This may inflame the one eyed but I have been doing some thinking and thought I would post this for your reading pleasure.
Article on Diversification for the Property Investor
Many investors here are dyed in the wool property investors collecting a portfolio of positive or negative geared properties to fund retirement – hopefully earlier retirement if we choose well.
I am of a firm believer that the markets are cyclical having been through three cycles since I began my investment journey in 1989. I hope that the younger readers might take some heed of what I have seen and be better placed to enjoy the next boom than I was for the last few. If people tell you “That this time it is different†do not believe them. It is never different!
The aim of this article is to compare the stock market to the property market. I will be using Managed Funds as my example as they equate to a parcel of well selected stocks rather than individual stocks. Individual stocks may not follow the actual market closely however if diversified into a pool of stocks we can use the effect of a boom to our advantage.
I am also writing for the “Buy and Hold†investor who collects assets and holds them for the long term believing that “time in†the market is easier than attempting to “Time†the market as a trader might.
Property Investors buy properties when the market is less buoyant, when it is a buyers market – as I suspect we are nearing in today’s cycle. The majority buy when they are confident of the market. They are confident because all their friends and the media claim the market is hot and profits are being made. Some will make profits but many will time it wrong, buy at the peak and watch their investment stagnate or fall. Fortunately for some, they will not realise any loss unless they attempt to sell. As the property market is less liquid many people prefer to buy and hold – in this respect time will heal most poor decisions.
The seasoned investor will buy when demand is low. He will have his choice of the market and will be able to buy when he feels a vendor is motivated to accept his lower offer. He will hold his property for the medium to long term and either let time increase his value and/or he will add value in a number of ways such as renovations, development, subdivision etc.
Why hold all your assets in one class with just the one boom every 7-11 years?
I propose that we can treat the stock market in much the same way. Buying on weakness and allowing time to add value to our portfolio. Unfortunately there is little we can do to add value ourselves.
Imagine buying a $200K managed fund as opposed to buying a $200K property. We have exposure to a different market cycle which means that we can be buying in either market on the downturns of the cycle and thus extending the “buying seasonâ€.
One can gear into the equity market much like properties. Although the interest rate is fractionally higher (8ish% as opposed to 7ish% currently) it is actually a far easier loan to get with lending being assessed on the stock or fund being purchased and the deposit raised. Your income is not assessed.
Thus with a stock “rated†at 70% as most blue chips are, for every $30K you have you may buy $100K worth of stock or managed funds. This compares favourably to the 20% – 80% ratio of non LMI property lending. Buying costs are lower with the abolition of stamp duty on stocks and agents fees can be reduced by using an online broker.
Going back to my earlier example – one can buy a $200K Managed Fund for no upfront fee, no mortgage application fee, no inspection fees, legal costs or stamp duty. Normally with an IP one allows 5% to cover these costs.
Minimum deposit required is $60K. Repayments are as for a LOC and a minimum might be around $1080 pm. However this may be capitalised as long as the overall equity position remains under that specified for the fund.
Other advantages include ease of sale. MF may be sold in approx 24 hours with low fees compared to a property being marketed with a 3% sales fee plus legal costs etc.
Whilst this may sound like I am comparing MF favourably to property I am not. I am merely suggesting that one should seek to be able to buy in both markets.
Management fees are less with the MF and there are no tenancy issues. Although a property may provide a lucrative Depreciation Schedule one should also remember that Managed Fund distributions may have franking credits attached which also give taxation relief to the owner. A franking credit is basically a tax credit that comes with the share to recognise that the company paying that dividend has already paid tax at the rate of 30% on its income.
One major advantage of property is that, with LMI, one may actually gear into it with as small as a 5% deposit. The property is not revalued by the lender and as long as the borrower makes his repayments he can be assured of keeping the property. However should one gear the maximum into equities then a fall in value could see the lender requesting further funds or selling part of the holding to address the imbalance to the equity position. I personally choose to only gear to 50% to allow a large buffer before this might happen. To my advantage is the liquidity which means that I can reduce my holdings when I suspect that the share market boom is at an end and have my portfolio at a healthier position in preparation for a buying season.
So perhaps a portfolio can have several properties and then several holdings in Managed Funds or Blue Chip shares.
I have not described Speculative shares here as I do not feel they can be likened to property. There is certainly a place for them but only with amounts one can lose without stress to the financial situation.
Simon Macks
Residential and Commercial Finance Broker
***NODOC @ 7.15% to 70% LVR***
[email protected]
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
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