The single most important rule for buying investment real estate
If you want to be successful in real estate investing, you absolutely must get one thing right. I have invested in all types of real estate over some 40 years: and> READ MORE
If you want to be successful in real estate investing, you absolutely must get one thing right. I have invested in all types of real estate over some 40 years: and> READ MORE
In economics, you need three things to do anything at all: Land, labour and capital. Any economic endeavour requires these three basic resources, in varying> READ MORE
Another day, another survey showing that Hong Kong is one of the most expensive cities in the world to live. The Economist Intelligence Unit’s Worldwide Cost> READ MORE
Today I’m sharing an article written by my friend, Peter Churchouse, who with his son Tama runs Churchouse Publishing in Hong Kong. Peter spent decades as the> READ MORE
“Investing should be like watching paint dry or watching grass grow. If you want excitement… go to Las Vegas.”This quote from American economist Paul> READ MORE
There are plenty of great reasons to own residential real estate – you need a place to live, it’s cheap to borrow money, you get a tax break, and you pay your> READ MORE
In many parts of the world – depending on the period and place – buying a house or flat has the reputation of being a one-way ticket to wealth. Buy, hold, and> READ MORE
To create wealth from investing, you need time, money and a positive rate of return. But maybe not in the combination that Personal Finance 101 suggests. It’s> READ MORE
If you want to be successful in real estate investing, you absolutely must get one thing right.
I have invested in all types of real estate over some 40 years: and this factor has a bigger impact on property price than any other.
I’m talking about a property’s location…
It is the oldest cliché in real estate. But there’s more to it than meets the eye.
The basics of the “L”
A property’s location is the single most important factor in determining your investment success. That’s a fact.
You can buy the grandest house in the world. But if it’s next to a smoke-belching factory, or in the middle of a rundown neighbourhood with no prospects of gentrification or upgrade, you’re not going to build wealth.
Real estate prices can vary significantly at a very local level. The position of a property on one side or one end of the street matters. Prices can differ enormously within and across neighbourhoods, suburbs and districts.
The particularities of location are infinite. How do you judge the desirability of one position over another? How do you assess human nature? What really drives people to pay more for the same piece of property in one location versus another – not only now, but in the future?
When it comes to location, a few simple ideas have worked for me repeatedly over decades of investing in real estate in many different cities.
I buy properties in places where people wear a suit and tie when they go to work.
Does that sound a bit elitist? Perhaps. But this makes my life so much easier. People who wear a suit and tie to work are usually in higher-paying jobs. Therefore, as an upwardly mobile white-collar worker they are typically able to afford to pay more to buy property or to rent it.
In these days of casual work clothes, you’ll have to give this point a bit of latitude, but you know what I mean. I always buy in locations where white-collar workers want to live, whose earnings are in the higher salary brackets.
To everyone who thinks the Chinese middle class boom is an ‘old story’ – this is why you’re wrong
LEARN MORE HERE.
Your “suits and ties” need to get to work.
New transportation infrastructure, like underground rail, can be a major value-enhancing factor, in particular in big cities where getting to and from work can be a major hassle
For example, in Hong Kong, the construction of new mass transit rail lines has had a huge impact on property prices. In the early 1980s, the prices of residential property in the new town development of Tsuen Wan, some miles to the west of the densely developed tourism and office district of the Kowloon peninsula, sold at about a 40 percent to 50 percent discount to the more central Kowloon prices.
As the mass transit link to the new town came on stream, that discount narrowed to about 20 percent to 25 percent. Anyone owning property in Tsuen Wan saw the value of their apartments rise sharply relative to prices in the core urban areas.
“They aren’t making any more of this.”
You’ve probably heard this old saying when referring to beachfront land. But it applies equally to land in the inner core of prime cities. There is no new land being created in Central London, or Manhattan, or around Sydney Harbour, or indeed in many large cities around the world.
As cities grow, there are often increasing pressures on existing land resources that make land increasingly valuable. Recognising this, municipal authorities may dramatically increase how many people can occupy a particular piece of land.
For example, low-rise warehouse areas in the middle of a city may be rezoned for high-rise offices, or apartments, or hotels or retail.
