Financial Independence: Building FIRE from ground up (3)

In our two previous posts:

we considered the question: “If you can do it all over again, what will you do, or not do? If you can pass some inspiration to the next generation looking for financial independence, how will you light their FIRE? How will you help them in building FIRE?” In many ways, the path to good personal financial management is not difficult, and really revolves around a few core tenets, such as managing:

Emergency funds
Insurance
Savings and investments
Getting on the property ladder
Debt

Previously, we looked at the topics of Emergency Funds and Insurance, and touched on how the family, or financially independent parents in particular, can help their children get started on the path to FI or FIRE. Turning to attention to savings and investments next, we showed that while investments are usually regarded as a cornerstone for building a retirement nest egg, it really applies for typical retirements after about 30 to 40 years of work, because the compounding effect of investment returns only work with regular savings and investments over periods longer than 20 years. So for early retirement, earning and saving more is the key, rather than investment returns.

And now, we turn our attention to the last two topics: Getting on the property ladder and debt. Let’s see how these two topics work for building FIRE!

Building FIRE from the ground up for the next generation

Getting on the Property Ladder

Purchasing a place of one’s own, especially for city dwellers like us, is probably the single biggest decision a person can make over a lifetime. And it is justifiably so, as shelter is a basic need. As is safety, which no doubt encompasses security from losing one’s home if you are renting. But what role does property play on the road to building FIRE?

A few come to mind immediately:

A popular way of achieving FIRE elsewhere, is through a portfolio of residential and other properties, which will yield a steady flow of asset income to support FIRE. This is less tenable in a city where single-family home prices are expensive, as the costs to building a diversified portfolio of rental properties is quite high. Without the diversification from many different properties, the rental income flow can become less reliable as any property will go through periods being untenanted
Property can also function as a source of capital. A fully paid up private property can be re-mortgaged to raise funds for investment at low interest rates
Property can also be an investment asset as well, just like financial assets like stocks and bonds are assets from which to earn income

Its value as an investment or source of capital aside, an owner-occupied residential property also provides security in FIRE. It is rather strange that many discussions on finance and on FIRE do not explicitly talk about property, and the role it plays in one’s portfolio. It is almost as if permanent renting is a default option or choice in life, and all the more puzzling considering that most people in the developed world actually own their homes! And it is common to find that the main asset many people have upon retirement is their home, hence the proliferation of products to monetise this asset for retirement.

In fact, it is downright puzzling that while most ordinary folk around the world would be as passionate and crazy over property as they are over which stocks to buy, the literature on finance, FIRE and personal finance has very little to say about it! If shelter is a basic need, then the default position of a residential property in one’s portfolio should be a long position. Say one unit. Anyone who prefers to rent indefinitely is basically taking a short position in the property assets. And just like stocks, the long term returns of property across the world tends to show that shorting the property market for long periods, just like shorting the stock market, is unlikely to reap better returns. After all, just like stocks, property is a reflection of the health of and growth in the economy. And over the past few centuries, this has been positive.

How has property fared as an investment?

So how has property fared as an investment asset? The chart below shows the Singapore Residential Property Index from 1975 to the current day. Property indices, though, are smoothed out, and hence are pretty useless for forecasting the short term movements in property values. However, the long term trend is quite clear. Upwards!

Singapore Residential Property Index 1975 – 2023

Singapore Residential Property Price Index — Source: *Trading Economics based on URA data*

Over the past 47 years, residential property in Singapore has gone up 21 times, or roughly and annual rate of return of 6.7%. THat does not sound like a lot, but let’s see what it does next to the stock market, represented by the Straits Times Index.

Straits Times Index 1988 – 2023

Over the 36 years from 1988 to the present day, the annual rate of return on stocks in Singapore comes to only 4.1%. Throw in an extra 2.5% to represent the dividend yield on Singapore stocks (which will also compound over time) and stocks will barely keep up with the growth in property values over time. Of course property will also have a rental yield (imputed rental in the case of owner occupied properties), but it is not easy to reinvest the rental earnings back into the property, and property are subject to more taxes and maintenance costs, so we can disregard this rental yield for now.

So, as an asset, property performs at least as well as stocks, which are often regarded as the mainstay for investing to achieve FIRE. Moreover, property, being less liquid, tends to be less correlated to other investment assets as well, providing useful diversification during the critical asset building years to reach FIRE. While you can argue that the Straits Times Index is a poor representative of the gains from investing in stocks, recall that the Dow Jones Industrial Index only grew at an annual rate of 5.3% over the course of the 20th century, and in the first 23 years of this century, has even failed to reach this modest level of returns!

