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godsakes

Why Btl And Shares Aren't So Different

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There's been a lot of talk about how BTL doesn't make sense i.e situations where the BTL at current poor yields doesn't over the mortgage hence the landlord effectively subsidises the tennant (cashflow negitive).

Some BTL landlords justify this by holding onto the hope of capital gains - personally i feel this is at best a big gamble if not downright stupid.

Most people on this forum however seem to believe in shares - i personally think shares are little more than a socially acceptable form of gambling.

Now, this is the point where people will say that shares are different because you're buying into the future cashflow of a live business.... so in theory as that company grows, invests more and generates more profits, and somehow those profits will filter to the shareholders.....

Now i would accept that arguement if you could actually get a decent return on your shares in the form of dividends, which comfortably beats bank interest. Do any of you serious investors, invest based purely on dividends? because if you don't it seems stock market investors are quite like these current BTL investors who have to hope for capital gains

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Guest muttley

Well, lets assume BTL was a plc. Why would you buy shares in it? Not for the dividend. Yields of 4-5% are not uncommon (This assumes zero voids) Not for future growth. Best case scenario...keeps pace with inflation. Worst case scenario....falls by (insert your favoured figure here).

My opinion: STRONG SELL.

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Guest muttley

Pricing people out of Amazon.com stock is not the same as pricing people out of a home.

What about buying shares in Bellway? Don't you expect to get a cut?

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Interesting to compare BTL and stocks, since many people seem to be relying on one or the other for their pension. Also, you are dead right to look at income, which has to be the ultimate basis of value.

A BTL can generate rental income. In terms of income, that's all it can ever do. On the other hand, it is unlikely to ever be in a state where it generates no income. The yield might at some point in time be less than the bank rate but it will presumably never be zero.

A business can expand and contract. An expanding and successful business can generate an incredible level of income, which may or may not be dispersed to the shareholders at some point during the company's lifetime. On the other hand an unsuccessful business might end up in a state where there is no prospect of it ever turning a profit.

So, in income terms one might think that property is a boring but safe investment, and stocks are the wild risky and exciting play. However, there are stocks and stocks. There are stocks in large, established companies which have maxed out their market share, established a brand or other hard-to-emulate business practice. These companies are generally (it is believed) not going to bomb out in the near future. They also tend to pay dividends, because they do what they do well and don't see a reason to plough profits back into the business to drive further growth. On the other hand there are the smaller start up companies who are really selling more of a lottery ticket. These companies might well come to nothing but on the other hand they might eventually turn into one of the bigger type of company which I mentioned before. The smaller, growing companies tend not to pay dividends as they are putting all their money back into the business to drive the growth.

So, with property you have a rather limited upside. All a property can ever provide is the benefit of living in it, which you can exchange for rent. The value of this benefit might well go up over time, but it isn't going to change much in nature. This seems to be the main downside with property. On the other hand that benefit will always be there and it will always be worth something.

With stocks people have a range of growth / income plays to choose from. Many small companies and even some large companies will bomb out over a given time period. But the growth opportunities for industry are fairly unlimited. Stocks are liquid and you can change direction easily if you are prepared to do a bit of research. For example, moving between different industrial sectors or geographical areas.

frugalista

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What about buying shares in Bellway? Don't you expect to get a cut?

Not really, the market (or the lending or general muppetry) determines the sale price rather than the share price, Bellway shares were up 60% on the year up until recently, have their houses inflated by that amount over the last year?

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Guest muttley

Not really, the market (or the lending or general muppetry) determines the sale price rather than the share price, Bellway shares were up 60% on the year up until recently, have their houses inflated by that amount over the last year?

They also issued a dividend, which could have been used to reduce the price of their product.(A house)

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There's been a lot of talk about how BTL doesn't make sense i.e situations where the BTL at current poor yields doesn't over the mortgage hence the landlord effectively subsidises the tennant (cashflow negitive).

Some BTL landlords justify this by holding onto the hope of capital gains - personally i feel this is at best a big gamble if not downright stupid.

Most people on this forum however seem to believe in shares - i personally think shares are little more than a socially acceptable form of gambling.

Now, this is the point where people will say that shares are different because you're buying into the future cashflow of a live business.... so in theory as that company grows, invests more and generates more profits, and somehow those profits will filter to the shareholders.....

