Are investors ignoring golden property investment rules?

Kunal Sawhney, chief executive, Kalkine Group

Investing in the right asset and building a portfolio that can create wealth is no mean task.

The ongoing pandemic has made it easy to understand the global economic landscape. The body blow to all economies has created a near-identical disturbance everywhere. Whether in the US, the UK, Canada or Australia, housing markets are on a boil. Governments are struggling to find ways to address the ‘unaffordability’ factor but to no avail.

Canada or the UK, prices remain high

In Canada, the average house price peaked at C$716,000 in March 2021.

In the UK, the government resorted to cutting stamp duty on houses priced under £500,000 to address declining sales during the initial months of the pandemic. By August 2020, the picture changed. A record rise in mortgage approvals was observed, and there has been no looking back since then. According to Nationwide, the British mutual financial institution that tracks real estate, prices were up nearly 13% in August 2021 compared to the pre-pandemic level.

Individual investors in housing markets can do little to rein in rising prices and sales activity. But what they can certainly do is making a prudent investment decision. Though prudence is more qualitative, it becomes quantitative when we talk about some golden rules in property investment space.

The 1% rule

Not every individual investor holding a housing asset is aware of this rule. Did you know Invitation Homes Inc., a leading investor and home leasing company in the US, collects nearly US$2 billion in rent every year? As per the company’s statutory filing, it owns homes worth almost US$16 billion. The company can collect the entire purchase price of any specific house within eight years of acquisition. One can always say that investors like Invitation Homes, BlackRock, and Core Development (Canada) can strike a better deal than retail investors due to their deep pockets and better bargaining power.

This, however, does not mean that the individual investor can overlook some ideal real estate investment rules.

The so-called 1% rule implies the monthly rental income from any investment property must be at least 1% of the purchase price. By this measure, the investor will be able to collect the purchase price over a span of nearly eight years. Does that not add up to big institutional investors’ strategy?

Experts also suggest an extension to the 1% rule – the 2% rule. The underlying theme about monthly rental income is the same, but calculations also factor in repairs and costs like vacancy for a few months to suggest that 2% is better than one. Of course, many may argue that finding an asset that can give such high yields is not possible. But the point is, when the individual investor sets a target of 2%, s/he is more likely to settle anywhere between one and two, but not below one.

Investor rush in housing markets

In mid-June, outrage followed in Canada after Core Development announced its plan of investing nearly CS$1 billion in suburban homes in Quebec, Ontario and other places. Big investors with deep pockets in the US, the UK, Canada and elsewhere are snapping up affordable homes. Besides record low mortgage rates, thanks to low policy rates of all central banks, institutional investors’ dive into hot housing markets have turned things even hotter.

In Canada, rising prices became a central talking point in the run-up to the snap election. Both Liberals and Conservatives pledged to rein in the frenzy through measures like banning foreign investors and ending blind bidding.

According to the Bank of Canada, investors have a share of almost 20% in all purchases in Canada. The central bank defines an investor as someone who already has a mortgage on some other property when availing house loan on a new property. It indicates that individual investors are pretty active in the market. However, in the race to acquiring a house in the hot market, these investors tend to ignore golden rules that do not skip the attention of shrewd institutional investors.

Be wary during unusual times

The expression ‘ignorance leads to suffering’ holds value. But at the same time, a golden rule may not be the best approach at a time when market forces are behaving strangely.

Today, housing markets in Canada, the UK, or elsewhere are treading in a higher trajectory than the pre-pandemic level. This means that the 1% or the more demanding 2% rule can lead to a lack of any investment prospect. Rental growth has yet to match the frenzy in sales price.

A crucial point to consider here is that the investor may not be looking for rental income. Instead, many investors look for short-term capital gains during boom periods by purchasing an asset and selling it by charging a slight premium. For this, it is justifiable to not strictly follow the 1% rule but closely watch small communities and out of sight markets where prices can appreciate earlier than expected.

Rules may not apply perfectly in every case, but it is always good to be aware, especially when we know that institutional investors, too, swear by them. As stated earlier, building a portfolio that can create wealth is no mean task.

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