Let’s talk about real estate today. I’m sure there have been many times in the past when you heard a friend or a family member talk about how they have been able to create wealth in property.
You may have noticed that the ones that have made money are the ones who invested a long time back – more than ten or fifteen years ago. The people who have invested in the last decade may not have been so lucky and might even have been scarred from the experience.
It is tempting to get carried away by the stories others tell us to think that real estate is a good bet to create wealth over time. But before giving into that temptation there are a couple of things to look out for.
The first is the returns: when your friend tells you that they have made three times their money or five times their money, the question you need to ask is over what time period. If something goes up five times in thirty years, that works out to a compounded return of roughly only five and a half percent per year. Absolutes can be deceiving and so you really need to see what the annualised growth is.
In theory, property is a proxy for land. A property that is here today will be the same property a decade or two from now. And therefore, in theory, the property returns should match inflation over time. Of course you can upgrade the house to increase its value or rent it out to get some cash flows and that could boost your returns.
The second thing that you need to keep in mind is the cost. If you are upgrading the house, that costs money – heck just to maintain the house costs money. There are property taxes and stamp duties to be paid, utility bills and society maintenance charges and more. And every few years the house will need to be repainted, furniture will need to be repaired, AC’s to be replaced – all these bills add up to a significant amount over time. And this takes away from your return.
So without understanding the annualised return and the rough annual cost, we have no idea what the actual returns of a property are. Figuring this out should be a key element when making a decision on a property. This is not to say that real estate doesn’t generate wealth over time – it definitely can – but the real question to be asked is what is the total return that the property will give you and how does that compare to other assets.