Now i would accept that arguement if you could actually get a decent return on your shares in the form of dividends, which comfortably beats bank interest. Do any of you serious investors, invest based purely on dividends? because if you don't it seems stock market investors are quite like these current BTL investors who have to hope for capital gains

I commend your thinking & have to say that this is the first time I've heard this angle from someone on this forum.

You are essentially to my thinking saying that the forum accuses new BTL's of subsidising their tenants with negative cashflow investments with the hope of CG to compensate.

You are also saying that stock market investors are doing the same or worse, because many shares don't even pay a divided. What is the avg yield of the stock market at the moment? 3%? 2%?

Spot on and just another reason why property is such a winner & will continue to be a winner whilst yields are so high and IR's are where they are. 6.3% is the avg yield apparently.

I think the truth of the matter is that bears like shares because they can make a small investment. By their nature, bears are weary of large investments as they perceive larger risk. But the truth of the matter is that property has shown itself to be reliably less risky than shares. Bears just need to realise that you can't lose much from zero. That was my own starting philosophy. What did I have to lose doing what I was doing? Nothing. But if I failed to act on an opportunity, I would lose my chance to rise up from zero.

Right now there are plenty of opportunities out there, but bears just see the risk of failure. What about the risk of failing to succeed, isn't that worth more?

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Spot on and just another reason why property is such a winner & will continue to be a winner whilst yields are so high and IR's are where they are. 6.3% is the avg yield apparently.

Highly debatable figure that one, but probably achievable in shared houses etc. at a push. But then I'd want to offset the yield with higher management charges (my time) - so pushing the yield lower. Flat yields are lower than this.

Spot on and just another reason why property is such a winner & will continue to be a winner whilst yields are so high and IR's are where they are. 6.3% is the avg yield apparently. What is the avg yield of the stock market at the moment? 3%? 2%?

Fairer to compare P/E with BTL yield. You also need to consider whether or not the risk premium on each of these investments is fair. Current house prices have broadly the same risk premium as 15 years ago despite general wage disinflation over that time.

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Spot on and just another reason why property is such a winner & will continue to be a winner whilst yields are so high and IR's are where they are. 6.3% is the avg yield apparently

I personally wouldn't do a BTL at a (gross) yield lower than 10%, seems too much risk for me - but I do prefer the BTL model as an investment over buying & selling shares.

The whole buy low and sell high thing isn't for me - a situation where I pay £x per month in expenses but recieve £x+y in rent makes far more sense to me as an investment.

Highly debatable figure that one, but probably achievable in shared houses etc. at a push. But then I'd want to offset the yield with higher management charges (my time) - so pushing the yield lower. Flat yields are lower than this.

I'm personally looking into some tennanted commerical property at auction and based on the top guide price I have seen some with a yield of 13% which comfortably covers a repayment mortgage (assume 7% interest rate).

there's issues such as requiring a bridging loan to cover the VAT on the property sale and the risk of your tennant going bust, and what price the property will actually sell for on the day but on paper it seems like a worthwile investment.

due to the effect of gearing you end with a yield on your despoit of over 20% after expenses

Fairer to compare P/E with BTL yield. You also need to consider whether or not the risk premium on each of these investments is fair. Current house prices have broadly the same risk premium as 15 years ago despite general wage disinflation over that time.

Do you consider a PE of 10 to be decent price? I'll assume you do

Now, if your mate ran a business which generated £20k profits per year, would you pay him £20k for a 10% share of his business? I wouldn't but that is effectively the deal you're getting with a PE of 10

When you buy based on PE you're not buying with the intent of holding and living on the income stream, you're hoping that by industry standards you've bought at a low PE and someone else will buy the shares off you at a higher PE.

Edited by godsakes

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I personally wouldn't do a BTL at a (gross) yield lower than 10%, seems too much risk for me - but I do prefer the BTL model as an investment over buying & selling shares.

The whole buy low and sell high thing isn't for me - a situation where I pay £x per month in expenses but recieve £x+y in rent makes far more sense to me as an investment.

I'm personally looking into some tennanted commerical property at auction and based on the top guide price I have seen some with a yield of 13% which comfortably covers a repayment mortgage (assume 7% interest rate).

