Investing vv speculating.

Just recently I have been asked to help a string of new clients wanting to invest in residential property. As with all clients I start by trying to understand what their brief is so that I can sketch options and advise on a course of action. Maybe it is just because I have had half a dozen in the last month but I heard myself explaining to each the difference between investing in property and speculating.

Most people with a couple of quid looking for a home at some stage consider property. Most understand property or they think they do. Many have own their own home and a lot who have done so for some time will have seen it rise in value during their period of ownership. The result is that many mistake riding a wave with being a successful property investor. If all you’ve done is bought something that happens to have appreciated along with all the others then you can’t really take the credit even if your home has doubled in value over the past decade. Unless you have improved the property in some way, bought in a area that has improved more than perhaps neighbouring areas have and if that was a deliberate policy then you can’t really take the credit. Many people do though and this is why many people talk about “investing for capital growth”. House prices always go up, right?

Wrong. Just look in Northern Ireland where prices are half what they were ahead of the credit crunch in 2007. Prices can fall and in my 30+ year career they have done so three times!

Investing is all about the yield that can be derived from the asset. The interest earned in a deposit account. The dividend paid each year on shares or in the case of property the rent generated. A bank deposit is very safe so give very low interest. Shares can be sold quite quickly but the capital value can fall further than cash so investors demand a high yield. Property is complicated, it is illiquid, can be hard to sell, takes time, money and effort to let and investors therefore demand even greater returns to reflect this. A deposit account might yield 1% interest today, shares in a decent company 3 or 4% but residential property needs to return 6% I think if you assume that you have to knock off all the costs – taxes, fees, voids, dilapidations… The yield you get reflects the risk you are taking and so it is with property. A buy-to-let in Newcastle might generate 7% gross but you are taking a bigger risk than the property in Elstree that only generates 3%.

You can buy a property hoping that it will rise in value but this is not ‘investing’ it’s more of a gamble. It’s called ‘speculating’ and whilst it is quite legitimate it carries with it much more risk because we don’t know what is going to happen to prices. You can buy a house and convert it into flats. You could buy a pub and get change of use to convert it into a house. This is what is also called ‘development’, it involves taking a property, doing something to it that changes the market for that property from one that doesn’t value the building(s) to one that does. You might buy a property close to where CrossRail2 is going run or a new school or academy is being built. These will improve an area and with it house prices relative to neighbouring areas. This is ‘speculating’ but the uncertainty means it is more similar to going to Newmarket races with all the risks that that can have.

I act for both ‘investors’ and ‘speculators’. What’s important is that each understands the risks they are taking. The investor can expect to see his rental income come in week after week, month after month, year in, year out. He gets less reward than the speculator because he is taking less risk but he gets more certainty. The speculator may get less yield but he hopes for a bigger payday once the train line is built or the planning permission granted.

Clients often like a bit of both income AND the chance of capital appreciation. Again, this is not unreasonable nor is it especially hard but the chance of a bonus down the line is off-set by slightly lower yields in the meantime. It’s much easier to be confident about the yield you can expect from an investment – the rent is unlikely to change a huge amount over time but what might happen to house prices in five years is always going to be a guess even for me. An educated, informed guess but an opinion that is at the mercy of the markets.

If you are looking to buy a property, for either investment or for captial appreciation then do please get in touch. I can try and explain this better, help you to understand which might be right for you and if you need it, some help in where to look for what it is you need. In the meantime, please help spread the word to others who may be confused. Investing is something that is relatively risk-free and perhaps a little boring. Speculating may be more exciting but then so is a trip to the races and you could loose your shirt!