Proper Wealth from the Nova Cafe EP 2 – Property vs Shares - Nova

Proper Wealth from the Nova Cafe EP 2 – Property vs Shares

 

Hosted in the Nova Cafe by our MD Paul Mahoney, Proper Wealth explores all aspects of wealth creation with a specific focus on Property. This second episode covers Property vs Shares, Cash portfolios and Leverage portfolios and Retirement Planning with Stefan Vadamootoo from Nova Financial Ltd. Click above to watch the second episode.

Paul Mahoney:

Welcome back to Proper Wealth with me, Paul Mahoney. Today we’re going to be talking about property versus shares, an age old question with a slightly new take. Joining me today is Stefan V from Nova Financial. Thanks for joining me Stefan. Stefan, when it comes to building an investment asset base, people obviously have a range of options. I suppose the three broad options are property, shares and interest-bearing investments and a range of things that might fit in within that category. Can you talk to me a bit about those options and potentially who they might suit?

Stefan V.:

Yes, of course. There are those three options. We don’t like to consider commodities as avenue investments per se for wealth creators. The reason that is, is because things like gold and silver don’t pay an income stream. What they do, it’s more of a speculation essentially, so we do consider shares, property, and interest-bearing securities. There seems to be a lot of options when you think about the investment landscape, but it really does come down to those three. Now, I think that really the question is what a particular person’s situation is. It really does depend on which asset class they go to or they should be invested in. I mean, ideally, the people that are in their pension phase, we want to be seeing a good mixture between those three assets, but during a wealth creation phase, there are some that we prefer for people or for clients and for myself included in that.

I’ve been investing … I bought first share when I was 11 years old. Now, it did actually lose money, but I’ve been hooked ever since and I’ve been advising for my whole professional career in the space of shares, property and interest-based securities.

Paul Mahoney:

Okay. Right. If we start with returns and talk about the returns of property and shares over the past 10 or 20 years, what have they been lacking in comparison to each other?

Stefan V.:

It’s a really good question and it really does depend on whether we’re talking about cash portfolios, or we are using leverage.

Paul Mahoney:

Okay. Let’s start with cash.

Stefan V..:

Absolutely. Generally speaking, in the past 10 or 20 years, the returns from shares of property have been around the same. In some cases, you have property being a little bit better. I think in the last 10 years property has done 90% cash portfolio and shares have done 70 odd percent, which is much for much when you cash portfolio for those two assets.

Paul Mahoney:

Right. That’s the cash part, that’s if someone actually going out and buying those assets solely with cash. What if you include leverage, if I was actually taking a mortgage or a margin loan when it comes to investing in those two options?

Stefan V..:

Well look, I think going back to that point of cash portfolios across those two asset portfolios, is rarely do we come across people that can just go out and spend a few million pounds on a property portfolio, so there is a requirement. For a lot of people, it’s two year’s leverage. Now across shares and property, the discussion surrounding leverage greatly differs and it really comes down to what interest rate you can pay on those types of investments. Shares, you’re looking to pay a much higher rate to invest in a portfolio of shares. When it comes to real estate or property, you can be invested with a much lower interest rate and a much higher LBR or loan-to-value ratios, as we call it.

Paul Mahoney:

Well, I suppose it’s slightly cheaper to borrow to invest in property, and you’re able to borrow more money, so therefore able to leverage your funds more and potentially multiply your returns more.

Stefan V..:

Correct. Now, it’s certainly not a penalty that you do have to pay a high interest rate to invest in shares, but it’s really the perception of the lender, who sees these shares as a more risky investment relative to real estate and that’s obviously because of the volatility associated with shares relative to property investment.

Paul Mahoney:

From a return perspective so far as how property performs with leverage and compared to shares with leverage, what are the differences there?