So authorities are making more “use” of land by rezoning it from industrial buildings to residential or commercial spaces. in many areas around the globe. This is a reflection of the changing industries that work out of our cities, and the increasing populations of renters and home-owners who are attracted to city living. Look out for locations that could be moving from industrial to mixed use and you just could be onto something
You don’t really get a feel for an area unless you visit, spend time there and walk around. Every location is different – and every micro area differs too. A lot of people invest without checking out the property, or the neighbourhood. This is a terrible idea. Unless you don’t care whether your real estate purchase makes money, you absolutely must kick the tires before you buy anything. And far and away the best way of doing this is to go there. Walk and walk and walk some more to get a feel for the neighbourhood, the shops, the people, the streets, everything. Seeing is believing – go take a look.
You can research any location from anywhere in the world, thanks to the worldwide web. But if you want to find the best locations, you’ll need some local knowledge to back up your research. By asking a local, you might find a location you hadn’t considered before, or realise a location isn’t as great as you thought.
For example, a property next to a cemetery might not be a big deal in the West. But in China, where buyers take Feng Shui (that is, harmonising with your surrounding environment) seriously, a property next to a cemetery would be a horrible investment. Chinese investors wouldn’t be interested. It’s unlikely you’d find this information out on a basic web search. But any local would know.
So whenever you’re looking to invest in real estate, remember location is the one thing you can’t get wrong. It’s the first step to successful real estate investing.
In economics, you need three things to do anything at all: Land, labour and capital.
Any economic endeavour requires these three basic resources, in varying amounts. From the simplest business you can think of (say, a kid setting up a lemonade stand on the side of the road) to the sprawling empires of multi-nationals, they all need some land, some labour, and some capital.
(Sometimes a fourth factor of production, entrepreneurship, is included, depending on which economist you talk to.)
Land doesn’t mean just real estate. It includes anything that comes from the land, like natural resources, forests, and water.
But for now, we’re focusing on the real estate element. By this I mean the square footage or acreage of land upon which towering office buildings, factories, apartments, and shopping malls are built. This is the commercial, residential and retail real estate that underlies nearly everything we as individuals and businesses do on a daily basis.
Your portfolio probably doesn’t have enough bricks and mortar
Given how essential real estate is to everything, you’d think that its importance would be reflected in the average investment portfolio. But it’s not.
In global stock markets, real estate is hugely underrepresented.
For example, take a look at the MSCI All Country World Index (ACWI). This is one of the largest aggregate global equity market benchmarks available. It captures large and mid-cap companies across 23 developed markets and 24 emerging markets. It includes nearly 2,500 stocks. The chart below demonstrates how the MSCI ACWI is broken down by sector.
The three largest sectors are financials, IT, and Consumer Discretionary (that is, non-essential consumer goods and services). And the very smallest slice of the pie is real estate, at just 3.14 percent.
It’s not just the MSCI ACWI where we see such a small weighting towards real estate. In the S&P 500, for example, it’s just 2.9 percent.
This is important: Because of the low weighting of real estate in broad equity indices, if you want listed real estate exposure, you will need to actively seek it out yourself.
But I own my home – don’t I have enough real estate?
When it comes to personal wealth allocation, a lot of investors factor in physical real estate that they own – whether it’s the roof over their heads, and/or an investment property. And they’ll think, I’m covered with real estate, so I won’t bother putting it in my stock portfolio.
This is understandable. But it’s wrong. You see, your physical real estate returns are tied to whatever city or area you’re living in.
To everyone who thinks the Chinese middle class boom is an ‘old story’ – this is why you’re wrong
LEARN MORE HERE.
What this means is that limiting your real estate investments to the home you live in is like limiting the stocks that you buy only to companies located in your city. It’s the opposite of diversified.
In fact, this is the epitome of “home bias” – the tendency for investors to gravitate towards their domestic market, rather than diversify globally. (And in this case, it’s literally “home” bias!)
Real estate stocks and other listed real estate securities offer you a couple of additional advantages, from an investment perspective, over the roof over your head.
In the real estate world, especially real estate investment trusts (REITs), we can often buy a basket of real estate assets for far less than they’re worth.
For example, one REIT we’ve recommended in The Churchouse Letter trades at a 30 percent discount to book value. That means you pay 70 cents for one dollar of property assets.
This doesn’t mean necessarily that the discount will disappear any time soon (unless analysis suggests otherwise). But what it does mean is that you have a nice margin of safety. Simply put, would you rather pay 70 cents for a dollar of property? or a dollar?
Owning physical real estate as an investment has a lot going for it. But being a landlord can be a hassle. Chasing up tenants for rent, finding new ones when the lease expires and your tenant moves out, repairs, taxes, maintenance… it’s time-consuming.
