Investment Properties‘ Best Years Are Over
The rise in residential property prices in recent years has elevated many Slovaks into the upper middle class. However, for long-term owners of investment flats or houses, questions about the future profitability of this investment arise. High property prices offer a unique opportunity to turn "bricks" into financial wealth that does not require care and brings higher returns. Sell the property and buy stocks at a double discount.
Finax is increasing the investment transfer discount and expanding the assets accepted to qualify for the transfer discount to include REAL ESTATE.
Utilize the new terms of the discount – 50% of the value of the transferred investment will be managed with no fee for 2 years.
Note: The data presented in this article are tied to the Slovak market. If you wish to view charts and legislation details for other CEE countries, please refer to other language versions of this blog, which contain localized data.
Keeping money in real estate has long enjoyed popularity in Slovakia. In 2018, 62% of respondents ranked them as the best form of long-term investment. A more recent survey also suggested that more people invested in properties than funds and securities (23% versus 21%).clie
Given the price development in recent years, this comes as no surprise. Real estate prices have risen by tens of percent, almost regardless of location and condition. Years of low interest rates and high competition among banks have played into the hands of Slovaks. Thanks to extremely cheap mortgages, they could work efficiently with debt, allowing many to build decent wealth.
But is investing in real estate still worth it in 2022? Or is it more profitable to sell an expensive apartment or house and invest the funds elsewhere? These questions are troubling more and more investors and potential buyers. Over the last six months, our clients have also been frequently asking us whether it makes sense to sell properties and buy stocks.
Warning: Past performance is no guarantee of future returns and your investment may result in a loss as well. Learn what risks you are taking when investing.
Sell the Peak, Buy the Dip
Contrarily to the fabulous growth in real estate, stocks are experiencing downturns. Compared to the beginning of the year, the value of stock indices around the world is still roughly 15% lower.
The secret advantage of such development is that most of the adverse events you can think of are already priced in (war in Ukraine, high energy prices, inflation at all-time highs, rising interest rates, etc.).
Although the upcoming months may continue to be challenging for stock markets, we can expect growth again when times return to normal. Historically, every crisis has been overcome within the range of a few months to a couple of years, and the investors who bought cheaply during downturns managed to ride the wave of market recovery and earn the highest returns.
Conversely, in real estate, we can list several risks to which the price has not yet responded. Several years of double-digit growth seems suspicious even to the National Bank of Slovakia. In the fourth quarter of 2021, its composite index for assessing the development of housing prices entered the high-risk zone of price correction. Until recently, this category bore a simpler name – a bubble.
In the table below, we outline some of our arguments in favor of a price correction and a few points supporting further growth. You can decide for yourself which you find more likely.
Among factors supporting a correction are more expensive mortgages or a decline in the number of buyers due to relatively cheaper rents (as indicated by several indices) and the inability to save 20% of the property price required to obtain a mortgage due to the inflationary strain on personal budgets.
The possibility of property tax rises (either due to OECD recommendations or the pressure on municipality budgets created by the passage of the pro-family package in parliament) should also be considered.
Of course, there are also arguments for continued growth. There will be pressure on prices from high inflation and lack of supply due to slow construction and a lengthy approval process. With mortgage rates still favorable (given high inflation) and a strong preference by Slovak investors, the fairy tale of endless real estate growth may continue a little longer.
Naturally, the truth may also lie somewhere in the middle. Prices may neither fall dramatically nor maintain double-digit growth. A realistic estimate is a slowdown to a growth rate of 3-4% per year. A similar estimate was recently published by the Financial Times based on data by Refinitiv and Oxford Economics.
The chart below summarises these facts. Between 2002 and 2021, real estate recorded an average annual return of more than 7%. Those investors who jumped into the market at the post-2012 lows made a great decision.
They could have earned as much as 100% on their investment, and that's not even counting the possibility of mortgage financing. Funding investments with cheap debt decently multiplies the return derived from the property price growth during the investment’s first years. More on that in the next blog.
