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The concept of gearing remains the elusive secret of wealthy people worldwide. Forbes magazine published details that 90 per cent of America’s wealthiest people made their first money in property. Once anyone has money they can go off and make more in many ways but we all have to agree to that your first million is the greatest challenge.
Banks have always been willing to be the most generous, in terms of loaning money, when it comes to fixed property. There are fundamental reasons for this. Firstly, there is limited land on our earth. Secondly, when something is built on it, it promises a roof, which is an essential good. So the banks worldwide are willing to loan money to buy but does that automatically mean it as all good?
Well, returns on loaned money are more difficult to calculate than a lump sum with a fixed interest rate. This is a key deterrent.
A client of ours bought a unit once in Sandton for R220 000. A year and a half later, after having invested R15000 in costs and shortfalls, sold it for a R60 000 profit. I asked why he was selling and he said he had been offered 25% returns somewhere else. I asked him how he had calculated his returns to be less than that – because it is in fact way more. He pointed out that the R220 000 could have been better utilized. I mentioned that he didn’t come up with that money. He then asked me why I was questioning him as he had a high level of education. The point is that he attained growth off the R220 000 without coming up with R220 000. “That’s Magic” – and I do not need a higher education to understand it.
So, obviously working with debt and returns thereon is complicated enough to keep many away.
The next thing is that the press and bankers, who primarily drive the information flow, do not own investment properties. They understand property as security but not the returns associated to the asset class.
They all talk about comparing capital growth with inflation and shares. The problem with the inflation comparison is that they have firstly excluded rental returns and secondly, like our CA client, excluded the fact that the returns are very different when using the banks money. In terms of the shares comparison, again rentals are generally higher than dividends so it is intricate. I always say that both Trump and Buffet are pretty wealthy so there’s no need for an asset class debate. I personally choose property because the gearing assists me.
It must be said that there are risks attached to gearing. But, as all the experts concur, wealth creation involves risk management and not risk avoidance. So being prudent and being able to manage interest cycles is wise, but avoiding a carefully selected property portfolio may not be.
Wayne Lee
Sirius - The Future is Bright.
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