The Easiest Property Investing Strategy

Oct 2021

 

 

“Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.”

–Franklin D. Roosevelt

“Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. That’s where the wise young man or wage earner of today invests his money.”

Andrew Carnegie

 

Real estate is supposed to be a safe asset class. There are always more people in the world and those people all need to live somewhere and usually they would like to live in a nice home. It’s one of those fundamental human wants. Everyone wants to live somewhere nicer.

Investing in real estate is about as simple as it gets. You work and save as much money as you can until you have saved 10% – 20% of the price of a house. Then you borrow the other 80% – 90% from a bank or lender to buy it. Then the property has tenants which pay rent to live there which services your loans and hopefully pays it off.

Over time you pay interest to the bank on your loan while the rent earned slowly pays off the debt on the property. Over a long time frame like 30+ years of rent earned, the property will usually be fully owned and all debt paid off. Once the loan is paid off, the rent is your cashflow. Or you sell it, then whatever the growth is of the property value plus the rents earned minus the ownership and interest costs is how much money you made.

I like real estate because houses are so expensive that it concentrates the number of decisions that you can make. Regular people can’t afford to buy a lot of homes, you may only be able to afford a handful in your entire lifetime, even if you have a solid income. So it limits the number of possibilities and decisions you need to make to become successful.

There’s a great quote by Warren Buffet of Berkshire Hathaway, “I could make anyone a good investor. I would give them a ticket with only 20 slots in it so that you had 20 punches–representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”

Property naturally does this. In the stock market you could buy and sell a new stock every week, but you just can’t do that in real estate. Plus in Australia, returns from real estate have outpaced returns from the stock market. If you invested the same amount in property as shares, you ended up with a lot more if you chose property.

The reason is because of leverage. When you make a 10% payment and buy an asset with 90% borrowed money and that asset goes up by 10%. You haven’t made a 10% return, you’ve made a 100% return and doubled your money. That is the compounding power of leverage. If the property goes up 100%, then your return is 1000% and so on and so on.

Very few people use leverage to buy stocks, in fact it is not recommended to do this as fluctuations in stock price can widely influence returns and seemingly strong companies go bankrupt all the time. Plus margin calls exist where if the stock price ever dips below a certain point, which happens to stocks quite regularaly before rebounding, the lender automatically sells it all. But in property buying with leverage is the normal way that most people purchase. The system of banks lending money to people to buy a home is very normal.

In Australia the average growth rate of real estate is approximately 6% per year. If you purchased a property with a 10% down payment and 90% borrowed money, then while your gross returns are 6% per year, your cash on cash returns are something closer to 60% per year. That’s why Australia has such a wealthy middle class. By doing nothing but buying a house the average Australian has achieved a compound annual return on their capital better than the best investors in the world.

What drives property values? That is a super interesting question with a simple answer. Usually I don’t like using macroeconomics to try and think about investment decisions, but in real estate, values almost entirely rely on the macroeconomics of an area. All of real estate comes down to Supply and Demand.

If the population is growing faster than new houses are being built, then property values will increase. If population starts to leave an area and there are more houses than people, then property values decrease. And Australia’s population is basically always growing because it’s a desirable place to live. It doubles every 50 years.

Because houses take longer to build than it takes a person to move to an area, housing is always lagging population. Simplistically, a house might take 2 years to build and will be occupied by a family of 4 people. But a lot more than that might move to or leave an area in the same amount of time, competing up or down prices.

Why don’t governments just let developers build to increase the supply of houses to reduce prices? Isn’t affordable housing a public good and thereby a good motivation to do so?

Well if you ask developers, they say it’s because local Councils won’t approve their projects fast enough and put too many restrictions which add costs and take too much time. If you ask councils, they say it’s because of residents complaining too much about projects. There’s even an acronym for this, NIMBY’s which mean Not In My Backyard’s, a stereotype for conscientious objectors. Residents who complain about developments. If you ask residents, they blame the developers who they say aren’t making quality housing.

It’s a vicious cycle where the developers blame council who blame residents who blame developers. So unlikely supply will significantly increase anytime soon. Which means that population growth is pretty likely to always be higher than housing and there will be a supply shortfall.

How much can you afford to spend? Well there’s a simple rule for that. You take your total household income per month. Then you divide by 3. Your monthly interest payments shouldn’t be more than that. Multiplying that number by 12 and dividing that number by whatever the interest rate is gives you the maximum you can afford to spend buying a property. Ideally most of that will be taken care of by the income from the property. But going above this 1/3 rule is how people end up going into more debt than they can handle.

That’s it. That’s all there is to know. The rest is just timing and choosing the right property. Some properties perform better than others and changes depending on the demographics of the area. So you can’t really talk about that at a high level. Timing on the other hand, you can.

Australian property goes in cycles that generally last about 7 – 10 years. It means every 7 – 10 years there is a boom, a correction and a crash. And you know when you’re in either because front page news will usually be talking about it. But it means that you always know what stage of the cycle you are in.

Most of the reasons for the downturn and crashes are psychological, political or financial, not strictly economical. Often they’re due to the levels of optimism and confidence people have in the market or country.

In 2019 there was a property downturn where values decreased almost 10%-20% because the opposition Labor government had a policy to remove the negative gearing tax write off. They didn’t win that election and the policy was never introduced. So the downturn largely happened for no reason, just because people were afraid of something that never occurred.

In 2011 property values similarly decreased by 10%-20% when Responsible Lending laws were introduced that increased the checks and requirements banks had to have to lend money to people. This was intended to reduce loans to people who may potentially be at risk or had low incomes but had a side effect where it significantly reduced most people’s borrowing bower. Borrowing less or not at all meant that less people, particularly first home buyers, were able to buy a house – reducing demand.

So what is the easiest strategy and how do you successfully do this?

Save money, everytime you find yourself in a downturn, try your best to buy a property. Hold onto it for 7-10 years till the next cycle and use the rent to pay down the loans and build up equity. Then when there is the next downturn, use the equity to buy another one. And so on and so on and keep doing this over the course of your life.

After a lifetime of 50 years you’ll have built up multiple properties and have a portfolio worth a fortune. You will have achieved a rate of return enviable by the greatest investors in the world. A path to earn millions of dollars by only making a few decisions over a lifetime. Time in the market is better than timing the market but sometimes you can do both.