And the sheer fact that it is a bigger investment than a share investment for an avarage person means that your type of thinking is more likely to bring you success than the on/of speculator type thinking!

The best advice I could give anyone starting out in BTL is to first put your personal finances in order so you can be ready for the opportunity when it lands in front of you. But it sounds like you may already have done that.

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The best advice I could give anyone starting out in BTL is to first put your personal finances in order so you can be ready for the opportunity when it lands in front of you. But it sounds like you may already have done that.

I'm doing alright currently from my internet business, enough to say i don't have to worry about the monthly bills and can focus my attention towards making my money work for me. I'm cash rich but I don't have my own home sadly.

The idea of investing in a commercial property is that there will be enough excess cash flow to cover a future mortgage on my home when i do decide to buy.

The strategy requires a fair bit of cash savings (if your tenant got run over by a bus you'd be buggered for quite a few months until you got a replacement).

I'm just trying to arrange finance for the deal but what may sink the deal is the VAT - I can do a 25% deposit but adding VAT onto a whole property is alot of money to find even if you're going to reclaim it back in 3-4 months.

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For TTRTR to say this is an original topic is disingenuous. I covered the topic with BBB 18 months ago.

In order to approach this logically, you need to understand the difference between cashflow, earnings and dividends. To look merely at dividends is to miss the point. Why?

Dividends are just a part of the profits owned by the shareholders of a company. ALL earnings BELONG to shareholders, it is just that some are RETAINED and some are paid out as dividends. The retained earnings are retained to GROW the business without the need for ever higher borrowing (BTLs route!). If you wish to understand investment you must STOP viewing your investments as units and think of the whole to which they are a part.

Folks have conflated a whole bunch of concepts which amounts to not comparing eggs with eggs.

For instance, when TTRTR talks of "Yield" he means "Gross Rental Yield". This is then compared to Yield on shares, by which folks mean "Gross Dividend Yield"

There is also a problem with the usefulness of ROCE in companies that write down intangibles. This massages ROCE higher. See why I hate fundamentals! LOL

These may sound similar, buttheay are quite different. Comparing the two businesses, here is how we arrive at (more) equivalent figures:

Gross_rental_yield_on_BTL

- voids_on_BTL

- agents_fees (part of operating costs)

- insurance ( operating cost)

- property_maintenance (depreciation)

- profit_retained_in_non_BTL_biz ( no equivalent in BTL - they just borrow more )

____________________________________________________________________

= Gross_dividend_yield

If you really want to compare them as businesses (rather than investments) you should look at the Return On Capital Employed (ROCE).

ROCE is the calculated by expressing the operating profit before tax as a percentage of the year-end capital employed.

So for a BTL, we would take the notional gross-rental-yield, subtract voids, subtract maintenance (depreciation charge in a business), and arrive at a figure, which we could then make into a percentage by dividing by the amount of money tied up in the bricks and mortar (ie the price). IMO, THIS FIGURE IS CURRENTLY NEGATIVE OR IN SINGLE DIGITS.

Here are the figure for listed companies (oh yes, I shit you not)

10 May 2006 Index Statistics Company REFS - Really Essential Financial Statistics

INDEX STATS - Latest ROCE Statistics

__________________Weighted Ave _______ UpperQuartile ____Median ______ LowerQuartile

FTSE 100 ___________41.9 ______________45.0 ___________26.0 __________12.7

FTSE Mid 250 ________45.5 ______________37.2 ___________23.2 __________11.9

FTSE SmallCap ______64.7 _______________43.1 __________24.8 ___________10.9

FTSE Fledgling _______22.7 _______________18.9 __________8.31 ___________1.19

FTSE Non Index ______23.5 _______________21.8_________ 0.17 ___________-30.5

AIM ________________42.8 _______________33.9 _________15.6 ____________5.35

Market _____________42.3 ________________28.8 _________8.63 ____________-6.23

(why the f@ck do we not have tables enabled on this forum)

I should add that some feel ROCE is NOT a suitable measure for banks and property companies as high leverage is seen as "traditional" and thus acceptable.

ROCE can also be boosted by writing down intangibles. Fundamentals: what a hoot they are!

