they repossess, they can claim any shortfall from you. (NB: This only applies in the UK. In the US they cannot come after you for this shortfall, which is why so many people walked away from properties when they fell into negative equity and were unable to keep servicing the mortgage.) If you owe the bank money, you will end up getting a bad credit rating.
This process happened rapidly and left many people reeling. In fact it might be more accurate to call the “aftermath” a “bloodbath”!
If you want a really eye-opening and fascinating account of what led to the global economic crisis, watch Charles Ferguson's Oscar-winning documentary Inside Job. Also, Jacques Peretti's brilliant documentary for the BBC, The Super-Rich and Us, investigates the rise of the “super-rich” as a result of the crisis and challenges the theory of “trickle-down economics”.
But what we were left with (after the aftermath) was actually a potential goldmine for any investor left standing. All the people who'd bought their portfolios when the property market was on the rise, i.e. at the “top of the bubble”, had ignored the cardinal rule of value investing as decreed by the man known as “the most successful investor in the world”, Warren Buffett, who said you should always “buy low, sell high”. It was the savvy investor who knew this, that profited in the aftermath of the crisis by scooping up under-valued properties.
CHAPTER 2
Traditional Property Investing
Until recently, everyone seemed to accept that there were only two ways to become a property owner, which in turn was believed to be the necessary first step towards becoming a property investor. Either you inherited property or you applied for a mortgage and bought it yourself.
When you inherit property from an elderly relative, there is a good chance that the mortgage has been paid off and you will own it outright. Even if there is still a mortgage on it, it's likely that the mortgage is small and there's a sizeable chunk of equity in the property. Either way, as long as you make smart decisions, you've got a good chance of becoming a successful property investor … if that's what you want!
In the past, mortgages weren't too hard to get and properties were affordable. Most professional people with a clean credit history could get a mortgage. People were able to save up for a deposit, or some might have had help from their parents. Once you had a deposit, you'd talk to your mortgage broker or lender and, depending on how much you qualified for, you'd go and look for properties in your price range. You might have chosen to buy a property in need of refurbishment and spent your own time doing it up in order to add value to it. You might have chosen to buy a property with more than one bedroom and rented out the other rooms to help you cover your mortgage repayments, becoming a live-in landlord.
The point is, whichever way you got onto the property ladder, it really wasn't too difficult. However, as I will come to show, for most people, this model simply doesn't work anymore.
Before we look at what does and doesn't work, let's look at two important principles that any serious property investor needs to understand: the principle of leverage and, related to this, the myth of ownership.
The Principle of Leverage
The ancient Greek philosopher and mathematician, Archimedes, said, “Give me the place to stand and I shall move the earth”. He was demonstrating the principle of leverage by explaining that if you had a long enough lever and a place to put a fulcrum, you could lift the earth.
In other words, if you've got enough leverage, you can do anything! Leverage is about finding the path of least resistance. Finding the place where you can put in the minimum effort to get out the maximum results. Apply this to property and we're talking about how little of your own money you can put in to get the most out (by selling for profit or renting out).
In our daily lives I believe most people don't think nearly enough about leverage. Even when moving furniture around the house, people just go ahead and do it without thinking of the best way to do it. They just bend down, pick something up and run the risk of injuring themselves in the process. In the same way, I watch many property investors put their money into property without thinking through all the possible ways in which they could do it. For example, if you bought a house using all cash (whether yours or someone else's) and then you had to put in a lot of your own effort and money, maybe to refurbish it, after which you made a small amount of profit, then that is not good leverage.
Let's look at a real example to show how leverage works. Let's say you have £250,000 in cash to spend. You could buy a property for £250,000 outright. Now let's say that you sell it two years later for £275,000. You've made a profit of £25,000, and that represents a 10 % return on your investment over two years. But your entire pot of £250,000 was tied up in that property, unable to be used for any other investment over the time it took for that property to go up in value.
Now let's say that instead of putting in £250,000 of your own cash, you use £200,000 of someone else's money (a loan) and only £50,000 of your money. Again, after two years you sell the property for £275,000, so you've made a profit of £25,000, but this time the profit represents a 50 % ROI (return on investment).
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