Last month we wrote about 6 Reasons to Still Chose Property Investment Over Other Opportunities.

But in all fairness we can’t say that property investing is for everyone. There are a number of negative factors that existing investors will know and would-be investors should be aware of.

1. Leverage

Just as leverage can be a very positive factor for returns when prices are appreciating, it can also be a devastating factor when prices are going down.

With leverage, it does not take much of a fall in prices and your entire deposit can be erased.

For example, let’s say you bought a 1,000,000 CZK property with a 90% LTV mortgage. This means you have 100,000 CZK of equity that you have in this property.

A 10% decline in the property value with a 90% LTV mortgage means that your total deposit has been lost not just 10% of your equity as would be the case if you hadn’t leveraged the purchase.

Historically property prices have gone up so leverage has been a major advantage to the real estate investor. However, as the last recession has shown, this is not always the case and timing of the purchase and sale can be critical.

2. Transaction costs

Have you ever bought an equity or bond where the costs of the transaction were 6 to 8% of the asset value (typical transaction costs in Czech Republic) or worse yet, 9 to 11% (typical transaction costs in Austria)?

3. Illiquid nature

It is true that you can sell your property when required. However, it can take months to get the right price, especially in a down market.

4. Ongoing capital investment

With equities, bonds or commodities you purchase and then there is nothing more required in terms of capital investment.

Property, however, can need continual inputs of capital for things like negative cashflows or repairs, the latter which could be substantial in the case of an older property.

5. ‘Pain in the butt’ factor

Real estate investing can require the meeting of many legalities, especially at purchase or sale, which can consume large amounts of time.

It’s every owners worst nightmare – bad tenants. They can cause considerable damage to your property, refuse to pay rent and/or refuse to leave the property. Resolving the issue can take months to resolve and be very stressful for the landlord.

6. Size of the capital requirement / Lack of diversity

A large chunk of an investor’s capital can be tied up in one property. This greatly increases the risk of a loss in the case of a market downtown or other negative development which affects the property’s value (ie. a factory being built on the previously empty field next door).

7. Steep learning curve / Amount of skills needed

Owning a successful property investment has been likened to owning a business in that a number of skills are necessary in order for it to succeed.

A landlord needs to be knowledgeable on a number of levels (think mortgages, construction, titles, insurance, negotiations, market familiarity, income potential, appreciation potential, etc.) and have the ability to deal with a myriad of little oversights or difficulties that will inevitably be encountered.

A landlord also needs to make periodic business decisions related to the mortgages, repairs (ie. whether to replace or repair the faulty furnace), tenants (ie. where to advertise, how much to spend, how to qualify tenants, etc.) and negotiations (with tenants, banks, sellers, buyers, etc.).

8. Liability

You could never be personally liable if a company you owned shares in was sued in some affair but you sure could be if someone was injured, or worse, killed in a property you owned.

Property investment is definitely not for everyone. In fact, in this article we identified more negatives about it than we did in our article about the positives.

However, for those who are willing to make the plunge and put in the effort long-term, I personally think the chances of achieving your investment goals are much, much higher than through any other available investment mediums. Then again, I may be biased…

Nathan Brown www.czechpoint101.com

More people have made fortunes through real estate than through any other investment medium.

With so many investment mediums why has real estate been one of the most effective ways to generate healthy returns?

1. Leverage

Have you ever tried to get a loan to invest in the stock market? Or currencies? It is possible but extremely difficult.

In comparison, real estate is an investment class where banks will readily lend money to investors. This in itself is a strong vote of confidence that real estate is a more stable investment than most. Bankers are typically extremely conservative about how they lend out the bank’s money.

This allows the investor to leverage a small amount of capital into a much larger investment.

In an appreciating market this is a great way to increase returns, however, as the last downturn made too evident, it can also work the other way.

Many investors found their leverage worked against them, wiping out the entire deposit in a short period and moving the actual value under the mortgage amount.

Inflation is actually an advantage with leveraged debt on property as the mortgage becomes ‘cheaper’ with time. Case in point is to ask how large a 50,000 GBP debt would have been viewed in the 1960′s compared to if that size of a debt would be considered large today.

So clearly leverage is a valuable tool but, like most tools, needs to be used correctly to prevent injury or damage.

2. Positive cash flow

Real estate is a multi-dimensional investment and one aspect is the cash flow.

In properties either with a high rental yield or low loan-to-value ratios, it is possible to have positive cash flow each month.

Some investors will only purchase properties which have positive cash flow and use a measurement of cash-on-cash return to evaluate a property.

3. Appreciation

Property has one of the most stable and consistent appreciation histories of any asset class.

Equities have historically also performed well with an average of 9.9% compound annual growth rate (S&P 500 Index) if you measured from 1926 to 2010. However, the difference with equities is that the growth can be very sporadic with long-term down periods and other times of very high growth.

By comparison here is a chart of the median home value in the US since 1940 (click for source)
With equities if an investor doesn’t have patience or makes emotional decisions, the timing can really work against them. In contrast, the non-liquid state of a property can force the investor to view things in a longer term way.

Median Home Value in the US

The difference with property over equities is that the volatility from year to year has historically been more stable. Using leverage it is possible to achieve higher returns than equities.

4. Principal Reduction

In a tenanted property, the renter is paying down the leveraged amount of mortgage on a continuous basis. You can sell the asset at any time and recoup on the amount of principal that you have paid down.

5. Depreciation

There are few other asset classes where you can depreciate the value of an object and use this to reduce taxes in the short-term, when in actual fact, the asset is growing in value.

In fact, you can have considerable income from a property and not have to pay tax on it because depreciation makes it seem that there is actually not a positive net cash flow.

6. Tax Advantages

Have you ever been able to write off vehicle expenses or hotel costs for an equity investment?

The fact that you can expense many additional costs related to property is a tax advantage which lowers considerably the amount of tax you actually pay on your income.

Do you have any advantages to add to the list above?

After looking at the above advantages, is there any excuse you can make for not putting some of your investment money into real estate? We would be happy to advise you on the best real estate investments currently available in the Czech Republic.

Of course, there are also disadvantages to a real estate investment, including lack of liquidity, high transaction costs, management requirements, etc. This will be the discussion of a future article.

Nathan Brown www.czechpoint101.com