But real estate holding companies and REITs in particular offer you much easier way to be a landlord. And the rent collection is automatic – dividends just slide straight into your brokerage account.
What’s more, you can buy properties that you’d never be able to if you were investing on your own. It’s unlikely you’ll ever own a price of a prime downtown Manhattan office building or a luxury retail mall in Beijing. But real estate stocks offer you an easy way to do just that.
So the next time you’re giving your portfolio a check-up, take a look and see what kind of real estate exposure you have. And if you’re looking for reliable, dividend-paying stocks backed by real assets, then have a think about property securities. (And we’ll be talking a lot more about this in coming weeks.)
Another day, another survey showing that Hong Kong is one of the most expensive cities in the world to live.
The Economist Intelligence Unit’s Worldwide Cost of Living Survey released recently showed Singapore as the most expensive city to live in, with Hong Kong second.
When it comes to the cost of real estate, Hong Kong prices are at the top of the list. Buying a no-frills one-bedroom apartment near Hong Kong’s central business district will set you back around US$1 million.
Just take a look at Hong Kong’s residential prices since 2008 versus the U.S. and U.K. Prices are up more than 100 percent!
Why is Hong Kong property in such a massive bull market?
Over the past few weeks, I’ve been asked about this numerous times. The week before it was Bloomberg’s Rishaad Salamat doing the asking (click here watch the interview.)
And then last week I spoke about Hong Kong’s property market at Morgan Stanley’s 7th Annual Hong Kong Investor Summit.
A lot of people think that buyers from mainland China are pushing up prices in Hong Kong. (Remember, Hong Kong is politically separate from China, but it’s under Chinese control.)
Over the past few years, we’ve seen the story of “Hot Mainland China Money” playing out across real estate markets all over the world.
There’s a lot of mainland Chinese cash looking for a home outside of China, for diversification reasons and because wealthy folks simply want to move their money outside of China’s borders.
Their number one investment target is offshore real estate in markets like London, Los Angeles, New York, Vancouver, Sydney and Auckland, to name some prominent examples.
This “hot” mainland China money has also gotten a lot of the blame for property price increases in Hong Kong.
But I want to show you some data on why that conclusion is wrong for Hong Kong.
Here’s why Hong Kong is different
You see, back in 2012, the Hong Kong government introduced a new stamp duty aimed at cooling Hong Kong’s red-hot property market.
This additional Buyers Stamp Duty (BSD) added a whopping 15 percent to the purchase price of residential property for certain buyers. Any buyer who is not a permanent resident of Hong Kong is subject to this stamp duty, along with corporate buyers acquiring a property in the name of a company.
So for that $1 million small apartment, you now have to pay an additional BSD of US$150,000… and this is before we get to other stamp duties or costs payable.
This BSD, therefore, captures individual mainland Chinese buyers, along with anyone who is looking to buy residential property in the name of a company and not themselves.
But in each of the past two years (2015 and 2016), less than 5 percent of the total residential sales transactions have been subjected to this additional BSD.
So even if ALL of the BSD taxpayers were mainland Chinese (unlikely given that people living in Hong Kong and elsewhere continue to use companies to buy Hong Kong property), it’s obvious that mainland Chinese money cannot be blamed for driving prices up.
Mainland buyers are a fraction of the total. We cannot blame them for Hong Kong’s high apartment prices.
So, if not mainland buyers, who is to blame? The Federal Reserve for keeping interest rates so low for so long? Perhaps, but the real culprit is much closer to home.
The Hong Kong government
All land in Hong Kong is owned and sold by the government. Public housing is provided by the government and either sold or rented. This housing, which accounts for about 56 percent of the total residential housing stock, is provided for lower income families who would normally find private housing unaffordable. These families don’t usually buy in the private real estate market.
On the private side, land parcels are auctioned by the government to local (and increasingly mainland Chinese) developers.
Those residential units are built and sold into the market.
Take a look at the chart below. It shows the number of both public and private residential units completed each year. This is Hong Kong’s total annual housing supply.
Between 1984 and 2005, total annual housing production was around 67,000 units per year.
But between 2006 and 2015, that number dropped to just 24,000… that’s 65 percent below the long-term annual average!
Hong Kong’s population has continued to grow, along with a need for more housing.
Government land policies have cut back the supply of housing to meet those demands, in both private and public sectors.
The government’s own forecasts of future private housing supply in the coming few years still fall well short of long-term average production.