Stefan V..:

Well look, as we discussed earlier, the overall owner cash purchase, you have generally speaking the same sort of returns. Now, if you break returns into two different parts, being one, capital appreciation and the other being income, generally speaking you can expect capital appreciation across shares and property to be around 5% to 6%. When you’re talking about income, you’re talking about rents and dividends, you can also expect 4% to 5% on your portfolio. Now, essentially what leverage does to those returns is it increases them. If you have your 50,000 pounds, you can go out and invest in that cash portfolio and get again what we talked about a 6% to 10% return on your cash portfolio. Or, you can go out and leverage that 75% loan-to-valuation with real estate, purchase a 200,000 pound property and get that return for 4% to 5% to you, rent, or the 5% to 6% capital appreciation on the entire assets, so a much greater return on your applied capitals.

Paul Mahoney:

I suppose the differentiating factor when it comes to property and shares is really the ability for leverage?

Stefan V..:

Well, yeah, exactly. Well, I think it’s the major difference. I mean, it is the major consideration when any investor goes to say look, generally speaking, a Mom and Dad investor will say, “How are we going to retire? What are we gonna use in our retirement as income?” I mean when you buying shares and property, I think it’s a major difference between the two. It’s the main consideration that any investor should have when approaching the market when they’re talking about building an asset base.

Paul Mahoney:

Okay Stefan, talking about the ability to leverage property, lower interest rates, high loan to values, more stable, compared with the shares potentially less stable, higher interest rates and lower loan to values, how can a Mom and Dad investor, an average investor as opposed to a professional investor, utilize that strategy to improve their financial position?

Stefan V..:

Yes. It’s a really good question. Well, when we come across Mom and Dad investors, we generally find that they have some equity in their home, which they’ve built up over time, or even they might have a small pot of cash. They can draw out 25,000 pounds out of their home equity and then leverage that asset and buy a 100,000 pound property, and again, get the returns on that 100,000 pounds versus say if they drew that equity out with 25,000 out to buy some shares, they would be getting a return on that 25,000. The reasons why they would have leveraged on that 25,000 is because the interest rates are much higher. At the moment, they’re actually beyond the average dividend yield that you’ll be getting from a portfolio of shares, and so you really do have to get a major return when it comes to your share portfolio if you to max the ability to grow wealth similar to real estate and property.

Paul Mahoney:

Okay. Given that we’re in a historically low interest rate environment, the basic rate at the moment is 0.25% and, therefore, when it comes to investing in property, you can borrow at 2% or 3% for a 75% loan to value. I suppose what that means is you don’t necessarily need to set the world on fire with regards to your rental return or your capital growth to still do quite well.

Stefan V..:

Yeah.

Paul Mahoney:

Would you say that’s the case?

Stefan V..:

Absolutely. There is a huge disparity between the interest rate that you’d be paying at the moment and the returns that you can get. I would say that with caution that everyone that is considering a leverage portfolio into property is appropriately doing their sensitivity analysis because at the moment, as you mentioned Paul, the interest rates are historically low. If they do creep up, we want to be making sure that people that are investing in this way are gonna still be able to maintain their portfolios because as you know it’s time in the market versus timing of the market when it comes to this.

Paul Mahoney:

I suppose it is probably quite likely that rates will rise.

Stefan V..:

Absolutely.

Paul Mahoney:

Over the coming years, so I completely agree. Stress testing the portfolio, which is becoming a hot topic in the advisement marketing at the moment, isn’t it?

Stefan V..:

Absolutely. Yeah.

Paul Mahoney:

So far as stress testing a … Most buy-to-let lenders at the moment are using rates of 5.5% for stress testings, so making sure that works. Okay. That’s all very good. We’re talking about leverage for property being more stable and better ability to utilize your money. So far as the actual markets themselves and their stability, property versus shares and the stability overall, how do they tend to differ?

Stefan V..:

Well, they differ greatly. There’s no question about it. The fact that you can readily access or sell shares or buy shares also leads to the reason why it does have a lot of volatility. Volatility is essentially the risk associated with that investment. You can have something that’s not even related to the company that you’ve invested in and you can have your shares go down, or your portfolio down.

