Today, let’s talk about risk…
In particular, let us talk about the risks inherent for those brave souls still investing in property. And homebuyers, please do not zone out, this is not an issue exclusively for investors. In fact, homebuyers assume, in many respects, a relatively greater risk than professional investors. My question is – do you know this?
We will start with the basics. Firstly, when you invest in any class of investment
(property, shares, business, etc) there is always a risk that you will lose money, (before anyone jumps in to defend guaranteed interest schemes etc. I must point out that savings are not generally investments – anyone who has ever read “the Richest Man in Babylon” by George S. Clayson will be familiar with this).
There is a world of difference between speculation and investment. Speculation is when money is invested in the hope of disproportion wins. Such speculation is generally subject to some outside influence (market turns, local re-zoning or changes to planning permissions, major industry announced in a particular region etc.) and for that reason, is ultimately outside the investors’ immediate control. Buying already over-valued property to make short-term capital profits, particularly with high levels of gearing (mortgage to value ratio) is speculative and this particular type of speculation is in no small way a contributing factor to our current economic and banking crisis. Speculation is extremely risky but, when successful, yields truly great results that are out of all proportion to the markets general performance. That is the appeal for the speculative investor. The correlation of risk and return is entirely evident in speculation, the greater the risk, the greater the likely returns. The skill is therefore to choose the level of risk that you are comfortable with and manage this risk appropriately.
Investment, on the other hand, is about earning a consistent return or regular investment income. It involves choosing a quality property, in a well researched area (with established rental demand) and securing same for a price below its intrinsic value, not the stated guide price (builds in some degree of future-proofing). The investor then manages the property, similar to a business, to increase the level of returns. By doing this effectively it is likely that the investor will also benefit from capital appreciation (and therefore increase capital returns) but is not reliant upon it. A well worn adage tells us that the day you buy property is the day you make your money on it. To a great extent this is true. We are all subject to the same prevailing market forces, however, the stronger your asset is, the less dependent you are upon these forces. In short, the risk is minimal, the returns steady and, in a buoyant market, high returns are possible but are considered to be an add-on to the investment.
As we can see above, buying well minimises the risk, which is further decreased by leveraging i.e. purchasing property with borrowed money, generally a mortgage. (This also greatly increases an investor’s return on investment but that nugget of wisdom will be dissected and analyzed in a later post.) Risk is increased only where buyers/investors over-leverage, this practice was prominent in the boom times but is unlikely to re-appear in Irish banks for the immediate future (or at least until current, hard-learned lessons are forgotten!).
One fact to be gleamed from studying the past century of Irish land and property values is that long-term capital appreciation occurs. Historically, property doubles in value every seven years. High-demand areas of Ireland saw property values double over a two to three year period, this was entirely unsustainable. Recovery time for current values will most likely distort that seven year time-frame; however, it is worth remembering that unlike other classes of investment, property is a tangible asset and its investment income is (to a large extent) within the control of the investor. Long-term, mortgaged investors who did not over-leverage should continue to enjoy their investment income with the likely prospect of capital appreciation into the longer term. Finally, it is worth keeping a sense of perspective, the Irish property market is not apocalyptic; we are undoubtedly suffering at the lower stage of a cycle and cycles are only ever apparent in retrospect.
Our advice? Risk is to be acknowledged and respected, but not feared.