At Nova Financial, as property advisors our core business is to assist clients with guidance on how best to go about investing in property and what they can hope to achieve from the right investments. Most of our clients are mum and dad investors wanting to provide for retirement.
We find that most people tend to start with a default position of “cash is king”. By that I mean chasing cash flow from the outset tends to be their main focus. What we often must explain to our client is that until they have an asset base that will generate them an acceptable level of income, capital growth is often an important consideration.
In the case of a smaller proportion of our clients that have large sums of money to invest and the desire to retire as soon as possible, the focus would generally be on securing those funds and generating as much cash flow as possible and generally with little to no debt. So in this case “cash is king”.
However, for most who are aiming to turn a smaller amount of capital (money) into a larger amount sufficient to allow them enough to retire at some point in the future, a slightly different approach must be taken.
Let’s look at an example;
John is 30 years of age, he earns £40,000 per annum and has managed to save £50,000 over the past 5 or so years that he now wants to invest. He would like to retire one day with £35,000 per annum of passive income. If John invests in a property that generates him a 7% NET yield but very little growth in value, then John will have £3,500 per annum which perhaps may be pegged to inflation if he is lucky. So how does John get the rest of the £35,000 he requires, well he could keep saving 10 lots of £50,000 until each set of £3,500 adds up to £35,000 of income but that would probably take a very long time if achievable at all.
An alternative to John eating baked beans and locking himself indoors for the next 60 years would be to invest his funds in a capital growth focused asset with 75% borrowings and a £200,000 price point and a property with the likelihood of doubling in value over the next 10 years. Then John has turned his £50,000 into £250,000 (£400,000 less £150,000 of debt) which is an incredible 500% return on his funds. Now the old cliche of property doubling every ten years isn’t always true these days so let’s say that he achieved a more conservative return of 5% per annum which means his property will be worth £325,779 and that is a profit of £175,779 or 350%. This would allow John to reach his goal a lot quicker even if the property isn’t providing him with a lot of income straight away. Most of the clients that we meet with that are similar to John don’t need income straight away but will do in 20 years when they want to retire.
So what does property investment have in common with a big juicy orange? Well when an orange is small and still green would it be a good idea to juice it? No, because you won’t get much juice and anything you do get probably won’t taste very nice.
However, when that orange is large and juicy is it perfectly placed for juicing and will provide all the juice you need. The analogy compares an orange to an investors asset base and the juice to income. For many we find that in the wealth creation phase of their life they should focus on growth with the prudent use of investment debt to accelerate returns and then when they’ve grown their orange/asset base the focus shifts to high yielding income assets with little to no debt.
No Advice Disclaimer: this article should not be perceived as personal advice and you should not take action based upon its contents. Prior to investing seek professional advice which Nova Financial can provide on a one-to-one basis.
This article was written by Paul Mahoney, the Founder and Managing Director at Nova Financial. He is a public speaker and property commentator and has extensive experience in financial services and property. He is a trusted advisor to many in both Australia and the UK.