And even their forecasts are often very optimistic. Our research has shown that over some 30 years, the government overestimated future housing supply by an average of 23 percent!
So what does this mean?
Well, from a supply point of view, Economics 101 will tell you that lots of demand without supply will lead to high prices.
And it means that when a government holds so much control over a scarce asset (in this case land) then it commands a huge influence on pricing.
We should use that to our advantage. Hong Kong has some of the largest and most profitable real estate developer companies in the world. Several are trading at very attractive valuations compared to their longer-term averages.
As for the folks trying to get on the world’s most unaffordable property ladder who keep asking me, “Pete, when’s it going to end?”, I’m afraid that the base case scenario is that prices don’t meaningfully correct any time soon.
You might not be able to buy an apartment, but you can still participate in Hong Kong’s property market with the right real estate stocks.
I’ve been covering Hong Kong property stocks for nearly 30 years, and I tend to focus the majority of my recommendations on a handful of top quality companies. (But in the interests of being fair to subscribers of The Churchouse Letter, I won’t include those here.)
Alternatively, you can take a look at the Guggenheim China Real Estate ETF (New York Stock Exchange; ticker: TAO). This gives you a basket of Hong Kong and Mainland Chinese real estate developer stocks and REITs. Around 80 percent of the ETF is in Hong Kong real estate stocks, with mainland China taking up the other 20 percent.
If you’re looking for a Hong Kong property ETF then this is OK. Although jumbling up Hong Kong and mainland China stocks in a single ETF isn’t ideal. These are completely different markets and should be treated as such.
Just yesterday, mainland Chinese developer stocks fell between 3-5 percent in a single day due to real estate tightening curbs announced over the weekend. Hong Kong property stocks were more or less flat!
Today I’m sharing an article written by my friend, Peter Churchouse, who with his son Tama runs Churchouse Publishing in Hong Kong. Peter spent decades as the Head of Asia Research and Regional Strategist at Morgan Stanley in Hong Kong, and is a fantastic source of stories and insight on investing in Asia. Peter specialises in real estate. He ran the real estate equity research team at Morgan Stanley, ran an hedge fund specialising in Asian real estate, sits on the boards of major listed Hong Kong and mainland China property companies, and has put together an incredible track record of global real estate transactions over the past four decades.
Peter and Tama write The Churchouse Letter, a monthly publication about investing in Asia, along with a free email called Peter’s Perspective, which you can sign up for here.
Below, Peter recaps a famous deal that changed the course of history – and highlights timeless lessons for investing in real estate.
By Peter Churchouse
The “mighty” Mississippi River is born a mere trickle in Lake Itasca, some 1,500 feet above sea level in the northern U.S. state of Minnesota.
From there it meanders its way south, gathering volume as the increasing flow from tributaries swell it into the fifteenth largest river in the world (and fourth-longest, at 2,320 miles, or 3,733 kilometers).
The river creates some of the most fertile agricultural terrain in America, along with navigable rivers, forests, prairies, and mineral riches.
These bounties led France throughout the 17th century to explore the Mississippi River valley creating settlements across the region.
By the middle of the 18th century, the French held sway a length of terrain from New Orleans in the south, to Montana in the north.
This “Louisiana Territory” was enormous, covering some 828,000 square miles (over 2 million square kilometers).
That’s nearly three and a half times the size of France today – or the size of Cambodia, Vietnam, Myanmar, Laos, and Thailand combined.
The territory becomes a bargaining chip
The territory came to be, as historian George Herring puts it, a “pawn on the chessboard of European politics”.
France ceded control to the Spanish at the culmination of the Seven Years’ War in 1762 under the Treaty of Paris. But Napoleon Bonaparte regained ownership from Spain in 1800 under the secret “Third Treaty of San Ildefonso” between the French and Spanish.
Around the same time, U.S. President Thomas Jefferson demonstrated foresight and smart thinking by agreeing to increase American presence in what was a politically unstable area of North America.
However, he was concerned that political instability in the area could undermine efforts to occupy these lands and lead to further conflict with the American state.
Word filtered that France had entered into a secret agreement with the Spanish to take back control of the Louisiana Territory.
Soon thereafter, Napoleon’s France was facing revolutions across its colonies, most notably Haiti and Hispaniola, where French forces suffered thousands of casualties from war and yellow fever.
Napoleon’s visions for the French colonies in the western Atlantic were in tatters.
