SUPPLY AND DEMAND

In our last newsletter we looked at the basics of financial planning, this time we will be taking a look at the supply and demand factors which affect all markets and we will be applying them to the property market. Before we start though, we would like to say that in an ideal world everyone would know all these things before they leave school. It’s quite strange that in our schools we still teach ancient history, Latin and technical drawing but we do nothing to prepare our children to face the financial realities of the real world. It’s almost as if somewhere back in the distant past a group of academics got together and set a curriculum and no-one has dared change it since. Wouldn’t it be great if someone introduced some new subjects to the modern curriculum like relationship building, communication skills and financial planning?

Isn’t it strange that the most important and highly paid jobs all require highly developed communication skills and yet so little emphasis is placed on how or where to learn these skills? Everyone strives to be happy, and to many happiness depends on financial security. However overriding this, the one thing that determines happiness more than any other factor is relationships, yet almost no effort is put into teaching our children how to build relationships successfully.

We mention these things because when you set out in life the most valuable asset you will ever find is a true and loyal friend. Friends are there for you when you need them, they tell you what you need to know even if it’s not what you want to hear and they are with you for life. We would not presume to offer the kind of rare friendship which only occurs a very few times in a lifetime, we are a business and our aim is to be successful; our motives in offering help and assistance are therefore commercial rather than altruistic. Aside from this esoteric difference, there is a school of philosophy that contends there is no such thing as altruism anyway and everything we do is ultimately motivated by self interest. If so, what we are offering you is very much like a friendship. We aim to be there when you need us, we will give you the advice you need whether or not it is what you want to hear and above all we aim to have a relationship that lasts a lifetime and results in us both being better off.

Attitude, belief and confidence are so much more important than knowledge, talent or skill in determining success. Nevertheless knowledge can inspire confidence; it can also make you aware of your limitations and stop you making costly mistakes. Why do prices go up or come down? A classic example is the price of gold - everyone agrees that gold is desirable and therefore valuable yet as we can see its value in relation to money and other assets varies greatly over time. What is it that causes these huge movements in price?

The answer is of course supply and demand, which in the case of gold is interesting because the commercial uses of gold are strictly limited and that includes its use in jewellery. Ironically most of the gold that has ever been mined ends up back underground in bank vaults! The supply of gold is determined by geology, ingenuity and economics. Mother Nature has preset the amount of gold in the world and how much of it we can get at depends on how clever and determined we are, which in turn is affected by how valuable it is. The higher the price of gold the more money can be spent mining it at a profit, if the price falls then expensive mines become unprofitable and have to cease production. The demand for gold on the other hand is driven by politics, fashion and above all speculation. Historically gold has been used as a standard to underpin the value of paper money, hence the gold standard. Even though gold no longer serves this purpose all nations keep reserves of gold which is seen as a hedge against inflation and economic uncertainty. Sentiment drives speculation which if you look at the charts can clearly be seen in a series of pronounced booms and prolonged busts. Money can certainly be made in gold but the risks are high and the outlook uncertain.

To make money out of gold you could buy the metal itself, but for obvious reasons for most people that would be impractical. Instead you can buy securities that represent the metal in that they have the same value and can be traded on a market. If you open up a spread betting account or an account which deals in contracts for difference you can go a step further and buy gold on the margin. This means for every $100 of gold you speculate on you only have to put up a stake which could be as little as 1% of the contract value.This means if the price goes up 1% you double your money and conversely if the price falls 1% you lose all your money - you therefore have ‘gearing’ of 100 because you stand to gain or lose 100 times more than if you paid 100% of the face value price for the gold. Take another look at the graphs and you will see that if you got your timing right you could have made a fortune on gold trading; equally you could have lost your shirt.

So is property any different or is it all just a lottery? Well there is no doubt that property can be a highly geared investment, it is possible to borrow 100% of the value of a property and in some cases even more. This means if the property goes up in value you can accumulate equity from nothing and if the property falls in value you can end up in negative equity.

In this respect buying property with a mortgage is similar to trading gold, or any other security, on the margin. There is however a major difference between gold and property at least in this regard. If you trade gold on the margin and the price goes against you then once your margin is used up you are liquidated, so even if there is a recovery in the price you will not benefit because you are out of the game. In the case of a property with a mortgage things are very different, in that what determines whether you keep the property or not is not its value, but your ability to service the mortgage payments. So even if the property falls in value in the short term, provided you can continue to pay the mortgage, usually from the rent, then the property is not liquidated and therefore you stand to benefit from any recovery in the price.

The crucial thing is to take all due steps to ensure that if prices fall and interest rates rise, you can ride out the downturn on the back of good rental returns. If you are unable to do this and have overcommitted yourself then if times get hard you will lose your property to the lender. So property selection is the key, you have to select property which has the right mix of capital appreciation prospects and a solid and rising rental demand. You have to balance your commitments carefully to ensure you have retained a comfortable margin for safety, and again individual property selection is crucial. Its easy to point out the advantages of buying property, there is a growing demand and a shortage of supply that is predicted to carry on for many years and yes, in the long term, this will almost certainly lead to increases in price. That does not mean that there will not be certain properties that do better than others or that there will not be some setbacks along the way. Referring back to our previous missive it is all about balancing your assets and liabilities with your income and expenditure on a short, medium and long term basis.

Finally let’s look at risk in a bit more detail. The thing about risk is its all relative and it’s very much to do with perception. As an example if you won a dream holiday to an exotic country you might go and have a great time without being aware of the risk you had taken - how would you feel if you were to return and find out there was a deadly contagious disease in the area against which you were not protected? Faced with the same decision again you would not go, so in hindsight ignorance was bliss. Rule one is therefore to be aware of the risks you are taking but that doesn’t mean you need take no risk. Rule two is you have to balance up what you have to gain and what you have to lose by taking a course of action. It may be possible to lose money by investing in property or anything else, but what have you got to gain and what have you got to lose? In most cases the financial prospects if you don’t invest in anything are grim and out of the range of options open to you a choice has to be made. Do something or do nothing, if you do something then do you prefer property to the alternatives? If you do prefer property another decision has to be made - do it yourself or seek help? Our belief is you are better off with our help than going it alone, it comes down to knowing who your friends are and who you can rely on to give you the advice and support you need when you need it. Life so they say is a race, but it’s a marathon not a sprint and winners always win in the end, we are here to help you get to the start line.

Yours sincerely

Choices Acquisitions and Investments
01342 840000

© Choices 2009 - 2010. All Rights Reserved. Permission required to use or duplicate content and/or code found within this site in print or electronic form. We reserve the right to make changes at any time and without notice.

Choices was designed and built : By The People

Choices Estate Agency

Property Investment

SUPPLY AND DEMAND