Investment 101 - Property

One of my favorite courses at Harvard was the introductory class in Economics, which could have been labeled Economics 101. It was fascinating and I got an “A” with ease. Later, I passed the intensive financial training program at Chase Manhattan Bank on Wall Street in New York with high marks as well. But neither of these excellent courses taught me what I most needed to know about handling my personal finances. That I learned very slowly in the “school of hard knocks”.

I have already written about handling money well with frugality, saving and generosity. Now I want to tackle the question I am most frequently asked: how to invest money wisely? (This will involve more than one post.)

For young people starting out, the most important financial principles are:

saving a minimum of 10% of your income (starting today!)

avoiding debt, particularly high interest credit cards.

Once you have some savings accumulated, the main question usually becomes whether to buy your own house or apartment. Although for most people that has been their best investment ever, my advice is not to rush in too quickly. The recent global boom in property has nearly run its course, and prices are already falling in many places, although still rising in other parts of the globe.

This recent property boom was all about interest rates. When interest rates fall and stay low for a few years, property soars. But the old adage still applies: whatever goes up must come down sometime.

The reverse also happens typically in economics – so there is a risk that interest rates could go back up at some point (due to inflation reappearing) and cause a quick property tumble.

In my view, buying your first house or apartment should never be done for getting rich quick, because the opposite could happen just as fast, particularly if you borrow a huge amount. In that case, you would be vulnerable to both interest rates rising considerably and suddenly losing your job (which happens to most people sooner or later).

However, the tax laws in many countries make owning a home very advantageous, due to capital gains exemption or interest deductibility. If you have 20 – 25% saved for a down payment, steady income and no other debts, buying property is good for the long term, no matter what the real estate market does this year or next. But don’t buy with the intention of selling in a year or two, because you may get caught!

I once worked with a group of graduate students who presented me an interesting concept on buying up houses in lower-priced areas throughout British Columbia. As the value of their real estate portfolio would rise, they intended to buy still more houses by borrowing more and more. I rejected their investment thesis, because it assumed that property prices could only rise, and never fall.

This got me into an argument with their professor of business. Sadly, circumstances proved me right. This professor himself bought 4 or 5 houses with high debt and then lost them all in the property crash of 1982 in Vancouver. His dream of financial success was ruined.

(There is a solid strategy for a sophisticated investor to buy more and more property based on steady cash flow that covers all of the debt. This requires long leases and fixed rate debt. However, a property market reversal could still bankrupt this method, unless there is geographic diversification and lots of financial flexibility to withstand sharp market corrections.)

But I like home ownership for two other reasons, beyond the pride of owning you own place. First, it is a forced savings plan, which for many people is almost the only way they will actually save. Second, it avoids the immense pitfalls of buying stocks and other hazardous investments, which I will deal with in a future installment: Investment 102.