His plans to use the Mississippi basin as a base for food production and trading activities to support French colonies in the region now made little sense.
The colonies were breaking, and French forces would be inadequate to protect the Louisiana Territory.
Moreover, plans were afoot for conquests closer to home in Europe. But he needed money to fund those military adventures.
America’s big deal
Jefferson offered to purchase some of the territory from Napoleon. Specifically, the Americans said they were prepared to pay up to US$9.375 million for New Orleans its surroundings.
Napoleon countered, offering Jefferson a deal of incalculable value…
He proposed the sale of the vast Louisiana territory for US$15 million. That’s equivalent to roughly US$250 million today.
The Americans couldn’t believe their luck. The offer was completely unexpected. They were stunned.
In a single stroke, the newly emerging America could almost double its total land area, at a cost of less than 3 cents per acre.
Signed in Paris on April 30, 1803, and aptly announced to the American public on July 4, this deal became known as the Louisiana Purchase.
America went on to become the most powerful and wealthy nation on earth.
Four lessons in deal making from the Louisiana Purchase
In my decades in finance and real estate, one thing I’ve learned is this: the core underlying principals of investing rarely change.
You see, the fundamentals aren’t new. Technology, computing, speed of information dissemination and transparency – sure, these have all helped change the game.
But throughout the span of recorded human history, the same lessons are there in plain sight, again and again. They’re timeless.
The Louisiana Purchase was more a political deal than an outright real estate one.
But there are some major lessons that still ring true today.
Firstly, motivated sellers offer value.
If you’re a buyer, the best sellers of real estate are ones who need to get out, and fast.
Distress equals opportunity
There are hundreds of reasons why an individual might need to sell: Maybe they need cash to bail out their business, maybe they’re leaving the country, it could be a divorce, it could be a case of over-leverage… who knows?
Regardless, a motivated seller usually gives you (as the buyer) negotiating power – in other words, the opportunity for a lower price.
And hopefully, you can pounce, which brings me on to the next lesson: The ability to act quickly can be critical.
Take the Louisiana Purchase. The deal was completed on the April 30. Napoleon’s offer of the entire territory was only made NINETEEN days prior to that!
Had the Americans not acted so quickly, who knows what could have happened.
We do know that Napoleon’s two brothers were trying to talk him out of the sale.
Some of the best real estate buys I’ve made have been done quickly – sometimes on the spot.
Combining a speedy transaction with a motivated seller will give you a better price. Period.
But critically, you have to know your market inside out.
A seller looking to offload quickly often wants to sell you more than just his property. He wants to dump you with the problems that come with it.
Maybe there are structural issues, a leaky roof, asbestos, or a new sewage plant to be installed close by. You get the picture…
The final lesson from the Louisiana Purchase is this: Don’t sell real core assets to fund spending.
It’s one thing to sell assets and reinvest, it’s quite another to do what Napoleon did.
He frittered the entire proceeds on senseless wars and military incursions, squandering one of France’s greatest financial and economic assets.
Some time later Napoleon was reported to have said, “America is a fortunate country. She grows rich by the follies of our European nations.”
I couldn’t agree more!
“Investing should be like watching paint dry or watching grass grow. If you want excitement… go to Las Vegas.”
This quote from American economist Paul Samuelson sums up the difference between investing and trading – investing is for the patient… trading is for those who want more excitement as they search for profits.
Any kind of investable asset, whether it’s individual stocks, stock index ETFs, bonds, commodities or foreign exchange, can be held as a long-term investment or traded for short-term profit. The major difference has to do with how long you hold on to the asset.
Traders will buy an asset and hold it anywhere from a few seconds to a few weeks. Over the last decade or so, and thanks to the exponential growth in computing power, a growing number of traders – called high-frequency traders – hold positions for only fractions of a second. Some of these traders even make use of algorithms to automate their trades.
All types of traders have one main objective – to make short-term gains on an investment, then sell it and move on to the next idea.
Different types of trading strategies
Some are momentum traders who look for assets that are making a major move up or down and have a large number of shares trading hands, or high trading volume. They hope the momentum will continue, and they hold the asset until the price reaches a pre-set level – which can take minutes or an entire trading day.
Technical traders look for patterns or trends in stock, bond, index or currency charts. They then make trades based on what those same patterns have done in the past. They may not know anything about the asset they’re buying or selling. Their decision is only based on what the chart looks like.
The patterns may have names like a “double-bottom,” a “V-reversal,” a “head and shoulders top” or a “rounding bottom.”
