Is Property Investment Suicide: Part 2

“Time is the friend of the wonderful company, the enemy of the mediocre.

– Warren Buffet

I recently had a conversation with a friend about their investment property. It was the usual exchange up until we started talking about capital gains.

“Jim just used his $200k property gain to buy himself a new boat!” I heard him exclaim. The guy had several properties – and several mortgages.

I was in two minds, I couldn’t deny that $200k was a huge gain but I also could shake that something smelled fishy. I crossed my legs.

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I started wondering “Hold on. Was it actually a gain? How long and how much money did he spend on the house before he sold it?” Why does this even matter? Money is money right? Let me illustrate why knowing how much money you actually gained is important.

The Property Guru

Lets look more closely at Jim.

Jim is an equity property investor and has 4 properties; A1, B3, C4, D5. For the purposes of this example we will focus on the sale of D5.

Here are the facts and calculations that I did in the background:

  • Jim has just sold D5 for $650,000 which is was worth $450,000 5 yrs ago and has a mortgage at 6% fixed.
  • Jim has tenants helping him pay his mortgage
  • Based on the above, the current value of Jim’s mortgage at the end of Y5 was $460,060 (Interest + Principal Contributions + remaining mortgage balance at Y5)
  • Commissions and other cost to sell were $25,000 (Based on B&T and this article)
  • Let’s assume renovations were required (because you generally won’t get something for nothing. Yes even for property) at a cost of $132,000 (60 sqm at $2200 based on Westpac)

I’ll save you the arithmetic, the gain after interest and fees is $32,940.

So what happened to this $200k gain? Most likely a product of the law of least effort (its easier to deduct $650k from $450k then do the arithmetic above or to keep track of several properties and their respective mortgages). If Jim did buy a boat for 200k it would have been at the detriment of his other investments.

Womp Womp, bad investment decision. 

But is Jim’s situation typical? In a “hot market” you may get away with a quick sell at a marginally higher price, which is what you’re hearing about in the news (as rampant speculators quickly start bidding up prices) however, in most cases you will need to do some sort of improvements/maintenance; especially if you have tenants.

More time passes = more improvements/ maintenance work = higher cash outlay required before sale. For property, time is a double edge sword.

The Property Market

Let’s compare alternative investment vehicles with the average returns of the property market in Auckland as per Barfoot and Thompson.

Why? Because you want to.

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2012 2013 2014 2015 2016 2017
Jan $470,000 $526,888 $580,000 $700,000 $760,000 $846,500
Feb $464,000 $525,750 $620,000 $685,000 $738,000 $820,000
Mar $500,000 $575,000 $652,000 $711,000 $798,000 $900,000
Apr $491,250 $566,000 $619,550 $753,500 $820,000
May $504,000 $570,000 $645,000 $750,000 $809,500
Jun $528,900 $590,000 $626,500 $786,000 $839,500
Jul $518,500 $585,000 $645,000 $757,000 $840,000
Aug $505,500 $561,500 $630,000 $755,000 $850,000
Sep $525,000 $599,000 $635,000 $790,000 $850,000
Oct $545,000 $590,000 $655,000 $780,000 $865,000
Nov $560,000 $621,400 $691,500 $795,000 $850,000
Dec $550,500 $629,000 $720,000 $800,000 $840,000
Yearly Average $513,554 $578,295 $643,296 $755,208 $821,667 $855,500
% change 13% 11% 17% 9% 4%

As you can see housing growth rate has decreased since its 2014 peak. Let’s assume the 5 year average is a good indicator 11%. As you’ve learned above this 11% is gross, meaning, that any interest effects, commissions, renovations, legal fees and other fees (like tax on capital gains) haven’t been taken out of this figure.

I’m going assume that none of these costs exist for our comparison because I’m too lazy to mock up example figures and I want to give property the benefit of doubt. Please note that the costs I am ignoring are VERY substantial and should ALWAYS be taken into account when making investment decisions unless you want to end up like Jim.

So let’s look for investment alternatives in a place where all kiwis should be familiar, the Kiwisaver.

The following funds currently outperform the property 5 year average:

  1. The OneAnswer Australasian Share Fund; 13.68%
  2. The OneAnswer Australasian Property Fund; 15.76%
  3. Milford Active Growth Fund; 13.84%
  4. Milford Wholesale Fund; 13.68%
  5. My personal P2P lending account; 18.39%

These are gross figures to make them comparable. If we were to take just last years property growth figure (4%) and compare that against the Kiwi Saver results we can see that almost every single Kiwi Saver fund (irrespective of risk preference) outperformed last years property growth.

Obviously future gains are not indicative of past results but it does show that there are other (easier) options out there that give you the same if not better results.

If property growth continues to slow is it wise to continue to hold your property or put more money into other investment options? Only you can make that call.

