Category Archives: Investing

Should I buy a property in London?

A friend with spare savings wrote to me the other day, asking whether London is worth investing in right now for income, should she look abroad, or  hand over the cash to a financial advisor and let them do the work? She also wanted to know how I educated myself on investing. Here is my reply:
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Hi xxxx

I agree the rents are very high in London, but prices more so. London seems to be in the middle of an unsustainable bubble, where prices are rising much faster than long term averages for no sensible economic reason. Here is a chart that I created showing house prices in London increasing at a much faster rate than rental income from 2005 to 2015:


source: ONS

When prices rise faster than rental income, yields are squeezed, reducing the attractiveness of long term buy and hold investment.

The following graph shows that anybody buying at this point is paying an exceptional premium compared to say 1995 when prices were only 2.7x the average income:
Inline images 1

Remember we are talking averages – London is not worth buying at the average price. That is not the same as ‘do not buy in London at all’. For instance, if your generous auntie May bequeathed a  London flat to you in her will, you would not turn that down would you? So the real issue here is what you pay (the price) for what you get (rental income). If you happen to have a lot of cash and get offered distressed properties in London, then you will have an edge (on price) and perhaps you could speculate to make money – that would work until the market corrected.

How did I learn? I simply studied the most successful investor in the world http://www.berkshirehathaway.com/letters/letters.html. Buffett turned $10k into $60bn over a period of time and once you understand what he did, it is easy to see that you will make a lot of money over time but most people do not have the patience to follow what he does. Value investors think 10 years ahead, most people think forward 2 or 3 years at most. His philosophy is don’t lose money whatever happens, 95% of people think about maximising their profits and lose sight of risk.

I have probably read 30 books related to value investing, watched 100+ videos, read a few hundred articles and then I implemented. I also have MBA and finance degrees which help, as does having a genuine passion for looking for undervalued investments. For example I recently purchased VW shares when they dropped, and made a very good tax free return on investment.

When it comes to investing abroad, be very careful. Lots of horror stories related to Thailand http://www.bbc.co.uk/news/magazine-34346620. Do not believe agents claims about rentals, you will almost certainly get less than you expect. There are also tax issues, and hidden expenses such as annual levy’s on foreigner owned property.

I do not work with financial advisor’s either but that is because I commit significant time and effort to learning how to invest myself. The stock market produces about 6% per year over the long term and you could get this by holding a FTSE ETF (an automated fund that tracks the stock market for almost 0% fees) over a long time period. Check out what happens if you instead have a 2% advisor fee every year – after 30 years the advisor has reduced your total stake by roughly half (assuming the advisor matches the FTSE 100 which most do not do):

year YOURSELF   ADVISOR @ 2%
1 £100,000.00 £98,000.00
2 £106,000.00 £101,802.40
3 £112,360.00 £105,752.33
4 £119,101.60 £109,855.52
5 £126,247.70 £114,117.92
6 £133,822.56 £118,545.69
7 £141,851.91 £123,145.27
8 £150,363.03 £127,923.30
9 £159,384.81 £132,886.73
10 £168,947.90 £138,042.73
11 £179,084.77 £143,398.79
12 £189,829.86 £148,962.66
13 £201,219.65 £154,742.41
14 £213,292.83 £160,746.42
15 £226,090.40 £166,983.38
16 £239,655.82 £173,462.34
17 £254,035.17 £180,192.67
18 £269,277.28 £187,184.15
19 £285,433.92 £194,446.90
20 £302,559.95 £201,991.43
21 £320,713.55 £209,828.70
22 £339,956.36 £217,970.06
23 £360,353.74 £226,427.29
24 £381,974.97 £235,212.67
25 £404,893.46 £244,338.92
26 £429,187.07 £253,819.28
27 £454,938.30 £263,667.46
28 £482,234.59 £273,897.76
29 £511,168.67 £284,524.99
30 £541,838.79 £295,564.56
Difference £246,274.23
I am running a free investment meetup at one of my developments on the 20th of February. You can learn more about how we think and look at deals we are doing, plus meet some interesting like minded people. Here is the link to reserve a free ticket: https://www.eventbrite.co.uk/e/property-investors-champagne-reception-tickets-20259792585

 

Never ask a barber if you need a haircut

  1. Are you above average at your job?
  2. Are you above average at making love?
  3. Are you an above average driver?

The vast majority of people answer yes to these three questions, which of course cannot be correct because half must be below average. By answering ‘yes’ you have displayed overoptimism.

The tendency to overrate our abilities is amplified by the illusion of control – we think we have more control over outcomes than we actually do. For example, did you know that people will pay four times more for a lottery ticket if they pick the numbers themselves, versus having a computer randomly pick the numbers for them? The act of picking numbers yourself does not make them any more likely to occur yet most people place a premium on the option.

Optimism seems to be the default state for most of us, but why?

Scientists suggest that optimism presented some kind of evolutionary advantage. Searching far and wide for food, hunting wild animals and other similar activities once performed by our ancestors involved taking risks (see  this link for more information). Pessimists would naturally avoid such risks.

Psychologists have documented a ‘self serving bias’ whereby people are prone to act in their own best interests. Try asking a barber if you need a haircut, or a management consultant if you need some consulting, or a personal trainer if you could do with some one to one workouts if you want to see the self serving bias at work.

The self serving bias is particularly dangerous in investing. If you choose to seek the advice of an expert, be very careful as to whom you choose to listen. The recent financial crisis provides plenty of examples. Just before the market crashed, 91% of analysts rated shares as either ‘buy’ or ‘hold’. At the same time, the ratings agencies, who were funded by the loan issuers they were rating, rated many sub investment grade loans as AAA.

So how do we beat this tendency? We must learn to think critically and be more skeptical. Ask why should I buy this property, not how can I buy this property.

 

To Investors Who Want To Quit Work Someday

Most investors are oriented towards how much money they could make from an investment, and pay little attention to risk and how much they could lose. This is especially evident at the present time. Investors are desperate for yield (see my yield pigs blog post here) and many have been prepared to pay high prices for correspondingly low yields.
The soaring demand for buy to let mortgages can be seen in the chart and table below:

soaring demand for BTL mortgages
soaring demand for BTL mortgages chart

source: CML

In times such as these, investors are sometimes their own worst enemies.

When prices are rising, investors speculate in the market to make high risk investments based on optimistic projections. The focus is on return and not risk.

 

When interest rates rise, and better rates can be obtained elsewhere I expect to see an outflux of investors from the market. I would also expect to see a reasonable quantity investment properties come on to the market once rates have risen to more normal levels of around 4.7% (the 40 year average is 7.6%).

 

All prudent investors should plan carefully for various scenarios post election May 2015. Value investors – those who focus on buying distressed property – do best when markets are falling because this is when risk matters and overoptimism hurts most. Those looking for bargains may well find that waiting for things to stabilise may present low risk opportunities to make wise investments.

 

For some, a correction in prices will present a rare opportunity to load up on high quality income generating investment property purchased at fair prices. Investors who want to quit work someday should heed the famous value investment creed – “Be greedy when others are fearful, and fearful when others are greedy”.