Why is the property market sometimes seen as a good investment?

In the right set of circumstances an intelligent investment in property can lead to the generation of substantial returns. Below is a list of the factors which have made property investment seem so compelling.

1. Investment in an Appreciating Asset
Over the long term property prices tend to rise due to the finite availability of land. A range of constraining factors such as an increasing global population, a shortage of sites available for development, and even rising sea levels will continue to force up the value of existing land and property.

What’s more, these returns can be boosted by improving the timing of your investments. If you invested in an average property at the average price in 1994, near the bottom of the market following the last house price crash, your returns over the next 10 years would have been far higher than the long term average.

The value of £1 invested from 1994 to 2004 is £2.79 with an equivalent annual rate of 10.8%.

2. The Ability to Leverage
If the average person walked up to their bank manager, explained that he had £5,000 to invest in the stock market and asked if the bank could lend him a further £95,000 to boost his profits, the bank manager would either have a heart attack or burst out laughing. And yet if that same person walked up to that same bank manager and asked to borrow £95,000 as a mortgage to invest in a £100,000 property he would be given preferential treatment. This ability to leverage is one of the most compelling reasons to invest in property – the ability to utilise your available capital and earn a return far in excess of the return possible by investing that capital alone.

3. The Combination of Appreciating Assets and Leverage
We have seen that property is an appreciating asset which tends to rise in value over the long-term. As time passes however, the size of the debt stays exactly the same or reduces as you pay it down. This has the effect of generating wealth for the owner.

4. Buy-to-Let

The Amount You Borrow is Not Constrained to the Size of Your Salary
Your ability to borrow and fund a buy-to-let property is determined by the rent achievable on that property, not by the size of your salary. This means that the opportunity to invest is open to almost anyone who is able to put forward the 15% deposit required in order to take out a buy-to-let mortgage. Most buy-to-let mortgage providers also require that the rent received is 130% of the size of the mortgage payment.

Mortgage Payments are Covered by Rental Incomee
When you purchase an investment property, the likelihood is that you will want to rent it out to a paying tenant. This income can be used to offset the costs of running the property and the mortgage payments. In effect the property is purchased using its own cash flow, it pays for itself. Therefore, any gain in the value of the property is a free gain.

The increases in value can be extracted as tax-efficient cash lump sums as described below. Alternatively, once the loan is paid off, income jumps as there are no longer any mortgage payments. This income could be used as a replacement for the income you currently receive from your job, or as a pension income later in life. Rental income also tends to be inflation-proof as it increases in line with peoples’ earnings.

5. Tax-Free Release of Cash from your Investment
Often, you will build wealth more quickly if you hold your investments and do not sell. Selling triggers a capital gain which is taxable and usually results in you paying a significant portion of your profit and thus wealth to the Inland Revenue..

There is, however, an alternative tax-free way to release any increase in value of your property. By re-mortgaging your property you receive a tax free lump sum which can be retained as cash or reinvested. And because you pay no tax, your current wealth and future wealth building power are not eroded. For example, if you buy a property for £100,000 and it rises to £120,000 over the next few years, rather than sell and incur a capital gain, the owner can re-mortgage, releasing some or all of the £20,000 uplift in value tax-free.

Of course, the size of the mortgage will increase and so will the size of the mortgage payments, but as long as these increases are covered by rents received from tenants, there is minimal impact on the owner's finances. The owner will also continue to benefit from any further rises in the value of your property.

6. Gearing
By re-mortgaging your existing property and releasing capital it is possible to reinvest this capital and build a large portfolio of properties using only a small initial stake. In the above example, lets assume the £100,000 property was bought with a 10% deposit of £10,000. Lets also assume that after 5 years the property increased in value to £120,000. The owner could choose to re-mortgage the property, release the £20,000 uplift and buy two more properties with the proceeds (lets say another two £100,000 properties with a deposit of £10,000 each)..

At this point the owner has still only invested his original £10,000 but has built a portfolio of 3 properties worth £320,000. Using this approach it is therefore possible to keep expanding your portfolio by extracting any further increases in value, leading to a theoretically huge holding of property, all funded by the original £10,000 investment. The more properties you add to your portfolio the bigger your gains are likely to be, but also the greater the risks and potential for losses.