The Take Aways:

  1. Don’t believe the media hype about property. As you can see from the March results the average cases are nothing special and with a declining growth rate it will be interesting to see if the hype continues.
  2. Get the full picture – Make sure you understand how much money your investments are making less the costs.
  3. Property is not always the best choice or the easiest to manage.
  4. Make your money work for you not the other way around.

That’s it for now. If you have any questions about anything let me know in the comments below.

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2 thoughts on “Is Property Investment Suicide: Part 2

Add yours

  1. I agree that owning a property is not for everyone. There are additional costs that come with owning a home, renting can be a better option for people who want flexibility in their lifestyles. However, return on a home investment depends on a lot of things. It depends on how tight the housing inventory is, what the going interest rates are, how high the rent is, and change in local demographics. For example, in Boston, housing inventory is at historical low and Libor rate is at all time high from the last 8 years. This makes it a seller’s market with a lot of buyers looking to buy before rate rises. If you bought a house two years ago for $350K, let’s say you invested $80K for maintenance and improvements, which brought your cost to $430K. Your house now can be sold in a tight market with a lot of demand for $700K (#s based on my own neighborhood). If you rented out your property, because there’s no rent control in Boston, your monthly income can be as high as $4000, not only do you cover mortgage expense, save tax from your mortgage interest deductions, you have positive cash flow every month. Your return on cash (original down pay of 20% on a $350K=70K almost quadrupled) Last time I checked, my index fund has not tripled in two years. This doesn’t include the monthly positive cash flow and tax saving you get. If you rent out half of you property and live in the other half of your property, you also save on rent and your ROE is even higher! That makes real estate a very attractive investment.
    The same thing for housing market in Toronto. Young people are starting families and are moving into the suburbs, this drove up single family house demand. If you bought a house 10 years ago in Toronto, you could afford to “move-up” and buy a bigger house. If you didn’t, you missed out all that lucrative equity you could accumulate with bank’s money! Getting a house is an major investment decision and there are risks involved, but my favorite part about owning a house is the use of leverage. I assume you will be investing with your own after tax money in index funds in your example, but with a house, you are leveraging your future income by building equity with bank’s money. You can certainly do that with a index fund borrowing on margin, but your interest rate is a lot higher and stock markets are more volatile.
    Bottom line, it all comes down to your risk appetite and life style choice. I’m not saying housing investment is less risky than index fund, but in the long term, houses always outperformed. Just think about your property in Toronto and how much it’s worth now. Then ask yourself, as an average investor, can you take your down pay 10 years ago and grow it to a million dollar portfolio in stock market?

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  2. Thanks for the comment! All good points. I agree real estate can be a good investment. I think the main thing we need to keep in mind is the timing of an investment. If you had invested during the height of the subprime debacle in ’08 you would have definitely lost money let alone outperform any fund therefore I don’t think its not fair to say that property always outperforms.

    Looking longer term however, yes property has done quite well, however, we must ask ourselves could we have done better? I took the liberty of checking up on some Boston Housing figures (I would have done Toronto but I was already on the Boston data). For a single family home from Dec-07 to Dec-17 (10y) the median selling price change has only been ~22% (450k-547k respectively) Source: (gbreb.com). Dividing that by years to find your annual return gives us 2.2% p.a. I also find it hard to believe houses doubling in price in only 2 years based on the data above. There are pockets of success stories all over the media which distort our perception of realty – we must be vigilant.

    Now on to rent and your particular example: I like to use averages and medians (within reason) because statistically we should expect a regression to the mean or average (which becomes more probable). With that said a 2 bdrm rental was ~$3000/mth (https://www.rentjungle.com/average-rent-in-boston-rent-trends/) and I’m going to use the Dec-14 (2 years past) median sales price for a single family house which was $519k and what it could be worth now: $547k (Dec-16 – Both from GBREB.com). $28k gain in 2 years.

    For a 20 year mortgage you’re looking at a repayment of ~$2740/mth. If you rented out your entire house you’d be making ~$260 a month – this makes sense since its not a renters market in Boston. I’m going to leave out tax but I will acknowledge that this benefit exists.

    Lastly, for any comparison you need to include all cash outlays that could have been used in each distinct scenario. For example, the down payment is only one cash component. There are still the mortgage payments you make to the bank. This is your cost base. Think opportunity cost. Any return you make, i.e. rent or gain on sale must be treated as a return in the calculation. For this example, I calculated $175k as the cost base (mortgage pay * 2 yrs + down) – assuming a 20 yr mortgage – and my rental income and sale gain as return (numerator).

    Conclusion: If we were to put this into securities trading terms; you have a dividend yield of ~2% and if you sold after 2 years a total gain of 18% in ’17 but an annualised gain of ~10%. Surprisingly similar to my Auckland example and quite comparable to balanced portfolios. Let me know if there are any questions.

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