There is fundamentally no better investment instrument than property over the long term. I am not talking about the property in which you live right now, but property as an investment vehicle. When economists and financial advisers think property they only think capital growth and compare it with other financial instruments. And then they ignorantly come to the conclusion that other financial instruments might be better. (Or very conveniently for them, they do not recommend property as investment instrument, because they will not be able to earn any commission on the recommendation, in comparison to the other products they have in their arsenal).
But that is a tunnel vision way of looking at investment property and very irresponsible. Example: Today Ian Liddle, Allan Gray’s chief investment officer is reported on investment issues but nowhere property, as an asset class, features in his mind. You can read his article in IOL’s Personal Finance here.
Because property as an investment instrument, apart from capital growth, which is a given anyway, also has a rental income stream. Therefore it is just logical to consider both income streams. This is typically overlooked by most financial advisers, fund managers and economists.
One of the most exciting reasons why smart investors invest in property is because of the fact that the investor has the benefit of using borrowed money to build up his own equity. It is important to take into account the leverage of mortgage bonds. In following posts I shall discuss all the pro’s and con’s: I’ll discuss the risks (or rather the lack thereof), cash flow, the selection criteria for potential investments, rentals, and much more.
Today I want you to see the power of compounding with buy-to-let property.
Let us consider a very simple scenario for a person who would like to get the best possible return on investment (note that I am not giving exact numbers, this is just to show the concept of compounding. For a real life example see here):
A person has R2000 per month to invest. Let us escalate the investment with 5% p.a. and accept an average inflation of 8% p.a. for this example. For the purpose of this example we also accept that the Banks offer a 100% mortgage bond and the repayment is R4000 per month .
Investor purchases a property of R400,000. In Port Elizabeth that will give you at least a sizable 2 bedroomed flat with a rental of R3000 per month. The rental escalates by 10% p.a.
The scenario for the first year is as follows:
Monthly payment of bond: R4000
Rental income: R3000
Rates, levies, maintenance <R1000
The investment is therefore the shortfall and the rates, levies and maintenance. Now next year the rental increases with 10% to R3,300 and the increases of the levies, etc will be paid by the 5% escalation on the investment.
You can do the calculation yourself (or check a real example here) – but the flat of R400,000 will cost you less than R60,000 to purchase!
After a period of 4 to 5 years, the shortfall will now turn into profits. Invest all profits back into the bond account. The result is that instead of 20 years, the bond will be fully paid off within a period of approximately 10 years. So now you purchase another property, use the strategy explained for the first property, but also invest all the profits of the first property into the second as well. The second property will be paid off within 7 years. If you carry on doing this, within a period of 40 years you will have a portfolio of at least 15 entry level residential properties, fully paid off.
Fifteen fully paid properties will give you a lifestyle “pension” that is going to be more than 10 times what you would have received at that time if you invested your R2000 (escalated by 5% p.a.) in a retirement annuity. Also bear in mind that when you die the pension stops, while the properties will still be supplying a magnificent income to your children or other beneficiaries ad infinitum. We’ll look at an example in more detail later.
If you live in the Port Elizabeth area, note that I do free presentations on a regular basis to show you how the P3-concept can help you to achieve your dreams. Call me on 082 3070 867 for more information.