How do you invest in property?

So how do you go about investing in property? This may seem like a dumb question, because the majority of the people in the developed world do go about purchasing a primary residence. But it is not immediately obvious that this is not really investment in property because you cannot really profit from the property you stay in. After all, if you choose to sell and take a profit, you will still have to plough the proceeds back in either purchasing another property to stay in. Or plough it back into rental payments if you choose instead to rent thereafter. Remember, the neutral position with regards to property is one, i.e. to be long the property market with once holding. Only if you have more than one holding can you usefully invest and gain from property.

Does this then mean that investing in property has to be through the ownership of 2 or more properties. Just like the various strategies touted about how one can sell off their property and use the proceeds to buy 2 properties, one to stay and one to rent for example?

Well, not necessarily. While the default, neutral position in the property market is to have one holding, having fractional holdings above one is possible too! Such as purchasing ahead of one’s needs, i.e. buying a bigger place than needed for current needs. For example, to accommodate a growing family over time. And then, just like many empty nesters have done, downgrading to a slightly smaller place in the future, to reap the benefits of having something slightly bigger.

Getting a property larger than is needed can help you not only get on the property ladder, but also invest in property as a long term asset!

Debt and property investing

For most part, it is impossible to talk about purchasing or investing in property without talking about a housing loan, mortgage or debt. To pay for a property purchase in cash is truly the preserve of a select few wealthy. However, taking on debt for a property is not a bad idea, as long as you are not over stretched. There are several advantages for doing so.

Firstly, debt allows the purchaser of a property to essentially do a lump sum investment. As we discussed in our previous post Financial Independence: Sparking the FIRE for the next generation (2), it is actually quite hard to invest our way to FIRE without taking on some large and undiversified risks. Th reason is of course when we save and invest, we are not doing lump sum investing. We are doing dollar-cost averaging. And even after about 20 years of this, the size of our investments do not look too different from the total amount saved.

Cumulative Savings and Investments over 40 years

Sparking the FIRE for the next generation through savings

In fact, some have argued that buying stock using margin finance when young can help to reduce retirement adequacy risk. In essence, this is just recognising that unless we can do lump sum investing at the start of our careers, and then let the magic of compounding do its work over 20 to 30 years, we are unlikely to be able to accumulate a lot more than we save over time.

But this is precisely why investing in property over and above your immediate need for shelter has worked well over time for most people. It allows you to do lump sum investment in an asset (i.e. property) thanks to the use of debt.

And not only is this form of debt readily available to a property purchaser (because it is collateralised), the second major advantage of taking on this debt to purchase property is that it is rarely ever callable. This is unlike margin financing for buying stocks, which allows the same for lump sum investing too. Margin financing tends to be callable, and so in a bad market downturn, there is an additional risk that you will get a margin call once the value of the stocks being pledged as collateral drop. So a mortgage loan allows lump sum investment in an asset with low correlation to other assets, low measured volatility, and without risk of a margin call. What is there not to like about it?

Of course this is not to say that purchasing property, stretching yourself, is not without risks and downsides. Many a tycoon has been bankrupted throughout time doing exactly the same thing when a financial crisis hits. Higher interest rates, like the bout we are going through right now, also threaten finances. The lumpiness and lack of liquidity in property purchases and investments also make it an asset position which is quite hard to get out of, shovel the need arise.

Conclusions

One the things that the FIRE literature spends too little time on is how property investments can help achieve FIRE. Perhaps this is because the usual spokespersons for FIRE all tend to be nomadic travellers who do not want to stay in a single place. But to ignore the potential for property as an investment class that can help reach those goals would be handicapping ourselves for no reason at all.

And this is also where financially independent parents can help to light the FIRE for the next generation. There has been some discussion of how you can plan to give bequests to your children at the point in time when these bequests can be of most use to them (see for example, Die With Zero). One of the best bequests that can be made to the next generation is helping them make a property purchase. Especially when property prices are rocketing sky high. Regardless, it doesn’t hurt to get on the property ladder as soon as you can!

Get on the property ladder as soon as you can, and get the largest place you can comfortably afford with a mortgage. This will allow you have a lump sum investment in an asset which will grow over time at a rate which can meet your FIRE goals!