Residential Property as an Investment

By webadmin on 12:15 pm Jul 31, 2012
Category Archive

A Sense for Money

Traditionally, a residential property has been viewed as somewhere to live more than an investment. In fact, it is all too easy to underestimate the huge impact that residential property can have on your finances and wealth. Some hypothetical scenarios will illustrate that house owners are continuously making investment decisions – perhaps without even realizing.

Imagine the case of a consumer earning a salary of $70,000 per annum, owns a house worth $400,000, and has a mortgage of $300,000. For the purposes of this example, assume the residence is this person’s only significant asset, so our consumer’s net worth is $100,000.

In a rising market the huge attraction of a residence as an investment is the leverage or gearing that you get from the mortgage loan. Imagine that property prices jump by 50 percent. Then in our example, the house increases in value to $600,000 but the mortgage stands still.

Our consumer’s net wealth rockets to $300,000, a threefold increase. He has got almost three years’ salary, overnight, and probably tax free. Such is the power of gearing. Many traditionalists do not like the idea of borrowing to buy a house – the old adage “neither a borrower nor a lender be!”. But our scenario illustrates the dangers of this conservatism. If you want to save 100 percent of the value of a house before you buy, you may never get there. How long would it take you to save three year’s salary, given all your other commitments (including rent)?  

Of course gearing works the opposite way around in a declining market. If the value of the property had declined by 50 percent, then our punter would be in negative equity territory with a house worth $200,000 and a mortgage still at $300,000. Net worth of minus $100,000 and a very uncomfortable situation. 

Interestingly there have been some cases reported recently of people who have “made money” by playing the property market in the US. These people have chosen to sell their property and rent for a while. So in our declining market scenario above, if our investor sold at $400,000 and bought back after the crash, he would have his $100,000 net worth in cash and would have avoided the loss of US$200,000.

He could claim to have “made” $200,000 by avoiding the loss. The disaster scenario for our investor would be if he had misread things and the market had risen by 50 percent rather than crashing. He would still have cash in hand of $100,000, but his old house would now cost $600,000.  Banks may not be willing to lend him the $500,000 he would need to get back his house so he may well lose his spot on the housing ladder.

So these examples illustrate the comment made at the start of this article – house owners are continuously making investment decisions. Every day, you are making a decision: whether to buy, sell or hold your property. If you own a house and do nothing, you are making a hold decision, since you could have chosen to sell your house and rent an apartment for a while. In this sense, property investment is no different from equities or bonds, and is often more complex because of the gearing and the illiquid market in properties.

The point is that you need to think carefully about your personal situation: how will I be placed if house prices rocket or crash? How will I be placed if interest rates rise on the mortgage? How will I be placed if I lose my job or if the house is damaged by a flood?

Now the above examples are fictitious, and your personal situation will inevitably be different. Your income, salary and house value will be unique to you. But the principles hold good. You can make or lose a fortune by selling, buying, trading up or trading down at the wrong time, or in the wrong location. In fact things can go even more awry. Asia is prone to natural disasters, whether earthquakes, floods, tsunamis or typhoons.

There have been reports of people who have sunk their life savings into the deposit of dream property, taken out a big mortgage and then lost everything to a natural disaster. Banks don’t waive a mortgage if your home is destroyed by an earthquake so do make sure you get full cover for all natural perils. Sadly, some lenders do not insist upon such full coverage. In the example above, our unfortunate consumer would end up with no home and a debt to the bank of $300,000.

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