If you ask people in the UK the following question ‘ would you rather invest in property or stocks?’ I am sure the majority of people will give a resounding vote in favour of property. The reason is because the financial press is littered with stories of how everyday people in the UK have become millionaires via property. On the other hand, you hardly hear any stories about people becoming millionaires through ownership in companies via the stock market. This is rather interesting because if you look at the facts, stocks (equities) have historically outperformed all other asset classes returning 9.9% per annum whereas property only returned 5.7% per annum. So how do people investing in property still end up with more money than those investing in stocks.
The main reason property does better than all other asset classes is due to leverage i.e. using other peoples money. When you buy a property, you take out a mortgage and thus the bank helps you fund the purchase. And although you only put down 10% and the bank puts down 90%, the person buying the house gets all the upside as the bank has no equity in the property.
As an example, say you buy a house for £100,000. You only put down £10,000 and the bank puts down £90,000. If the property grows by the historically average 5.7% over the year. At the end of the year, you have £105,700. As you as an individual keep all the gains, the return on your investment is a whopping 57%! This is due to leverage.
If on the other hand you get no loan from the bank and you put down £100,000 yourself to buy the property, your return on investment drops to 5.7%.
When it comes to investing in property, leverage makes all the difference. But the caveat off-course is it adds more risk as you are solely liable for any downside.
Whilst using leverage is the main reason property investors have better returns than stock market investors, a smaller reason is patience. As house prices are not quoted everyday, property investors are more likely to hold onto their assets for longer periods. Stock market investors, due to stocks being quoted every second, are more fickle and flee at the first sign of panic. You hardly have stock market investors any more who hold on to shares for more than a year, let alone 5 – 10 years. They don’t let the market do the heavy lifting.
Property investors do not see the price of their house fluctuate everyday and are more likely to sit still and do nothing. They let the magical effects of compounding do its work and are thus able to reap the rewards. So whilst stock market investors using leverage is not recommended, being patient and doing nothing is!