Day traders are often technical traders – they may look at various charts and indicators before the markets open in the morning. They’ll then make trades throughout the day to try and profit from how they hope the chart will look later in the day.
Other technical traders will hold an investment for several days or several months. Investors will also use technical research to make long-term investment decisions, but they usually base the decision on long-term charts that show longer-term patterns, not just on what happened the day or month before.
There are also fundamental traders. They base their buy and sell decisions on an asset’s fundamentals – things like earnings, profits and debt levels. The short-term fundamental trader may buy or sell a stock based on what an upcoming company earnings report will say or an anticipated acquisition.
Since a change in company fundamentals can take time to significantly affect a stock price (although a surprise change in fundamentals, like when a company doesn’t make as much money as analysts expected, will have an immediate affect on the share price) fundamental traders often hold a position for several days or weeks.
Trading isn’t for everybody
Being a short-term, active trader can be a lot of work and very stressful. We’ve known quite a few bright people who thought they would do some day trading in the morning, make $1000 by noon and take the rest of the day off. But they soon discover that doing that day after day is not that simple – and you can just as easily lose $1000 by noon if you’re on the wrong side of a trade.
That said, many investors who do make a living as traders – but they know what they’re getting into. And that being a successful trader takes more hard work than luck.
Successful traders have three things in common: they choose one short-term trading strategy (like momentum, technical or fundamental, mentioned above) and stick with it, they take a disciplined approach… and they have nerves of steel.
Three keys to disciplined trading
A disciplined approach to trading involves the right mix of assets and knowing how to set your position size and stop-loss levels.
Many would-be traders put a lot of time into researching what stock to buy. But they hardly give any thought to how many shares they should purchase. Knowing your optimal position size is vital to a well-thought out investment strategy. The amount to buy should be determined, not by how much money you want to make, but how much money you can handle losing.
To help determine your position size, you also need to know your stop-loss levels. A stop-loss, or trailing stop, reflects the most amount of money you’re comfortable losing on an investment. So, if you don’t want to lose more than 25 percent of your position on a stock, you set your stop-loss price at 25 percent below the price you paid for the stock. So, if you paid $20/ share, your stop-loss level would be $15 ($20 – 25%).
As the share price moves higher, and you now don’t want to lose more than 25 percent based on the new higher price, you would establish a trailing stop level. So, if that $20 stock has moved up to $25, your trailing stop level would be 25 percent below that – or $18.75 ($25 – 25%). If the price goes to $30, your trailing stop would be $22.50, and so forth.
Now, you can use your stop-loss target to figure out your position size.
Let’s say you’re buying the $20 stock and you couldn’t handle it if the share price dropped below $17. So, $17 would be your stop-loss level.
Now, consider how much of a paper loss (that is, how much it’s gone down on paper, before you crystallize the loss by selling the position) you can handle. With a $100,000 portfolio, you may feel that a $2000 loss will make you nervous. So, simply divide $2000 by that $3 per share loss you decided you could tolerate ($20 – $17 = $3), and you get your position size. In this case, that would be 667 shares.
Here’s the basic formula (this is just one out of dozens available) and a table to illustrate:
(Maximum $ Risk)/ (Current Stock Price – Stop Price) = Position Size
Asset allocation and risk management
The other part of being a disciplined trader is to know what asset allocation is best for you. Asset allocation refers to the mix of stocks, bonds, cash and other assets in your portfolio. Some say asset allocation is the number one factor affecting investment returns.
For instance, it’s a terrible idea to use all your savings to “play the market” as a trader. The prudent thing to do would be to just use a portion of your overall portfolio to trade – and leave the rest as a mix of good long-term investments, like dividend paying stocks, bonds, cash and some gold.
For the portion you do want to use to trade with, make sure you spread your exposure around a few different sectors. For example, you probably wouldn’t want to just trade energy company shares or make short-term foreign currency trades. Instead, get familiar with a few different sectors so you can make informed trades in any of them. That way, if one sector tanks your entire trading portfolio won’t go down the drain.
And even if it does, because you’ve “diversified your assets” by having the rest of your portfolio in long-term investments, it will be a little less painful.
This article was sponsored by IG. All views expressed in the article are the independent opinion of Truewealth Publishing.
There are plenty of great reasons to own residential real estate – you need a place to live, it’s cheap to borrow money, you get a tax break, and you pay your own mortgage instead of someone else’s.
