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My last article (Newlyweds and their new finances) focused on the importance of educating your soon-to-be or newly married children towards a stable and successful financially independent life. However, in addition to the gift of educating your children, most parents would like to be able to help their children financially. So how can you do that? How can you try to ensure that your savings will be sufficient for your retirement while also helping your children and/or any other dependents?
A critical element of your long term financial plan has to be the creation of an investment plan. It’s never too early to create such a plan, and obviously the earlier you put it in place the better. However, by the time you reach your forties, fifties and sixties it is far more crucial that you are following an investment plan and actively saving in order to achieve your goals. These are the years that you will hopefully be marrying off your children, helping them with their education, and planning for your own retirement. Sometimes at this stage some people also need to offer financial support to parents or more elderly relatives. And as parents and relatives age and pass away, it is often at this juncture that inheritances are received, which can be a major boost towards achieving your long term goals if handled correctly.
As I see it, there are three main tracks for potential investments:
- Real estate – residential and/or commercial
- Stock market-based investment portfolios
- Alternative investments
In order to be able to discuss these options fully, I will focus solely on the pros and cons of real estate options in this article, and address the other tracks in subsequent columns.
There are several pros to investing in residential real estate in Israel.
- There has been a history of long term price appreciation in Israel which has averaged between 3-4% a year.
- Buying a residential property can usually be leveraged with low cost financing from a bank with a low cost long term mortgage.
- The property can be rented out and the rent used to cover the cost of the mortgage (if your down payment was large enough).
- Owning a bricks and mortar investment where you can touch and feel the underlying asset provides a higher level of certainty that you actually own something ‘real’ and can give investors a feeling of lower overall risk.
Obviously, there are several cons that counterbalance the pros.
- The rent to value ratio (how much rent you can charge annually as a percentage of the value of the property) is relatively low – 2-4%. While this range does not seem bad compared with the zero-rate interest environment we are currently in, these returns are comparatively low when viewed against similar residential return rates in other Western countries like the USA.
- The property market has been on the rise for the past 11 years. Anyone buying in now is likely doing so at the market’s peak with the double digits’ gain a thing of the past.
- There are new fees and taxes that have been introduced as part of the government’s plan to lower the cost of housing (eg. the 1% tax on those owning 3 or more properties, and a purchase tax of up to 10%).
- Maintenance of the property can be time consuming and frustrating. There are companies that manage properties, but paying them reduces your profitability and ultimately you still have to make many of the critical day to day decisions relating to the property.
- The investment is not liquid. You will be unable to access the money at short notice should you need even part of your funds. You might be able to get a loan or mortgage but that is not always a simple process. As a rule of thumb, people are more familiar and comfortable with residential real estate investments because they can relate to owning a home, but they are often less aware of the other options available in the real estate industry.
But other parts of the real estate market can be very worthwhile exploring. Those opportunities can range from investing in commercial real estate via buying an office building (or part of one) to financing a land purchase, or investing in the construction of a mall, among many other opportunities available throughout the value chain. And although obviously the basic principles relating to investing in real estate apply to both residential and commercial, there are different pros and cons involved.
The pros of commercial real estate are as follows:
- There are generally higher rates of return. Israeli purchase groups often can generate 6-8% rates of return over time while entrepreneurial investments and mezzanine financing investments which are much more speculative can earn in excess of 10-15%.
- When you buy into a share of a larger project, you give yourself the opportunity to increase your diversification by going into different projects.
- It is easier to get territorial diversification by splitting your investment money into projects in different countries without needing to be involved directly in the management.
- There are many different types of opportunities available – from mezzanine debt (a middle layer of capital that falls between equity/ownership and purely secured debt) to large commercial properties, to multi-family units or student housing.
The cons are:
- There is less direct security than when you own an entire property yourself as properties are usually leveraged more, increasing the underlying risks.
- Whenever you transfer your money to a third party to invest for you, your level of certainty into what is happening behind the manager’s curtain is less than when you can track and ensure that your investment money is doing exactly what you intended it to do.
- You are part of a group investment which means you have less flexibility to decide when and how to sell.
- The investors generally need to have more money available for investment to be eligible for many types of investments that are only available to ‘qualified’ investors.
- Investors often need a level of expertise and experience to be able to evaluate the nuances between the various investment opportunities. Alternatively they might need to invest more to have the investment option evaluated by professionals in the field.
As with any investment there are no guarantees, but investments provide you with an opportunity to grow your savings if you can find one that matches your level of risk and you do your due diligence. If you can’t evaluate the potential risk and gain yourself then consult a professional for advice.
My next article will explore other investment options, but in the meantime, if you haven’t already done so, start thinking and being proactive in building your investment plan now.