounds for things, the companies you buy those things from need to pay dollars somewhere down the line to make them for you.

In fact over 80% of the things manufacturers need to produce the goods you buy are priced in dollars.

This means if the dollar strengthens against the pound, you need more pounds to buy the same amount of stuff.

Of course in the short term you could get the pound strengthening against the dollar too, but over the long term it only goes one way and unfortunately that’s down down down and down for the pound.

And here’s the key, when you are assessing investment returns you need to compare things in dollar terms because that’s what all the big investment assets like stocks and shares, bonds and commodities are priced in too.

Even UK companies do the bulk of their business in dollars. That’s why the FTSE100 always goes up when the £ weakens and vice versa.

So if we really want to evaluate how an investment has performed the best way to do it is to look at the price increase in dollar terms.

And unfortunately for the most part this can have an even worst impact than inflation.

Let me explain by going back in time again.

In 2008 one pound was worth 2 dollars.

But in 2023 one pound is worth 1.2 dollars.

Whilst its not halved in price, it’s pretty obvious that the pound has lost a lot of value.

In fact all we have to do now is convert pounds to dollars to see how bad an investment our house really was.

Double ouch! In dollar terms, that house has almost halved in value.

In reality, it’s been a terrible investment and we haven’t even mentioned fees yet because make no mistake every investor in property has fees to pay.

Insurance, tax, maintenance, letting agent, service charge, ground rent, licensing…… I could go on.

Fees are critical for anybody serious about property investment.

And when we take fees into account you’d have done even worse.

Sure, some property types in some areas will have done better than this, but at the same time others will have done far worse.

There are certain property types in certain areas that are nowhere near the prices they were 15 years ago.

A lot of people lost money buying new builds off-plan. Others lost money buying in the wrong area at the wrong time, and many more recently lost money due to government legislation changes.

Perhaps the biggest example of this in recent years was an update to improve apartment buildings’ fire safety following the Grenfell tower travesty.

Whilst I’m not arguing this wasn’t an important thing to do, that doesn’t mean it hasn’t made lots of apartments unsellable for the time being.

Sure in due course you’d expect those affected to recover and get back to average growth, but then again, as we’ve already seen, average growth isn’t all its cracked up to be.

And what if your property has been affected and you need money now? You probably have two options: go bankrupt or sell at a huge loss.

Is investing in property worth it?

Just to be clear. I’m not saying property isn’t a good investment for some people some of the time. I’m simply saying it isn’t as good as its cracked up to be for most people, most of the time.

The majority just blindly plough all their money into property without thinking about it, which in many cases could be a big mistake.

Particularly nowadays when there are such good alternatives out there.

The bottom line being, you have to ask yourself is it worth it for you?

Are you prepared to put the work in required to make property investment worth it?

The right property bought at the right time could make good investment returns. There will be work to do of course, but it could be worth it for somebody who understands what property investment really is.

How to stack the odds in your favour?

Professionals consider all kinds of factors before going though with a purchase.

These are just a few examples off the top of my head. I’m sure the better UK property investment companies out there will have a lot more things they look at than that to ensure they are buying a bargain that is going to give them the best returns available.

If you are familiar with ways in which to value property and you see a bargain, that could be the best use of your money.

But for most people that’s not going to be the case.

You have to ask yourself the following question:

Is the best way you can get a financial return through being an investor in property or would some alternative suit you better?

These days there’s a big elephant in the room for the would-be investor in property in the form of index funds and ETFs.

The best alternative to property investment

Essentially, anybody with an investment account can put together a strong investment portfolio with a couple of index tracking ETFs.

You don’t have to pick stocks or waste time trying to choose a super star fund manager. You just need a couple of broad based index funds or index tracking ETFs.

If you are interested, you can read more about that here, but the headline being anyone can put a really strong low cost globally diversified investment portfolio together these days in a couple of mouse clicks.

Yes, stock markets crash from time to time, but at the same time, so does the housing market.

They both crashed hard in 2008 but if you’d invested your £186K in a global index tracker in 2008 instead of buying an average priced UK property it would be worth roughly £730K today.

And don’t forget if you invest this way you can do it through a tax sheltered account such as an ISA meaning you could have enjoyed those gains tax free.

Even, without tax sheltering, it would have wiped the floor with our property investment example.

Sure there’s no guarantee of a repeat but one things for sure. If you invest this way, there’s practically no work to be done. You just set it and forget it and in all likelihood you’ll get better returns than you would have done by investing in property.

The day you became a better investor in property – the bottom line

Three key property investing principles often get lost in the wash.

  1. Mortgage interest
  2. Inflation
  3. The world is priced in dollars

The day you understand them is the day you become a better property investor.

Exit mobile version