There are many different types of investment vehicles that one can use for their spare cash, and all offer a different scale of
risk. Generally speaking the higher the risk to the capital investment the potentially higher returns that can be made. In broad
terms on a scale of 1 to 10, with one being the safest for the capital investment, the most common investment vehicles fall into the
scale as such: Cash deposit = 1 – 2; Gilts = 2 – 3; Property = 3 – 5; Managed Funds = 4 – 6; Unit Trusts = 6 – 8; Stocks = 7 – 10. A
balanced portfolio would include an element of all these different vehicles and the range of risk is largely dependent on where the
vehicle invests the money. For experienced and newer investors it is generally agreed that a good portfolio would hold an element
of cash deposits, property and some stock. The stock element may be purchased via a managed fund or unit trust to offset the lack
of experience. However, the property portion of a portfolio is an area where the learning curve is easier for a newer investor and
the returns are, over time, somewhat better than cash deposit whilst protecting the main investment with a solid asset.
The Family Home as an investment
For most people the only property they will ever buy is their main home. The UK is somewhat unique within Europe as it has a
property market that is traded almost like a stock market. For most countries within Europe the value of properties does not rise
and fall quite like it does in the UK. The main reason for this is ability to gain mortgages in a variety of formats on all manner
of properties, in particular Lease Hold apartments. This concept is alien to most European countries as the reality is one is
borrowing money to pay all their rent up front for the next 99 years. The consequence of this change in lending from the late 60s
and early 70s is that most people are acutely aware of the value of their family home and any gain or loss they have made on it.
As an investment the family home is a poor vehicle for gaining growth as it is more inconvenient to dispose of than an investment
property as it is the one you reside in. In the UK we have become conditioned into believing that while we work we keep increasing
the size and mortgage of our home so that when we retire we can trade down and have the excess cash. In reality very few people
achieve this scenario out of choice and most retirees are trading down out of necessity. When we reach retirement the family home
is still that – a family home, with memories and emotions that are not necessarily easily discarded. The wise advice is that the
property you want to live in should be bought as a home first and foremost, thus the growth/loss in value become less relevant.
Real Investment Property
Buying a property as an investment has two facets to it: the potential for capital growth and the income stream. An investment
property should be purchased with these two in mind and with a view of maximising the potential of these two facets.
Capital Growth
Since the mid nineties the UK has seen some incredible growth in the value of property.
This has largely come about from two factors: demand and low interest rates. There has been a large demand for property that has
been greater than the supply and with low interest rates individuals can afford to borrow more. Consequently many people that had
never invested in property decided to release equity from their home and invest in rental properties. As the desire and demand
increased more and more went this route with a view to making their money purely from the capital growth of the flat or house,
negating the need for the rent to service the loan and generate income. This is a strategy that can work as long as one is
confident of being able to sell the property if they feel the growth is slowing. However, property is not so easily disposed of,
and if the market growth is slowing then the probability is that the demand is slowing as well. The other main consideration here
is that if the market takes a fall, one now has negative growth (a loss) on the capital and if the rent cannot service the loan the
investment property is now a debt rather than just a lost investment.
Income Generation
The most important factor, in our opinion, of buying an investment property is to focus on the income generation of the flat or
house. In a nutshell if the net income generated represents an excellent percentage return on the actual capital investment then
the property is a worthwhile purchase and its capital growth is irrelevant. (Look at the ROI page for calculating income
generation.)
Summary
A property for investment is highly recommended as long as it fits certain criteria and is done as a long term investment. If you
acquire a portfolio of rentals why consider cashing in the assets at some time in the future as this releases cash that needs to be
invested elsewhere to generate income. Freedom from work to retire, at any age, is achieved with unearned income. Properties
provide for an excellent vehicle to provide an ongoing income with management easily outsourced.