Paul Mahoney:

Okay. What we’ve talked about there so far is the ability for leverage with property versus shares and it seems the overall running theme is that property gives a bit more ability to leverage your money at cheaper rates and over a longer term, potentially. So far as stability goes though, obviously people want to make sure that their money’s safe and they’re investments are stable. How do the two markets compare to each other?

Stefan V..:

Well, they do differ greatly, Paul. Shares are quite volatile and 2008 is a really good example of the differences between shares and property. In 2008, we saw the FTSE whole share index drop by 32%. The property sector actually dropped 8% in the same year. The reason that is, is because when people hear about an economic downturn across in China, they don’t necessarily sell their property, but they may sell part of their share portfolio, which can have an overall effect on the long-term returns that you’re getting from your portfolio.

Paul Mahoney:

I suppose waking up in the morning and seeing that your share portfolio has fallen by 30% would be quite a fright?

Stefan V..:

Yeah. Well, exactly right, and unfortunately what happens in those instances is people when they have a large asset base in their “retirement bucket,” let’s call it, they don’t really think rationally. Unfortunately, when you have those people sell at those times, even if you sold at the [puppy 00:10:55] market, which is going to going flat or maybe dipping, you’re still receiving your rent from that property. The transactional costs associated with real estate are much more significant, stamp duty, real estate costs and stuff like that. You’re less inclined to go, “Oh, actually, let’s just sell that quickly.” Even if you did that, it probably does take time to sell. It is quite a liquid, which I think is a positive more so that the negative when you’re building a long-term asset base.

Paul Mahoney:

Yeah. That’s a good point actually. I suppose some people would perceive that as a negative because you can’t sell property in a whim and have your money back within a few days like you can with shares, but that obviously results in more stability.

Stefan V..:

Exactly right.

Paul Mahoney:

I suppose the share market is more impacted by perception and I suppose psychology of investors, as opposed to the property market, which moves a bit more slowly and doesn’t tend to move on a whim. Would you say that’s right?

Stefan V..:

Yeah, absolutely. I mean, the psychological outcomes across both investment classes are huge. If there was a ticker in every single letter box out there in every property, it would be a different story because people could buy and sell their real estate whenever they wanted to, or for owner-occupied, if they didn’t want to live there anymore, they could go, okay, sell so you would have a more volatile market there, but it’s simply not the case.

Paul Mahoney:

Yeah, okay. So far as that investor psychology, we just spoke, they have that impact in the share market and the property market, how much do you think that comes into play and how can people, I suppose, perceive that to their advantage?

Stefan V..:

Look, it’s a huge factor. We’ve already talked about when markets go down when it comes to shares, but … It’s not just selling investments because you’re losing your money or you’re making money. When it comes to shares, we rarely see people building up a large portfolio over time, relative versus property, we do see that. The reason that is, is because Mom and Dad investors, say they want to do a renovation on their bathroom or their kitchen and they need some capital. Now, versus going to the bank and getting leverage or equity out of their home to do that, they can readily sell some shares and inject that into their personal circumstance. That psychology does play a factor immensely when it comes to [inaudible 00:13:00], ’cause you can’t sell a bathroom in one of your properties or a bedroom in another one to inject capital into your personal circumstances.

Paul Mahoney:

I suppose sometimes people are their own worst enemies, whether they need that money for general living expenses, or as we said before, if the value falls significantly and they get frightened and perhaps they might sell at the worst possible time. Whereas, I suppose in general, when it comes to property, so long as your property’s rented, you’re not all that too concerned with the value, …

Stefan V..:

Absolutely.

Paul Mahoney:

Because you can see that bad time out.

Stefan V..:

Yeah, absolutely. For myself, when I’ve seen one of my shareholdings increase in value and I sell, I see that money in my bank account and I think to myself, well, I might dip in there and buy something. It’s as simple as that psychology, that stops you from being able to accumulate a very large portfolio from nothing and that’s why, generally speaking, we do favor real estate as an investment.