Despite being called "fundamentalls" it is actually contentious. Views?

Edited by Sledgehead

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For TTRTR to say this is an original topic is disingenuous. I covered the topic with BBB 18 months ago.

In order to approach this logically, you need to understand the difference between cashflow, earnings and dividends. To look merely at dividends is to miss the point. Why?

Dividends are just a part of the profits owned by the shareholders of a company. ALL earnings BELONG to shareholders, it is just that some are RETAINED and some are paid out as dividends. The retained earnings are retained to GROW the business without the need for ever higher borrowing (BTLs route!). If you wish to understand investment you must STOP viewing your investments as units and think of the whole to which they are a part.

You make some valid points but I would argue that most successful business people tend to view things as simply as possibly.

In my view an investment should simply put money into your pocket (at the end of the day that's how companies work, if a UK factory is unprofitable, it gets closed and another is opened in the far east)

if a BTL is taking money out of your pocket, sell it off - if it puts money into your pocket keep it - simple!

it's all very well that these listed companies are highly profitable, but if that money doesn't filter it's way into your pockets what good is that?

Edited by godsakes

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if a BTL is taking money out of your pocket, sell it off - if it puts money into your pocket keep it - simple!

it's all very well that these listed companies are highly profitable, but if that money doesn't filter it's way into your pockets what good is that?

On the latter point I would agree if it were not for some factors.

Since 1997 the government has removed the dividend tax credit that allowed dividends to be paid free of tax into pension funds. pension funds a ) have huge shareholder power, b ) don't like paying taxes. If you found that companies seemed to stop paying dividends post 1997 there may have been a good reason for it: pension funds telling them to retain profits and invest them. This led to a rash of foolish investments in dotcom arms etc and is the subject of research papers. Basically the view was, use it or lose it. Were they wrong to take this view? It didn't seem like it in 2000!

Paying dividends may sound fine until you apply it to your own business. is it right to shell out dividends, then go borrow from the bank to replace a printer or company machinery? Should you shell out dividends and then borrow to fund that trans-national marketting campaign?

Much depends of course on the level of interest rates. If ROCE is greater than the borrowing rate, it makes sense, otherwise it's daft. If the gov plan to tax your div massively, you'd aslo have cause to retain dividends.

On the BTL side you say it is a simple matter of deciding whether it is putting money in your pocket. However, few factor in the cost of maintenance. Most totally underestimate it. In that respect what seem slike a winner is merely just the slow collection of money thatwill eventually disappear in that 20 year makeover.

People moan about pensions pot blackholes, but the conservative way they are calculated would worry the cr@p out of most BTLers.

Edited by Sledgehead

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I personally wouldn't do a BTL at a (gross) yield lower than 10%, seems too much risk for me

... which implies you would be happy to buy at 10.01% - ie after 10 years the BTL has paid for itself - as long as that 10% was AFTER maintenance and insurance and agents fees.

Do you consider a PE of 10 to be decent price? ..... I wouldn't

Why not? The business pays for itself after 10 years - same as the 10% BTL deal assuming that the 10% is after maintenance and insurance and agents fees. If BTL and shares aren't so different (your words), why make the distinction here?

:blink:

Edited by Sledgehead

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Yes, you're quite right. After all, Berkshire Hathaway has never paid a cent in dividend, and look how appallingly they've done!

:rolleyes:

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is it right to shell out dividends, then go borrow from the bank to replace a printer or company machinery? Should you shell out dividends and then borrow to fund that trans-national marketting campaign?

If i was faced with the choice of borrowing from a bank or to issue shares to the public to fund a company's expansion - i know which i would choose.

one requires you to pay bank interest regardless of your success or failures

the other doesn't even require you to pay dividends in many cases and if the share price falls well it's the shareholder's problem.

Why not? The business pays for itself after 10 years - same as the 10% BTL deal assuming that the 10% is after maintenance and insurance and agents fees. If BTL and shares aren't so different (your words), why make the distinction here?

No, the shares would pay for themselves after tens years if the dividend was 10% of the price you bought them at.

Again it's all about what goes back into the investors pocket

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If i was faced with the choice of borrowing from a bank or to issue shares to the public to fund a company's expansion - i know which i would choose.

one requires you to pay bank interest regardless of your success or failures

the other doesn't even require you to pay dividends in many cases and if the share price falls well it's the shareholder's problem.