The chart also shows the possibilities for future long-term development. The optimistic scenario foresees a long-term 7% annual growth, the realistic estimate is the aforementioned slowdown in average growth to 4% per year, and the pessimistic scenario is a slight price correction followed by slow growth of 2% per year.
You can pick a number you find the most likely from this interval. Afterwards, however, ask yourself whether the stock market contains a higher earnings potential in the upcoming years.
Such a question is reasonable, as investment properties are assets whose sales can be timed to a certain extent, unlike securities traded on stock exchanges. Their price adjusts to market events (such as rising interest rates) much more slowly, as processes such as selling take several months rather than a second.
Consequently, when conditions turn unfavorable, real estate slows down later than the stock market but is also much more cumbersome to start recovering. This allows us to get out while they are still high and move profits into stocks, which will achieve higher returns in the next few years as they recover.
Take the example of 2008. Although the global financial crisis was triggered by the US housing bubble burst, it took until early 2012 for property prices to reach their bottom. Although stocks collapsed more quickly, they started to recover in 2009.
People who sold their properties and put their money into the collapsed stocks made the most money. Since stocks have already managed to plunge in 2022, while real estate has not yet slowed down, there may be a promising opportunity in the transfer.
Grab the Chance and Get a Discount
If you own a 5 to 15-years-old investment property, sell it and transfer the sale proceeds into index ETFs in Finax. This way, your money will appreciate passively, with a higher long-term return, and provided you’re a Slovak tax resident, without incurring tax liability after a year of holding.
As a reward, you will receive a 50% discount on your portfolio management fee for 2 years, which will further multiply the potential of this opportunity.
In Slovakia, the profit from a property sale is exempt from income tax after 5 years from the date of acquisition (applies to individuals and properties not classified as commercial property). Hence, you will not lose money on the transaction. For taxation details in other CEE countries, please see the national versions of this blog.
All you need to do to qualify for the discount is to send us the supporting documents, e.g. the purchase contract or bank account turnover details, by email to email@example.com.
If you deposit more than 100,000 euros thanks to the transfer of money from the sold property, you will also receive the icing on the cake in the form of inclusion among the Finax Elite clients. That will yield a discounted basic portfolio management fee of 0.85% p.a. in addition to the investment transfer discount.
Other Elite client benefits include a personal wealth manager or brokerage service.
The Journey Towards Passive Income
As we described in our blog post on comparison to real estate, one of the benefits of passive index investing is the low time requirement. Once purchased, you don't have to do anything with the ETFs for years, they don't require new rental agreements, solving tenant drop-outs, or leaky toilet repairs.
The goal of lifelong wealth building should be to free yourself from such unpleasant obligations. Money is just a means to gaining freedom to enjoy leisure, hobbies, family time, or anything else that fulfills you.
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As wealth grows, property maintenance becomes increasingly annoying. You could be taking your kids on weekend trips or enjoying more leisure activities, instead you're rushing to deal with a leaky toilet, renovations, or locked-out tenants.
It can be solved by hiring people to take on obligations for you. However, by doing so, you further reduce your investment return. Selling an older property can be one step on the road to true financial freedom.
That logic isn’t limited to investment properties. After the children have moved out, we may no longer need to live in a large family home where empty rooms just bring high fixed expenses.
An unnecessarily large home that no longer suits your needs at an advanced age may also be worth turning into financial assets. You can use some of the proceeds from the sale to buy a smaller new-build home that is simpler and cheaper to maintain.
The remaining money can be invested in a payout portfolio that allows drawing passive income while continuing to appreciate the invested wealth (if you're searching for a similar solution, read about our Intelligent Annuity).
Conclusively, the current times may offer you the chance to kill two birds with one stone. Not only will you increase your returns, but you'll also move to a point in life where you'll have to endure less stress for your wealth. If you feel the same way, we’ll be happy to welcome you to Finax.
Next week, we'll publish a blog explaining how the return on a property funded with a mortgage decreases with time.