The Rent Review Specialist
Cash
Investment
Investment is about becoming better off, financially, and whatever you invest in is known as an 'asset'. (Whether an asset goes up (appreciates) or down (depreciates) in value doesn't make it less of an asset. Whether it can turn into a liability is a separate issue!
Investments are categorised as liquid or illiquid. Cash and cash-equivalent assets are 'liquid' investments. With a ‘liquid‘ investment you have (immediate) access, either to buy or sell or withdraw funds.
In finance, an investment strategy is a set of rules, behaviours or procedures, designed to guide an investor's selection of an investment portfolio. Usually the strategy will be designed around the investor's risk-return tradeoff: some investors will prefer to maximise expected returns by investing in risky assets, others will prefer to minimise risk, but most will select a strategy somewhere in between. Passive strategies are often used to minimise transaction costs, and active strategies such as market timing are an attempt to maximise returns. One of the better-known investment strategies is buy and hold. Buy and hold is a long term investment strategy, based on the concept that in the long run equity markets give a good rate of return despite periods of volatility or decline. A purely passive variant of this strategy is indexing, where an investor buys a small proportion of all the shares in a market index such as the S&P 500, or more likely, in a mutual fund called an index fund or an exchange-traded fund (ETF). This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors, so it is better to simply buy and hold. The smaller, retail investor more typically uses the buy and hold investment strategy in real estate investment where the holding period is typically the lifespan of their mortgage.
Cash is a liquid form of money, also known currency - notes, coins.
Cash is traditionally regarded a negative investment, because cash offers no scope for capital appreciation because, by virtue of inflation, the spending power of the capital will diminish. Even so, interest can mount up so it is important, when considering alternatives to cash, to allow for costs.
For example, if you were to deposit £500,000 at 3.5% pa fixed for 5 years, then after 1 year you would have £517,500. After year 2 you would have £535,612, after the 3rd year £554,358, 4th year £573,761 and by the end of 5th year £593,843. Whereas if you were to spend £500,000 on a property (yielding 3.5% pa) and sell after 5 years then, assuming no change in rent, you would also have £593,843 but you would lose approximately £30,000 in buying and selling costs and Stamp Duty alone; and that does not include non-recoverable ownership expenses over the 5 year period.
Since property is an asset, it provides a mortgageable security. A difference between cash on deposit and buying a property is gearing, whereby it is possible to borrow against the security of the asset (including any rental income) and buy a higher-priced property than the bare cash alone, but the costs of borrowing, including likely requirement for the value of the property to exceed the amount of loan by a specified percentage, creates a burden of responsibility over which the borrower may have no control. For example, if the loan must not fall below 80% of the value of the property, then any reduction in that value could breach the loan covenant. To remedy the breach would require either the borrower injecting more equity (if funds were available), or the lender restructuring the loan agreement if so minded; or the lender requiring early repayment of the loan or repossessing to get as much as possible of the loan repaid. Restructuring presupposes the lender would be relaxed and the borrower could afford to pay differential terms. The snag with repossession is not only that the borrower could lose out in loss of equity, but also the investment potential would end up with someone else.
With gearing, it is important to remember there is no correlation between a higher-priced property and higher-value. A higher-priced property is simply the price that the market at the time places on the proposition. Whether value would be more or less depends upon the price and the potential. For example, in the institutional investment market, comprising life insurance companies, investment trusts, pension funds, property funds, sovereign investors, and others that are responsible for investing other people’s money, there is normally a minimum lot size for a proposition, the amount for which may be out of reach for other investors. The amount of minimum is usually taken to mean including specific criteria that in the opinion of the institutional investor would only likely to be found in that price range. Whether the scope for rental and/or capital growth is more likely is questionable: the institutional investors is just as likely to get it wrong as any other investor. You only have to read the excuses dished out by property fund managers as to why the values of their portfolios have collapsed to realise that!
Even if you never sell, even if you were to keep the property to pass on through the generations, it does not follow it would necessarily go up in value once all costs and adjustments are accounted for. A property would go only up in value and become an investment when its value increases by more than costs and adjustments and at least maintain that level of increase during your period of ownership.
Over 5 or 10 years, the likelihood of no growth on property might be thought remote. However, because the property market is imperfect - with no certainty the property would sell for what it is valued at - prices are volatile, investors are fickle and there is no correlation between rents and inflation. All in all, profit is about timing: when to buy and equally when to sell.
Although I should expect many people to disagree with my definition of investment, it seems to me that to ignore the costs, loss of interest, inflation and tax is delusion. I think that if you are going to run the risk of using cash, and possibly borrowing to buy a shop property for investment, then you should reasonably expect a reward to compensate for the risk. Running hard just to stand still is not, in my opinion, a particularly productive use of resources. Although a property has to belong to someone, I should like to think that, by the time you have read Shop Investment you would appreciate the difference between owning property that just happens to be let, and being a successful investor.