No, the shares would pay for themselves after tens years if the dividend was 10% of the price you bought them at.

Again it's all about what goes back into the investors pocket

"No" implies what I have written is incorrect. It most certainly is not. You are adopting the view that the investment in a company is some sort of deposit account. It is not. It is the purchase of a share in a business. It entitles you to the income streams of that business. If the money is not paid out one would hope it is spent wisely to grow the business. This is the crucial difference. BTL can only be considered "the same" if profits are used to fund expansion, rather than a pyramidding of debt. In actuality they are seldom even used to pay for maintenance.

In business this is financial suicide. In BTL it is common practice. Your refusal to accept the non-equivalence of dividend yield and rental yield does not, I'm afraid, make you right. i have highlighted an obvious flaw in your thinking which you adamantly ignore. I can do no more. Cheers.

Edited by Sledgehead

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"No" implies what I have written is incorrect. It most certainly is not.

Well either the share price has to double every ten years or they have to pay out 10% in dividends every year - it's quite simple.

my issue with the capital gains side is that markets aren't exactly rational when it comes to valuing a company. It's all a bit of a gamble so to speak to follow the capital gains side be it shares or property

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To compare shares and property, think of it this way.

You are in the property business.

You buy a field on the edge of town with planning permission for 100 houses. However, even maxing out your borrowing, you can only raise enough capital to build 10 houses. You build the first 10 and rent them out.

Do you then take the first year's rent out of the business as income, or use it as a deposit to build another 5 houses?

It is obvious that you would expand your business, at least while there is more space in the field and the rental income for the new houses looks worth it.

So, while you are expanding, you have not taken any income. It is only when it is not worth expanding any more that you start taking income out of the business.

That's why rental yield should be compared with price / earnings rather than with dividend yield.

frugalista

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To compare shares and property, think of it this way.

You are in the property business.

You buy a field on the edge of town with planning permission for 100 houses. However, even maxing out your borrowing, you can only raise enough capital to build 10 houses. You build the first 10 and rent them out.

Do you then take the first year's rent out of the business as income, or use it as a deposit to build another 5 houses?

It is obvious that you would expand your business, at least while there is more space in the field and the rental income for the new houses looks worth it.

So, while you are expanding, you have not taken any income. It is only when it is not worth expanding any more that you start taking income out of the business.

That's why rental yield should be compared with price / earnings rather than with dividend yield.

frugalista

I disagree.

If I have 100k to invest, I generally have four options for investing the money. What I should do is compare the cash I will get back in my hand for the cash I have loaned to the investment:

1/ Cash in the bank 5% before tax. I will get this return in my hand. No chance of CG.

2/ Property 6.3% before costs & tax. I will get this return in my hand if my costs are controlled.

Good chance of CG, some chance of CLoss.

3/ Shares 0-3% before tax. I will get this return in my hand if the stock pays. Almost equal chance of CG or CL.

4/ Govt bonds. I will get this return. Similar return to cash with an almost equal chance of CG or CL.

It seems to me that shares are the poorest and most volatile relation in the family here.

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I disagree.

If I have 100k to invest, I generally have four options for investing the money. What I should do is compare the cash I will get back in my hand for the cash I have loaned to the investment:

1/ Cash in the bank 5% before tax. I will get this return in my hand. No chance of CG.

2/ Property 6.3% before costs & tax. I will get this return in my hand if my costs are controlled.

Good chance of CG, some chance of CLoss.

3/ Shares 0-3% before tax. I will get this return in my hand if the stock pays. Almost equal chance of CG or CL.

4/ Govt bonds. I will get this return. Similar return to cash with an almost equal chance of CG or CL.

It seems to me that shares are the poorest and most volatile relation in the family here.

I think frugalista did a great job of illustrating how property and shares can be compared - although all things being equal I prefer to have control over the cashflow.

Shares have their place though - the problem with cash is the inflation issue and so shares should be part of a strategy to prevent your wealth being eroded by inflation. However I'm not sure I could get to a point where I could rely on shares to become my key source of income, I can however see a future from making a living by some let properties.

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  • 338 Brexit, House prices and Summer 2020

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