Paul Mahoney:

I suppose that’s the other side to it, is when people see their shares increase in value quite a lot and they see they’ve made a profit, where they might be leaving quite a lot on the table [crosstalk 00:15:40] selling out. Whereas, I suppose with property, people view it as a more long-term investment perhaps because of the entry and exit costs that we spoke about, but I suppose, generally, that people just need somewhere to live, don’t they? If you invested in the right areas then I suppose the demand will continue?

Stefan V..:

Yeah. That’s correct. I mean, people live in their own properties for years and years and years. It’s the same attitude when investing. Nobody goes out and buys a property, well, I hope they don’t, goes out and buys a property to only sell it in a few months time or in a year’s time. Generally speaking, when people are making that decision to invest in property, they’re doing so with a seven to ten year time horizon on that investment, so you can really get the benefits of growth over the long term.

Paul Mahoney:

Okay, Stefan, what investment time frame would you say is recommended for when investing in shares?

Stefan V..:

Well, I would say that it’s a very similar time frame to property. If you’re gonna get the full benefit of holding a share portfolio over the long term, through the ebbs and the flows, we’re looking at seven to ten years.

Paul Mahoney:

Or, quite sooner.

Stefan V..:

Yeah. Very much so.

Paul Mahoney:

Great. Well, thank you very much Stefan. Very informative there. That’s all we’ve got time for now. Thank for joining us and join us after the break for more.

Welcome back to Proper Wealth with me, Paul Mahoney. Joining us today is Stefan Madamooto from Nova Financial. Thanks for joining us Stefan. We’re going to talk about wealth creation, where people are looking to build an asset base versus the retirement phase of their life where people are looking to take advantage of their asset base, following on from our previous discussion on property versus shares.

Stefan, if we start with wealth creation, the types of investments, both property and shares that might suit that type of person. Could we talk a bit about that?

Stefan V..:

Yeah. Following on from what we mentioned earlier, property versus shares and, which one is the better asset for the wealth creator, when we’re talking about wealth creators, we are really look for leverage strategy or using property with leverage to build up your assets. What we didn’t talk about though is whether it’s always gonna be appropriate for people, that type of strategy, which it isn’t. For people that are nearing retirement or in retirement, it probably doesn’t make sense to be going out and taking on a lot of borrowers from the bank ’cause there’s no strong ability for them to pay that asset off. Does that make sense?

Paul Mahoney:

It does, so I suppose the prudent use of investment debt.

Stefan V..:

100%. Yeah. Correct.

Paul Mahoney:

I agree with that. I suppose with a lot of people, even if they save every penny that they earn, they may still not be on track to achieving their retirement goals and to be able to live comfortably. I suppose that figures different for everyone, doesn’t it?

Stefan V..:

Oh, 100%.

Paul Mahoney:

As far as what they need to be achieving. I suppose what’s quite important for them to understand is what their end goal might be.

Stefan V..:

Absolutely. People should always have a really good understanding of what they actually want to achieve in retirement before actually investing, which unfortunately, the case is a lot of people don’t have that plan in place.

Paul Mahoney:

I suppose a lot of people tend to go about their investment journey, if you like, in a rather ad hoc way, don’t they?

Stefan V..:

Absolutely.

Paul Mahoney:

If we talking about wealth creation and that’s what that investment journey might be, how can people put in place a bit more of a strategy. I suppose between those two options you’ve been talking about, property and shares, what types of those types of investment suit that wealth creator, but I suppose tend to be more growth focused?

Stefan V..:

Absolutely. Well, I think to turn to your first question, is what they should be doing to set themselves up for retirement. I think the most important question is when would they like to retire? Getting a good timeframe of how many years until they retire because as you know when you’re talking about investments, especially these types of investments, we are getting our returns over the long term. Knowing when you’re going to retire and then setting the plan in place to allow you to get there relative to your resources. Unfortunately, sometimes what we see is people get very close to retirement, think okay, well, I’m not gonna have enough and then they make rash decisions or they invest in exotic investments, which is not the best thing to do, generally.

