The Role of Property in Long Term Financial Planning
Often we may start by buying a home to live in; it makes more sense to pay our own mortgage rather than rent a place and pay the landlord’s mortgage. ‘Getting on the rungs of the property ladder’ is common priority for many young couples. However with rising job mobility and larger sums needed for initial deposits, many people are rightly delaying a property purchase for a few years, rather than taking on financial obligations that would affect flexibility in the growth stages of a career.
Property is an important asset class that should form part of our long term savings & investment strategy. However, matters such as home ownership are a personal and sometimes emotive subject. I make a point never to underestimate the sentimental factors that come to bear when I work with clients in this area. People often make financial decisions with an emotional bias, and this is seen nowhere more profoundly than with property.
Your home in retirement
In the long run, most of us should plan to own at least one property - simply because, sooner or later, we’ll need somewhere to live in retirement.
The place you own now doesn’t specifically need to be the home you will live in later on. But if it is in the right location then your property asset value is pegged to what you are likely to need in future, when it comes time to sell that asset to buy your ultimate retirement home in the same region.
Once you own your first property, then the choice of whether to invest further in property should be considered principally as an investment decision. This means weighing up property against other investment options, in the context of your longer term objectives, your need for future access to cash, and your portfolio of other assets.
Property requires a long view
Property markets tend to be erratic. There may be large swings in house prices from year to year or decade to decade, with surges followed by dips followed by long periods of stagnation. Because of this, it can be risky to rely on property as an investment if there is a chance you will need suddenly need to liquidate.
But perversely, this potential issue for property investors - risk of poor liquidity - is in some respects actually a benefit. Property investment forces us to take a long term view. It keeps us detached from the wild swings and uncertainty in stock-markets. In fact for many, owning property brings a psychological comfort.
Property leveraging amplifies your investible resources
Property is one of the very few investments where leveraging makes sense for the private investor, and is supported by the real value of the asset. If you have a long term view, a mortgage loaned against property can be a very effective (and potentially low-risk) way of amplifying your investment, and even releasing cash flow for other purposes.
For example, suppose you can comfortably afford your monthly loan repayments, you have surplus cash-flow each month, and are thinking of paying down your mortgage early. How do you decide? Logic says it should depend on the interest rate you are paying to the bank. If your rate is low and you believe will stay low for reasonable period ahead, then your mortgage represents ‘cheap’ money. In this case you will look for other investment options that would offer a return higher than your mortgage rate. For instance, if your mortgage rate was 3%, then investment options safely yielding 4%+ would be preferred.
Of course, the above logic does not account for the emotional ‘feel good factor’ we might gain by paying down a mortgage early, and knowing that you are on the way to owning your home outright. This strategy suits many, as long as it’s done with the knowledge that it has a cost - the difference between the mortgage rate and other options for putting our money to work.
Taking a professional approach to property investment
For second homes and investment properties, emotions should definitely take a back seat to logic. It’s crucial to invest with a ‘professional’ methodology. If that apartment you’re buying will never be your home, then the selection criteria should be strictly held to. Emotion has no role to play here.
Just like any other area of economic activity, professional property investors - the guys who do this for a living - will have better information, more knowledge and experience, and make better decisions than we do. They will also have access to better opportunities than we do as ordinary retail purchasers.
Property investment (rather than home-ownership) is a business and we should approach it as one. That means managing costs. Getting the best deal on a mortgage. Understanding the market, the population demographics, the up-and-coming areas, the new transport networks, and the demand for certain types of accommodation. We must also manage the letting process, and know what rental yields are possible and how to maximise them.
If you are considering property investment, it is generally worthwhile to spend some time consulting property specialists.
A note about currency effects
Currency factors are a consideration when purchasing property in a country that’s not where you live and work right now. If you are making mortgage payments in a different currency to your salary, then exchange rate fluctuations can have an effect on your monthly cash-flow. It’s sound planning to leave a safety buffer in your monthly budget. Of course, buying property overseas is also an excellent way to lock in beneficial exchange rates for the long term.