What is the average return on property investment?

Investing in property or any other business or income-generating asset is a return-driven approach. What this means is that if you use some or all of your own money to acquire an investment, naturally, you would expect something in return. In other words, you need to be confident that the investment will pay you back with interest; otherwise, why invest?

Investors judge the worth of an asset by its investment return, and an average of 7% is generally considered a good ROI. The higher the return, the more your investment will grow and the greater your wealth will be, assuming there is no risk.

That being said, what if a company knocks on your door and presents you with a neat financial offer where they will pay you 20% interest for placing $10,000 in their growth fund, would to buy into it? Let’s assume that the next best investment only offers 5%? Would you take the deal now?

An investment return of 15% may sound too good to be true, given what other assets are paying. If that’s the case, one is going to feel skeptical and question the deal. Surely there is too much risk!

Conventional wisdom says that if something sounds too good to be true, it probably is.

If we follow this wisdom, you should stay away from a fund paying 15%. With all the people getting scammed on a daily basis, that may well be very good advice. But when is a deal too good to be true? When does conventional wisdom hold up?

In the world of money, a deal is too good to be true if you have no control over it. This is the key: control.

You can blindly invest $10,000 in a high-yield fund and expect to become rich, but the likelihood of that happening is very low.

You could also undertake an intensive investigation of the fund, its management, its business model, the economic environment and risks. This is a great start and an absolute requirement, a way better approach than blindly investing. At least you can avoid disappointed by knowing what to expect. But as an individual you still have no influence over performance of the fund. Zero impact.

A fund claiming to pay 15% irrespective of the company’s published reputation is, in my books, ‘ something too good to be true.’ Why? Because I do not control the business deal. Lack of control equates to very high risk. It’s as simple as that.

Investing in property epitomizes the ultimate level of control for me. You can use property to generate phenomenal investment returns, which, in my experience, is significantly more than any stock market can generate. And because you are involved in each step of the deal-making process, from finding the right sellers to obtaining finance to selecting the best tenants, the risk is lower.

I’d like to use my very first buy-to-let investment deal as an example to show you how a low risk process created high returns for me. Now ironically from your perspective, I may come across as a third party punting the power of buy-to-let property. Like that fund purporting to pay 15% on deposits, you may just perceive property as too good to be true!

The purpose of this example is to demonstrate how you can lower the risks by shifting control and responsibility back into your court. It’s not about buying into someone else’s fund, but rather structuring your own deal  through property thereby generating great investment returns and financial freedom at the end of the day.

Here are some of the important particulars of the deal:

• The property is a 32-square-meter bachelor’s apartment located about three kilometers from the University in a neat suburb, ideally suited for medical students.
• The apartment is located in a secure building near all major student transit routes.
• Demand for buy-to-let apartments is high. In a four year period, there have only been two months where my business has not received rental income. That’s a good stat to have on your books. Low vacancies translate into a consistent and reliable income stream.
• The apartment was purchased from a motivated seller, who happened to be a retiree in need of extra cash. The purchase price was $280,000, which was about 10% below the going market price.
• I managed to obtain a 110% mortgage from my bank, which is granted in today’s day and age, which is very difficult to come by. The mortgage was used to cover all legal fees and some minor renovations. As a result, I did not use any of my own money to purchase and improve the property.
• I asked the attorneys that handled the deal at the time for a discount, and surprisingly they gave it to me! But this was on condition that I use their service the next time around. The important lesson is to always ask for a discount…always.
• My managing agent follows a strict protocol when screening prospective tenants and their parents (if the tenant is a student). The essential thing is I trust and respect them. Trust is gold when it comes to having someone else manage your property business.
• There is one (small) mistake I made with this deal. The apartment is located in an area where house price growth has been flat for a number of years. Ideally, you’d like an income-generating asset that increases in value over time. I initially assumed the house price growth was 12%, which was the national average at the time. The lesson is never to assume. Always check. There are two reasons why I later considered the mistake to be small. Firstly, the property generates a reliable income stream. It’s better to get paid than not to get paid. Secondly, the apartment’s investment return told me to hang on to the deal.

So here it is, after obtaining a buy-to-let unit from a motivated seller at below market price, and having obtained a 110% mortgage, the four year investment return is 47.3%. And that’s after costs, tax and inflation. That’s an annual real return of 47.3%.

To put this into perspective, if you invest $10,000 in a fund paying 47.3% interest, your investment will grow to just over $47,000 in four years. At a 15% return, one will only realize about $17,500.

So, what’s the moral of the story? True wealth creators focus on creating opportunities that deliver the required returns. It really is up to you to take charge of your future. Simply handing your cash over to a professional fund manager may not cut it.

To achieve above-average returns consistently over the long term, you need control. If done correctly, investing in property is just one business vehicle that will help you with that.