Paul Mahoney:

I suppose if somebody is starting out with a relatively small pot of money and they’re looking to go through that investment journey, create wealth, so at some point in their mid to distant future, they can retire. Would growth be most important for that type of person, and potentially, income is more about supporting that leverage you’ve been talking about?

Stefan V..:

Yeah, absolutely. When we talk about wealth creators, we are talking about people that are earning an income, so they have the money coming in to pay for their lifestyle, debt reduction in their home. We are talking about investing for growth, so taking on some leverage and really having that income that they’re getting to facilitate the allowance of growth or leverage to build up their portfolio. They don’t necessarily need that wealth now, hopefully they don’t. It’s really for tomorrow or 10 to 15 years down the track.

Paul Mahoney:

I suppose focusing on, whether it be property or shares, focusing on assets that are going to grow in value so that they can best utilize that leverage we’ve been discussing, and multiply their returns, build an asset base before they’re looking to actually get the income from that asset base?

Stefan V..:

100%. I would say that there’s got to be a skewness towards real estate or in property as an investment with the use of leverage during the wealth creation phase of a person’s financial life.

Paul Mahoney:

Is that because of the better leverage, or the returns, or the stability, or a mixture of all three?

Stefan V..:

Well, it is a mixture of all three, but the main key is when you’re talking about building up a large asset base, if you’re talking about having a passive income of 30,000 pounds, which is about the average of what people would like to have for a comfortable retirement, we’re talking about a 600,000 pounds worth of investment assets. To be able to generate that size of a portfolio …

Paul Mahoney:

On what sort of a return?

Stefan V..:

On a 5% return. I like to use 5% because it’s quite a large risk strategy for that portfolio. Once you reach retirement, that asset base becomes your livelihood, so you don’t want to squander it. But, it also accounts for the unknown. I don’t have a crystal ball, Paul. In 15 or 20 years time, who knows what the market is gonna be able to offer us in terms of return, so I do like to use 5%.

Paul Mahoney:

Okay, so we’ll just recap from that. If somebody’s looking to generate 30,000 pounds of passive income at some point in the future …

Stefan V..:

Yes.

Paul Mahoney:

They should be looking to build an asset base of 600,000 pounds. I suppose that can be invested anywhere, whether it be property, shares or otherwise, so long as that’s giving them a 5% yield?

Stefan V..:

Yeah. Correct.

Paul Mahoney:

Okay. That’s the end goal, and I suppose once people have that end goal, they can then reverse engineer that to determine how they’re going to get there?

Stefan V..:

Well, that’s right. To build up that asset base, we’ve already talked about why real estate can assist in doing that in the most effective productive or effective manner. Once you’ve reached retirement, however, it may make sense to include other investments such as shares and fixed income. Shares will provide the liquidity and fixed income will provide that certainty with returns. It also has liquidity as well.

Paul Mahoney:

Okay. Let’s move on to that. We’ve covered wealth creation, the fact that growth is probably the most important thing. The prudent use of investment debt is almost essential in most cases and that, potentially, property’s a better asset for doing that.

Stefan V..:

Yeah. Correct.

Paul Mahoney:

Given its stability, given it’s cheaper and longer term leverage and also the returns that it generates, so that’s the wealth creation side.

Once people actually have that asset base, the example we’ve used if, let’s say, 600,000 pounds they’ve got invested in something. What happens then? Is there a shift in focus?

Stefan V..:

Perhaps there may be a shift in focus. I like to keep a skewness towards real estate or property whilst people are in their pension phase and it’s for a number of reasons. One main one being the fact that you have to have longevity with that asset base. Some people are gonna be in their retirement for the same amount of time they were in employment. They could be 30, 40 years in retirement.

Paul Mahoney:

Well, I suppose people are living longer these days. We don’t know how long we’re gonna live for.