Similarly, although capital value* fluctuates, stocks, shares and bonds are also considered liquid, because the ‘money’ markets are structured for almost instant liquidity. [*The value of the investment is known as its 'capital value'] Even so, the capital value can fluctuate because the stock market is volatile, so stocks, bonds and shares are riskier.
With cash on deposit, it is unlikely you could lose your capital and all UK regulated savings accounts are covered by the Financial Investors Compensation Scheme, a government-backed scheme providing investor protection up to a set amount.
Compensation limits vary - information can be found at http://www.fscs.org.uk/what-we-cover/eligibility-rules/compensation-limits/ - so many people like to spread the cash around numerous regulated organisations in order to ensure maximum protection for deposits; even so it is generally considered remote for the likelihood of a UK regulated financial organisation to fail.
Unlike cash, and cash-equivalents, property is an illiquid asset. An illiquid asset is one that cannot be readily converted into cash (or cash-equivalent) quickly and with minimum loss of value. Furthermore, depending upon the form of the illiquid asset, it may only be possible to cash an illiquid investment by selling it to someone else. When an illiquid investment produces an income, it may be possible to mortgage the income secured against the value of the asset.
There are practical advantages of liquid over illiquid assets. Liquid assets are portable. Money may be defined as any good or tokens that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services. The use of money provides an easier alternative to barter: in a modern, complex economy bartering is considered inefficient because it requires a coincidence of wants and an agreement that the needs are of equal value before a transaction can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth.
As an illiquid investment, property is high-risk. That does not mean the risk can never be low or minimal, simply there is no guarantee the market value of the property could be realised when the cash is required. To do so would require the certainty of a buyer at that price, completing the purchase and transferring the money on that required date.
With an illiquid investment, risk is not only about what you could lose in terms of how the investment performs, but also whether you could get your money back at any time. Performance is a matter of skill and judgement. The only way to get your money back is to be certain someone else would buy the investment at any time in the future for at least the same price as you paid.
Where many inexperienced investors go wrong when buying is not thinking whether someone else would pay the same. It’s no good thinking, for example, that since there were other bidders at the auction and you only paid slightly more than the under-bidder, when you want to sell there is sure to be as much interest. Auction prices are not representative of market value: all they represent is how much someone paid on the day of the auction.
Investments are categorised as liquid or illiquid. Cash and cash-equivalent assets are 'liquid' investments. With a ‘liquid‘ investment you have (immediate) access, either to buy or sell or withdraw funds.
In finance, an investment strategy is a set of rules, behaviours or procedures, designed to guide an investor's selection of an investment portfolio. Usually the strategy will be designed around the investor's risk-return tradeoff: some investors will prefer to maximise expected returns by investing in risky assets, others will prefer to minimise risk, but most will select a strategy somewhere in between. Passive strategies are often used to minimise transaction costs, and active strategies such as market timing are an attempt to maximise returns. One of the better-known investment strategies is buy and hold. Buy and hold is a long term investment strategy, based on the concept that in the long run equity markets give a good rate of return despite periods of volatility or decline. A purely passive variant of this strategy is indexing, where an investor buys a small proportion of all the shares in a market index such as the S&P 500, or more likely, in a mutual fund called an index fund or an exchange-traded fund (ETF). This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors, so it is better to simply buy and hold. The smaller, retail investor more typically uses the buy and hold investment strategy in real estate investment where the holding period is typically the lifespan of their mortgage.
Cash is a liquid form of money, also known currency - notes, coins.
Cash is traditionally regarded a negative investment, because cash offers no scope for capital appreciation because, by virtue of inflation, the spending power of the capital will diminish. Even so, interest can mount up so it is important, when considering alternatives to cash, to allow for costs.
For example, if you were to deposit £500,000 at 3.5% pa fixed for 5 years, then after 1 year you would have £517,500. After year 2 you would have £535,612, after the 3rd year £554,358, 4th year £573,761 and by the end of 5th year £593,843. Whereas if you were to spend £500,000 on a property (yielding 3.5% pa) and sell after 5 years then, assuming no change in rent, you would also have £593,843 but you would lose approximately £30,000 in buying and selling costs and Stamp Duty alone; and that does not include non-recoverable ownership expenses over the 5 year period.
