This article was published on 23 May 2006. Some information may be out of date.

Property backers underplay risk

Property backers seem to go in for hyperbole. Two examples from readers’ letters:

  • “Shares are not and have never been as lucrative as property…. We now know why the richest people in the world and in NZ are property investors.”
  • “The average person can quietly work themselves into a residential property portfolio worth several million dollars with a decade or two of judicious acquisitions…. People putting a portion of their income aside to buy into share funds are left in the dust.”

Firstly, the world’s richest person, according to Forbes, is Microsoft’s Bill Gates, followed by — wait for it — share investor Warren Buffett. The industries of the next eight are: communications, retailing, manufacturing, software, luxury goods, investments, media/entertainment and “diversified”.

Property no doubt contributed to the wealth of these men, but it was not the driving force. Same goes for New Zealand’s richest families, Richard and Christopher Chandler and the Todds, and our richest individual, Graeme Hart.

But the main point of the readers’ letters is that you can buy property “with other people’s money”. You can do the same with shares, of course, but that’s too risky for most people.

What many don’t realize, though, is that borrowing to invest in property makes it much riskier too. Let’s look at the example from one of the correspondents, a real estate agent.

We put down $10,000 and borrow $240,000 at 8 per cent to buy a $250,000 property. Its value grows at 7 per cent a year to almost $689,800 when we sell it 15 years later.

After subtracting interest-only mortgage payments totalling $288,000, and repaying the mortgage, we are left with $161,800.

Meantime, we’ve earned rent minus costs of $12,000 a year, bringing our total profit to $341,800. Our $10,000 has grown almost 27 per cent a year. That’s miles off the 221 per cent claimed by our reader — I suggest he uses’s lump sum calculator — but it’s still impressive.

What would happen, though, if things didn’t turn out quite as well?

Given that over the long term house prices grow about two percentage points above inflation, and recent growth has been much faster, growth might average 4 per cent over the next 15 years.

It’s also feasible that mortgage interest will average 10 per cent. And given the number of landlords competing for tenants, rental income might exceed ongoing costs by only $8,000 a year. What’s more, over 15 years, we’re likely to incur extra maintenance costs of, say, $20,000.

I’m not saying all of this will happen, but it’s not ridiculous either.

The house value would grow to about $450,000. After subtracting $360,000 of mortgage payments and repaying the mortgage we have a $150,000 loss. Add $120,000 of rental income and subtract $20,000 in maintenance and we are left with a $50,000 loss.

True, we didn’t allow for inflation on net rental income or the tax benefits of property ownership — although, as I’ve said before, they are vastly overrated.

On the other hand, we subtracted no costs of buying and selling (our agent forgot his commission!). And most importantly we ignored the time value of money.

Even in the reader’s good scenario, mortgage payments exceed net rent by $7,200 a year. If we had instead saved that at 4 per cent a year after tax, we would have earned almost $39,000 in interest. That should be added to our loss.

In a share fund, we could never lose more than we put in.

While a geared property investment is indeed quite likely to do better than ungeared shares, it is also reasonably likely to do worse.

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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.