Stefan V..:

Absolutely right. That money does have to last. You want to be skewing your investment portfolio in favor of assets that are going to tread well, or hedge well, with inflation. Now, given the fact that inflation is made up of a large part of mortgages and rents, property is a good option when you want to be hedging well with …

Paul Mahoney:

That’s a good point, actually, ’cause I’d say a lot of people would probably have that roundabout figure in their mind of what they might need, but then are potentially planning to just spend it. I suppose if you have your 600,000 and you just start spending your 600,000, it’s probably not going to last that long, is it? Making sure that that pot, that nest egg, is invested in something that will actually sustain its value with inflation, as you say, which I think at the moment is going to close to 3%, so above what the aim of the Bank of England is, which really eats away at the value of that money. Doesn’t it?

Stefan V..:

Well, it does erode the capital that you’ve built up. Real estate is a good growth engine as we’ve talked about, even with a cash portfolio, but it’s not necessarily a case that you need to sell down your properties that you had in the wealth creation phase and then buy different ones in your pension phase. If you’ve purchased the right types of properties, you’ve purchased them in blue chip markets around city centers and stuff like that, there’s always going to be a strong yield for that property.

Paul Mahoney:

Okay. Really important point in this, is sustaining the value of your asset base. As far as what becomes most important there, we spoke about wealth creators and the importance of growth, the importance of building an asset base. I suppose once people have that asset base, probably income becomes a bit more important, would you say?

Stefan V..:

Absolutely. There’s no point in having a portfolio of property with 600,000 pounds and you’re only generating 10,000 to 15,000 pounds, which we do see a lot happening like that for people that have invested in London that have a large property portfolio, which had the large value, but the income they’re generating from it is like a 2% to 3%, so well under what we talked about earlier about that …

Paul Mahoney:

Asset rich, but income poor.

Stefan V..:

Income poor. It may mean that an oscillation is required, selling those properties or investments and moving more towards your income generation, or income focused, in terms of those returns that we talked about earlier, in growth versus income, focusing more towards the income generation than the growth.

Paul Mahoney:

For example, moving away from the likes of central London, high value, low yield, more so towards things that are going to get you a much higher yield?

Stefan V..:

Absolutely. Correct.

Paul Mahoney:

You mentioned that could be through selling, that could be through diversifying. I suppose even through remortgaging to take some equity out and better balance your portfolio?

Stefan V..:

Correct. I mean, all those options are good.

Paul Mahoney:

Okay. Thanks Stefan. We’ve spoken there about both the wealth creation and the retirement phase, and what’s most important to each of those people in each of those phases of life. I suppose moving on from that is, it’s easy for us to sit here and talk about these things, but so that the average Mom and Dad investor can understand these things, what would you say is most important to help them through each of those phases?

Stefan V..:

Understanding their financial situation would be one. Understanding what, … Unfortunately, the case is you can go to the bank and you can get a large amount of borrowing, it might not necessarily be the case that that’s the best thing for you. Understanding what’s appropriate for your situation is probably the most important thing that I would say, and seeking advice. It is extremely important that people are seeking advice with regards to their finances. We have a lot of people that think they can do it themselves and some people can. Absolutely. But, there’s no harm in going out and seeking some advice, getting someone else’s opinion on your financial situation and what they believe is best for you.

Paul Mahoney:

I suppose understanding what your options are because you don’t know what you don’t know, do you?

Stefan V..:

Yeah. There’s so much invested. There are so many options out there. There are so many strategies. There’s so many things that you can do. A lot of them are probably not appropriate for your circumstances though. Relative to your own circumstances, only a few of them will be the best thing.

Paul Mahoney:

Yeah. Look, I’m a big believer in surrounding myself with people that are more intelligent than me …

Stefan V..:

Uh-huh. Yeah.

Paul Mahoney:

Which isn’t hard, but people that specialize in certain areas and certainly seeking advice from a financial planner or a property advisor or an equities’ advisor. If people actually know what they’re talking about, has helped me personally, certainly when it comes to making the right decisions.

Stefan V..:

Yeah. Exactly.

Paul Mahoney:

Well, thank you very much for that Stefan. Very informative. I’m sure our viewers have found a lot of value. That’s all the time we have for now. Thanks for joining us on Proper Wealth. Join us next time for more discussions on wealth creation.

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