Welcome to your November edition of the Fish Need Water newsletter!
Here’s what we’ve got coming up:
- Equity or debt: which is best?
- All the latest need-to-know news
- Top tool: DIY Conveyance
Equity or debt: which should you choose to increase your wealth?
One of our favourite property experts recently wrote a blog post about the difference between debt and equity investments. With his permission, we’ve summarised the main points – because we think it’s thoroughly useful information for property investors, and it doesn’t get talked about enough.
Here goes – with thanks to Rob Dix (AKA Property Geek) for his original post…
What are equity and debt investments?
An equity investment is your typical buy-to-let purchase: your equity is the proportion of the property’s value over and above any mortgage secured against it.
A debt investment is just flipping it around and putting yourself in the place of the mortgage lender. While you’re unlikely to lend for a 25-year term like a mortgage lender would, it’s otherwise exactly the same: you lend an amount of money based on the property’s value, and the borrower pays you an agreed interest rate in exchange.
The value of your debt remains the same regardless of what happens to the value of the property: the borrower must pay you a fixed amount of interest for a fixed period of time, whatever happens.
Which type of investment is right for you?
That all depends on a number of points. Here are the main ones to consider:
1: What’s your attitude to risk?
Imagine you’re taking out a mortgage to buy a house for £100,000. A mortgage lender puts in 70% (£70,000) in debt, and you put in 30% (£30,000) in equity.
If the market goes up by £30,000 (so the house is now worth £130,000), you’re quids in: your original equity of £30,000 has doubled to £60,000. But if the market goes down by £30,000, your equity has been entirely wiped out.
The mortgage company, however, is fine: their loan of £70,000 is still secured against a property worth £70,000. (Sure, they won’t be happy about the decrease in value, but essentially they’re not too worried.)
As the equity holder, you get the upside of a potentially huge increase in value – but you also get the downside of being the first to suffer if the property value goes down.
As the debt holder (like the mortgage company in the example above), you’re insulated from any decreases in value – but your returns are capped. That is, there’s no way to make surprisingly astronomical returns once you’ve agreed an interest rate with the borrower.
Which brings us to…
2: How much do you like certainty?
When you’re buying a property, your returns will be made up of two inherently variable components:
- Rental profit – derived from income that might go up or down, and expenses – which are unknown.
- Capital growth – which could be anywhere from “minus growth” through “no growth at all” and all the way to “huuuuge growth”.
By contrast, with a debt investment you know at the start exactly what return you should get: if you agree to lend £10,000 at an interest rate of 0.5% per month, you’re going to get paid £50 per month for the length of the loan.
3: How much money do you have already – and how quickly do you want to make more money?
In the same way that most investment portfolios contain a mix of stocks (equity) and bonds (debt), debt investments in property could be right for anyone – but the percentage of a portfolio that should be allocated to it will vary.
This is going to sound weird, but if you’ve got little in the way of funds you’ll probably want to take more risks. Why? Because £25,000 growing by (say) 10% per year isn’t bad, but even with compounding it’ll take you a long time to get anywhere. It might make more sense to seek quicker progress by using leverage, taking on renovation projects with a high ROI, or looking for investments with a greater upside.
But if you’ve got £500,000 kicking around, there’s a stronger case for allocating some of it towards debt investments. Allocating half of it to loans (for example) would produce a healthy £25,000 per year income, leaving plenty left over for the racier stuff with a higher payoff.
How can people invest in debt?
There are plenty of companies that allow you to invest your money with them over the short or longer term. Those companies will then lend your money out to borrowers who need it to fund the purchase of a property.
Whichever company you choose, you need to do your due diligence and make sure you’re confident that the risk has been controlled as far as it can possibly be.
Done properly, lending against property is a great way to grow wealth – it just depends on your goals, the amount of money you have to invest, and the timeframe in which you want to see a return.
(Rob Dix happens to run such a company. It’s called LendSwift, and you can find out more about it here.)
Here’s what you need to know:
London remains “most popular European city” for institutional property investors. But German cities continue to dominate the leaderboard.
Gulf investors know London property is fashionable in every season. The decline in the value of the pound has spurred interest among Middle Eastern investors.
The Park Crescent defies London property woes to generate £60m in sales after launch to market. The price tag of a single property? Anywhere between £3.95 million and £17.95 million, depending on what you’re after.
Monopoly board updated to reflect 2016 London house prices. Old Kent Road just got pricier.
London’s housing crisis hotspots attract most Airbnb guests. Will it lead to more regulations?
Think London’s property market is mad? Watch these frenzied house hunters break down door in scramble to buy flat. It’s times like this we should be thankful for the British obsession with queuing.
Top tool: DIY Conveyance
DIY Conveyance is intended for people who want to avoid the costs of a conveyancing solicitor, but it contains useful information for those who plan on using one too. It helps you get clued up on the process so that you know what’s going on, where you can push things forward a bit, how to avoid hold-ups, and what your rights and responsibilities are when it comes to buying and selling a home.
The end! (Until next month.)
See you next month!