Since property is an asset, it provides a mortgageable security. A difference between cash on deposit and buying a property is gearing, whereby it is possible to borrow against the security of the asset (including any rental income) and buy a higher-priced property than the bare cash alone, but the costs of borrowing, including likely requirement for the value of the property to exceed the amount of loan by a specified percentage, creates a burden of responsibility over which the borrower may have no control. For example, if the loan must not fall below 80% of the value of the property, then any reduction in that value could breach the loan covenant. To remedy the breach would require either the borrower injecting more equity (if funds were available), or the lender restructuring the loan agreement if so minded; or the lender requiring early repayment of the loan or repossessing to get as much as possible of the loan repaid. Restructuring presupposes the lender would be relaxed and the borrower could afford to pay differential terms. The snag with repossession is not only that the borrower could lose out in loss of equity, but also the investment potential would end up with someone else.
With gearing, it is important to remember there is no correlation between a higher-priced property and higher-value. A higher-priced property is simply the price that the market at the time places on the proposition. Whether value would be more or less depends upon the price and the potential. For example, in the institutional investment market, comprising life insurance companies, investment trusts, pension funds, property funds, sovereign investors, and others that are responsible for investing other people’s money, there is normally a minimum lot size for a proposition, the amount for which may be out of reach for other investors. The amount of minimum is usually taken to mean including specific criteria that in the opinion of the institutional investor would only likely to be found in that price range. Whether the scope for rental and/or capital growth is more likely is questionable: the institutional investors is just as likely to get it wrong as any other investor. You only have to read the excuses dished out by property fund managers as to why the values of their portfolios have collapsed to realise that!
Even if you never sell, even if you were to keep the property to pass on through the generations, it does not follow it would necessarily go up in value once all costs and adjustments are accounted for. A property would go only up in value and become an investment when its value increases by more than costs and adjustments and at least maintain that level of increase during your period of ownership.
Over 5 or 10 years, the likelihood of no growth on property might be thought remote. However, because the property market is imperfect - with no certainty the property would sell for what it is valued at - prices are volatile, investors are fickle and there is no correlation between rents and inflation. All in all, profit is about timing: when to buy and equally when to sell.
Although I should expect many people to disagree with my definition of investment, it seems to me that to ignore the costs, loss of interest, inflation and tax is delusion. I think that if you are going to run the risk of using cash, and possibly borrowing to buy a shop property for investment, then you should reasonably expect a reward to compensate for the risk. Running hard just to stand still is not, in my opinion, a particularly productive use of resources. Although a property has to belong to someone, I should like to think that, by the time you have read Shop Investment you would appreciate the difference between owning property that just happens to be let, and being a successful investor.
Similarly, although capital value* fluctuates, stocks, shares and bonds are also considered liquid, because the ‘money’ markets are structured for almost instant liquidity. [*The value of the investment is known as its 'capital value'] Even so, the capital value can fluctuate because the stock market is volatile, so stocks, bonds and shares are riskier.
With cash on deposit, it is unlikely you could lose your capital and all UK regulated savings accounts are covered by the Financial Investors Compensation Scheme, a government-backed scheme providing investor protection up to a set amount.
Compensation limits vary - information can be found at http://www.fscs.org.uk/what-we-cover/eligibility-rules/compensation-limits/ - so many people like to spread the cash around numerous regulated organisations in order to ensure maximum protection for deposits; even so it is generally considered remote for the likelihood of a UK regulated financial organisation to fail.
Unlike cash, and cash-equivalents, property is an illiquid asset. An illiquid asset is one that cannot be readily converted into cash (or cash-equivalent) quickly and with minimum loss of value. Furthermore, depending upon the form of the illiquid asset, it may only be possible to cash an illiquid investment by selling it to someone else. When an illiquid investment produces an income, it may be possible to mortgage the income secured against the value of the asset.
There are practical advantages of liquid over illiquid assets. Liquid assets are portable. Money may be defined as any good or tokens that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts. Money also serves as a standard of value for measuring the relative worth of different goods and services. The use of money provides an easier alternative to barter: in a modern, complex economy bartering is considered inefficient because it requires a coincidence of wants and an agreement that the needs are of equal value before a transaction can occur. The efficiency gains through the use of money are thought to encourage trade and the division of labour, in turn increasing productivity and wealth.
As an illiquid investment, property is high-risk. That does not mean the risk can never be low or minimal, simply there is no guarantee the market value of the property could be realised when the cash is required. To do so would require the certainty of a buyer at that price, completing the purchase and transferring the money on that required date.
With an illiquid investment, risk is not only about what you could lose in terms of how the investment performs, but also whether you could get your money back at any time. Performance is a matter of skill and judgement. The only way to get your money back is to be certain someone else would buy the investment at any time in the future for at least the same price as you paid.
Where many inexperienced investors go wrong when buying is not thinking whether someone else would pay the same. It’s no good thinking, for example, that since there were other bidders at the auction and you only paid slightly more than the under-bidder, when you want to sell there is sure to be as much interest. Auction prices are not representative of market value: all they represent is how much someone paid on the day of the auction.