But there are also bad reasons to own real estate. They’re misleading and deceiving and can lead to life-defining bad decisions. Here are two of them.
1. “There’s no better way to get rich than real estate.”
Dozens of “buy real estate today with nothing down and own twenty apartments tomorrow” seminars will tell you this. And real estate allows for leverage (that is, borrowing) that can amplify your returns (as well as your risk). Some countries offer big tax incentives for real estate buyers.
But as we wrote a few weeks ago, a house or apartment often generates returns that are lower than those of the stock market. Since 1975, stock market returns for the S&P 500 have far outstripped those of real estate. Hong Kong property similarly underperformed the Hang Seng. Only in Singapore did residential real estate appreciate more than the stock market over the long term.
So in fact there is another, better way to get rich besides real estate. It’s called the stock market.
2. “I love collecting rent every month”
Yes, collecting rental checks is nice. But you can earn potentially higher monthly payments – without all the headaches of being a landlord.
The table below shows gross rental yields for various residential real estate markets. Some of them look quite attractive… until you realise these are before maintenance fees, ongoing expenses and taxes. Once fees and taxes are factored in, some of these yields get pretty close to zero. (Please note that this is national data – local data can of course vary considerably.)
Another way to earn a steady monthly income is by investing in dividend paying stocks, bonds or REITs (real estate investment trusts). You have to pay taxes on that income as well, but depending on where you live, it can be a much lower tax bracket than rental income.
There are also no maintenance fees, no late-night clogged-toilet calls to take care of, or “the power went out” texts to disturb you. And it’s a lot easier to sell a stock than it is to sell a rental property.
As you can see below, you can often earn higher yields from these investments than from being a landlord (except bonds at the moment).
The best reason to own real estate today is for diversification – to diversify your income and assets. But real estate isn’t the sure path to riches some claim it to be.
In many parts of the world – depending on the period and place – buying a house or flat has the reputation of being a one-way ticket to wealth. Buy, hold, and be rich.
That’s worked for some generations, in some countries – including in much of Asia. But residential real estate’s reputation in many parts of the world as the ultimate wealth creator is often just wrong. In many markets, stocks do a lot better.
There are plenty of good reasons to own residential real estate. You need someplace to live, and you get tired of paying rent. You can borrow money for almost nothing. You can use your retirement money for a down payment. You saw your parents and grandparents grow rich by buying real estate when they were young. You like the tax advantages (in some countries) of owning real estate. You like cashing the checks that your tenants send you.
But owning a house or apartment, or several of them, often generates returns that are lower than those of the stock market. The chart below shows the long-term returns for the Singapore, Hong Kong and U.S. housing and stock markets. (Stock market results do not include dividends, and housing prices are nominal returns.)
Stock Market vs. Real Estate (R.E.) Performance
The U.S. and Hong Kong stock markets win hands down when compared to house prices over time. It’s only in Singapore where owning a house instead of stocks has made more money.
The U.S. stock market rules
For the U.S. market, the results aren’t even close. The S&P 500 has averaged an 8 percent annual return since 1975. U.S. house prices have earned just 4.8 percent a year since 1975. In fact, over nearly every decade, the S&P 500 does better than housing.
The only decade when housing did better encompassed the recent housing bubble, from 2000 to 2010. Even accounting for the sharp decline in the last two years of that period, U.S. housing prices still outperformed the S&P 500 for the decade.
So far this decade, the U.S. stock market is ahead once again. And for the past 40 years, it would have earned you almost 4 times as much as U.S. residential real estate.
Hong Kong – stocks win again
Hong Kong house prices have done much better than U.S. housing prices (Hong Kong house price data since 1980). But since 1980, Hong Kong real estate (up about 1,500 percent over the period) has trailed Hong Kong’s Hang Seng stock index (up nearly 2,700 percent).
And only since 2000 have Hong Kong house prices started to catch up to stock market performance. During the 1980s and 1990s the stock market was unbeatable. Since 2000, Hong Kong housing has performed much better.
But residential real estate has beaten stocks in Singapore
Since 1980, Singapore real estate has generated better returns than Singapore-listed stocks. It’s the exception in the three markets we looked at.
Singapore house prices have averaged 6 percent annual returns since 1980; stocks have only returned 5 percent a year (based on data from Datastream and the Straits Times Index). But stocks did better than housing in the 1980s and the 2000s. It was Singapore’s hot property market in the 1990s that made the difference. But so far this decade, neither house prices nor stock prices have done well.
