Tuesday, January 10, 2006

Is residential investment oversexed?

Title: Is residential property investment oversexed?
I was discussing and arguing with a friend about the merit of residential property investment as a surefire way to accumulate wealth. I admit that there are benefits having your own residential property to live in.
• Property/real estate is your own place under the sky. You can sit on it, feel it and do whatever – your very own place.
• If you own the residential property you live on, you are your own landlord, unlike tenant who might be ejected to the street by his/her landlord.
• Banks and financial institutions are more than willing to give loans on property.
• The property itself can be used as collateral should you need money for something else.
Safe as houses right?
Well let me qualify that expression, safe as houses.
Rule number one; you must insure your property – building, chattels and improvements. Remember Hurricane Katrina and Asian tsunami. In an unlikely event like that, even your land might be swept away, and your million dollars home might worth nothing the day after.
Would the value of houses continue its upward trend?
That depends on a lot of factors, economics, politics, birth rate, ecology and whatever else.
• If the economy is growing, the populace getting richer and wealth of the country is evenly distributed and not concentrated to select group of people (ruling class etc) then there is every chance of increasing demand – the value and price of residential property ought to increase in value.
• The country must be politically stable, a simple unrest and small wars would adversely affect property prices.
• Growth and increasing prices go hand in hand. Don’t buy property in countries with declining population, that’s why some countries encourage immigration to counter their declining birth rate.
• Ecology and the environment, plays an important part. People don’t just work and work, they also want to play and enjoy some recreational activities. That doesn’t mean putting up playground with swings is enough. Ever wonder why residential properties by the sea and lakes fetch higher prices?
Even those factors might not be good indicator. It’s all come down to supply and demand. Any factors that affect supply and/or demand would undoubtedly affect future prices. An economy in recession would mean correction in asset prices is still in progress, and asset prices are expected to fall, residential properties included.
A good indicator future house prices is the housing starts numbers published by government statistics department.

Let’s assume we made up our mind to include property in the mix of our investment portfolio. Check out what are the prevailing interest rate in the market for deposit and mortgage and the tax structure in the country. Is capital gain taxable?
If the prevailing interest rate is 5% for deposit, the income generated from the property should also be at least 5% to make it profitable. Income could be from cash flow generated from renting out the property and the expected capital gains from increase in value. If you are in high tax bracket, you could also rearrange your income and reduce your tax by setting up a company, put your income into the company and make property or any other form of investment to reduce your tax burden.
• What is the market value of the house?
• New building cost of a house of similar quality.
• Market interest rate.
• Mortgage rate.
• Rental market rate.
• How much is the tax benefit?
• Local government rates (to pay for services such as sewerage, road and parks).
• Maintenance costs and other costs such as insurance.
• Depreciation.
Unlike investment in companies, commercial properties and businesses, residential property does not generate future wealth and income for the country if it doesn’t generate income. It consume capital, if you pay one million dollars for your house, and live in it, given that interest rate is 5%, you are consuming $50,000 worth of capital annually. If you just deposit that million in the bank, you could have earned $50,000 in interest less tax.
As for me, I would rather invest in companies and businesses, or even deposit the money in the bank, because the money would generate wealth and income for me and the country.

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