If you’ve ever discussed financial investments with friends of colleagues, I am willing to bet that the topic of how to invest in property entered that conversation.
In our article how to build a basic investment portfolio, my illustrative portfolios never contain more than 20% property. Even for adventurous investors.
What explains this apparent discrepancy? Why is property investment so popular despite its silver medal in my portfolio allocation series? Read on to find out.
Why is property investment popular?
1. Property is aspirational
First of all, let’s address the fact that property ownership is a deeply embedded aspiration in most cultures. It doesn’t matter whether you’re in England or India, the prevailing wisdom is that ownership of real estate is a good thing.
This might originate from our histories. The original landowners were the elite social classes. To own your own property today is still a big milestone. It’s a status symbol that proves that you have successfully navigated the hurdle of unaffordability.
This makes property investment popular because it bestows a unique allure to the asset class which other financial investments cannot compete with.
What is a share? It’s ultimately just a legal contract. What is property? It’s something that you can see and touch, it’s a little slice of the country which is yours.
2. Property investment is a simple concept
But it’s not like investing in the stock market is a simple game either.
Heck, I even went ahead and built some free investing courses to try to help empower more people to make better investment choices.
A key issue is that investing in shares brings with it a lot of new terminology and concepts. These aren’t taught in school and aren’t exactly dinnertime conversation.
In contrast, property investment is a frequent topic of conversation.
The fact that you need to buy a house for yourself, means that most people considering property investment haven’t actually already done it once before.
And even before we buy a house, we typically rent somewhere for a few years beforehand. This means we’re already very familiar with the landlord/agent/tenant dynamic and understand how those relationships work.
Property investment is popular because it’s a process that we happen to have experienced from multiple angles before we reach the age where it becomes an option.
Folks who don’t have the time or interest to study up on stocks and shares may already feel that they know enough about property to give it a go.
3. The last two decades have seen abnormal returns
Property has had a great run in recent years.
In the article ‘Is property a safe investment?‘ I point out that many investors have been lulled into a false sense of security by the consistent price increases during the 2000’s and 2010’s.
House price increases aren’t as certain as they feel. In fact, over the last century, they’ve significantly lagged behind the stock market.
You wouldn’t get that impression from asking any home-owner about their experiences, because the recent golden era has (likely) made them quite rich.
Property is popular because it’s hot right now. Or more specifically, it has the right place to be in recent times, therefore people assume that these good times will continue.
4. Property investments are profitable to create and sell to investors
If you look for ‘investment seminars’ online or scan a shelf of investing books, you may notice that property content is over-represented.
By that, I mean that property content is being created in higher volumes than books about bonds or shares. Why is that?
Well, partly it’s the herd effect. Authors look to sell copies, and course providers want to fill seats, so it makes sense to cater for the hottest arena. It’s easier to sell a product that people already think they need, than to try an explain why they should pay interest in something else.
But another explanation is that there’s far more legitimate money to be made off the back of a small batch of property investors than equity investors.
When you choose a stock-broker, you will notice that the market is very competitive. It’s easy to reduce or eliminate your investing costs by shopping around and picking a platform that keeps costs low and minimises ‘middleman’ human labour. This encourages investors to ‘invest direct’ and update their portfolio themselves.
This is not the case with property. Property investments are difficult to scale up in the same way as equities. It only costs a few more pounds to place a £100m share trade compared to a £100,000 share trade.
What about the cost of investing £100m in residential housing versus £100k?
Any collective investment scheme that invests in residential housing will need to negotiate and buy each house individually. It will require surveyors, lawyers and difficult negotiations for every £300,000 home snapped up. There’s limited scope for efficiency because each transaction is very separate.
In such an environment, there is no ‘efficient’ platform which allows investors to transact swiftly. Instead, you see hundreds and hundreds of ‘property investment schemes’ which focus on a few properties and sell themselves to a small number of investors.
In such schemes, regulations are lower, transparency is lower, and of course, fees are higher.
This incentivises financial salespeople to market these schemes in an aggressive way. As a population, we are exposed to these marketing efforts and begin to connect property with the lottery-win style success stories we read about in the hyperbole sales material.
5. Leverage produces ‘get-rich-quick’ stories
These stories aren’t necessarily fabricated. It’s true that people have been able to turn small amounts of capital into significant real estate empires over time. But what the marketing materials don’t always articulate upfront is the secret ingredient: leverage.
Leverage is the borrowed money an investor uses to purchase a property. With leverage, an investor can control a far large portfolio of property than if they bought each property in cash.
For many investors, leverage is the only way they can afford a single investment property of their own.
Leverage is like pouring rocket fuel on your returns. It will exaggerate gains, but as I explain in my article, it will also amplify losses. I illustrated how a 16% reduction in property values (as seen in 2008) could wipe out 60% of a leveraged investor’s equity.
There’s no clear benefit to leverage. It isn’t a magic solution. When you think about the return as something you get for each unit of risk, leverage doesn’t change that figure. You are simply turning up the risk and expecting to receive a higher return as a result.
As long as you understand that relationship, leverage is an honest tool at an investors disposal. But if you also harbour the opinion that leveraged property is a safe investment, then I suggest that you take a step back and reflect upon the sheer conflict between those two positions.
So, why is property investment so popular? In short; It’s understandable, we’ve heard great things about property investment, we’ve seen great results, and it appeals to a desire to own something tangible.