Real estate should be part of a well-diversified portfolio. But not at the cost of investing in shares.
To create wealth from investing, you need time, money and a positive rate of return. But maybe not in the combination that Personal Finance 101 suggests. It’s never too late to start saving – and even if you’re starting late, you could be in better shape than you think.
Two hypothetical – and simplified – savers, Lee and Ann, will show how.
Lee – the slow, steady saver
The day Lee is born, his parents start to invest $100 for him every month in a special investment account that yields 5 percent (during a period when zero and negative interest rates are as foreign as chicken rice on Mars). For 60 years, they make a deposit every month, and interest builds every year.
So at the end of 60 years, Lee’s parents invested a total of $72,000 ($1,200/year). Thanks to the magic of compounding, when the interest earned is reinvested and starts earning more interest, Lee’s account balance after 60 years (he never touches it) stands at $424,300.
During those 60 years, Lee takes the scenic route through life. He doesn’t save a penny. On the day he starts his seventh decade, he’s the proud owner of absolutely nothing. But he also owes nothing. So his net worth is solely the account that his parents started for him when he was born.
This is a (very) simplified version of one of the foundations of personal finance: Start saving early, even if it isn’t very much. Skip the cappuccino, put the kids in bargain basement castoffs instead of Nikes, and keep your iPhone 4 in a world of iPhone 6’s. Take a short flight to Phuket or Orlando (depending on where you are), rather than a luxury cruise to Tierra del Fuego.
But a life of sacrifice doesn’t suit everyone. More importantly, it doesn’t have to be that way. For many people, the structure of lifetime earnings is very different. Compounding works, especially over longer periods of time. But it’s not the only way to build wealth.
Ann starts late – but makes it up
If you know early on that you’re going to take Lee’s career route, you’d better start saving early. But many people are more like Ann.
Ann’s parents didn’t open an account for her at birth. They bring her up and put her through school and let her figure out how to earn a living. So Ann gets a job and rises through the ranks.
Ann isn’t a good saver. She fancies Jimmy Choo and Kate Spade, and bright cars that roar. She gets a puffy coffee beverage every day and doesn’t even learn how to use her own stove. By middle age, she owns nothing – and owes nothing. She’s like Lee, but without a parental safety net.
Unlike Lee, Ann has been building her “personal equity.” She has a career and her earnings are rising every year. On her 45th birthday, she changes course and resolves to save $20,000 every year until she’s 60 (totalling 15 years of savings). She also earns a 5 percent return on her capital, compounded annually.
Ann banks a total of $300,000, and thanks to compounding, by the time Ann is 60, she has a net worth of $431,500, very close to Lee. Ann starts four and a half decades after Lee, so the power of compounding has much less time to work for her. But she saves a lot more. And Lee and Ann get to about the same financial place by the time each of them turns 60.
Ann isn’t so unusual
Ann’s scenario happens all the time. Saving when you’re younger is difficult for many people. Eventually, your kids leave home, or finish university, and suddenly you have more money to spend. Or the flat or house is paid off and the monthly mortgage bill vanishes. Or an aunt or a parent passes and leaves a small bundle. (In Hong Kong, 70% of adults expect to leave an inheritance and the average amount left behind is US$146,000.)
Or you get a raise at work, and decide to put off the five-star holiday or the new car or the bigger house in favour of starting a nest egg. Whether it’s a lump sum or an accelerated savings plan, it can save the Anns of the world.
In Asia, many entrepreneurs spend decades building up their businesses and paying themselves very little so that they can reinvest in their business. When the business is ready to be sold or passed on, the founders will be older – and will suddenly have a lot of money on their hands.
It’s never too late to start saving. Saving a big chunk of money later in life is a realistic scenario for a lot of people – maybe more realistic than saving a regular amount every month starting from a young age. If the amount you’re able to save later on is large enough, it can compensate for less time to compound (and a lower savings rate).
If you’re middle-aged and haven’t really had a chance to save much yet, you can start right away and still retire comfortably. It’s never too late to start creating wealth.
All content made available to you through our services are subject to and protected by copyright, and other intellectual property laws of Singapore and international treaties.
Legal disclaimer: The insight, recommendations and analysis presented here are based on corporate filings, current events, interviews, corporate press releases, and what we've learned as financial journalists. They are presented for the purposes of general information only. These may contain errors and we make no promises as to the accuracy or usefulness of the information we present. You should not make any investment decision based solely on what you read here.