I specialise in low value properties. I typically buy a property for around £30,000. This requires a £5,000 initial investment from me which includes the deposit, legal fees etc. Every time I get hold of £5,000 I’m itching to buy a property.
Now consider this. I’m walking past a car showroom and I see my favourite car, a Mercedes 300SL for £20,000. it’s a bargain, I’ve got £20,000 in the bank and its in my favourite colour – BLACK! Should I buy it? If I did buy it for cash it wont cost me £20,000. It will cost me what I will lose in the future as a result of the purchase. To see the calculation of what I would lose then read on.
- Purchase Price of Car £20,000
- Initial Investment for a house £5,000
- Number of houses that can be bought £20,000/£5,000 4
- Expected profit generated from each property £150 pcm
- Total profit expected from 4 properties £600 pcm
So if I buy it for cash I lose £600 pcm. This is £7,200 per year and this excludes capital growth. If the houses have risen by 10% in the year then the capital growth is 4 x £30,000 x 10% = £12,000.
So total loss including capital growth is £12,000 + £7,200 = £19,200 – almost the cost of the car!
And what would the car be worth in a year? Well it wont be worth more than £20,000 that’s for sure! Lets say £15,000.
So looking at the true loss of buying a car relative to buying 4 investment properties after 1 year:
Net Worth After Buying Car – Market Value of Car £15,000
Net Worth After Buying 4 Properties
- 4 Deposits x £4500 – – – £18,000
- Rental Profit – – – – – – – – – £7,200
- Capital Growth – – – – – – – £12,000
- Total – – – – – – – – – – – – – – £37,200
So after 1 year the difference in net worth of buying a car and investing in 4 properties is:
£37,200 – £15,000 = £22,200
That’s an annual salary for someone! If the £20,000 that I had in the bank was as a result of a remortgage then the figures are even worse. £20,000 borrowed at 5% makes you a further £1,000 worse off. And if you don’t redeem the debt after 1 year then it will cost you £1,000 year after year after year. If you let it run till the end of your mortgage term you may end up paying more interest than the price of the car! Very bad for your wealth.
I’ll be honest with you however. I do own a Mercedes 300SL worth £20,000! But you’ll be damn sure I didn’t pay for it for cash. I bought the car on HP at 17.3% APR. It costs me £462 per month which is paid for out of my £600 pcm profits generated from the property purchases made.
The principle is – preserve your cash! Wherever you can get sensible credit (less than 20% APR) then take it. As long as you are willing to invest the money you have you can always service the credit you get with the profits you generate. If you need help investing your cash check out some of my advice books.