What the eighth wonder of the world has to do with property investment
Albert Einstein famously labelled it the “eighth wonder of the world” but we hear little about in every day discussion. It’s a phenomenon that has separated the wealthy from the non-wealthy and the clever from the non-clever. It is one of the things that Warren Buffet attributes his empire to and it has generated something out of nothing for many. We’re talking about compound growth – and it is the most important thing to understand for anyone who wants to get serious about property or get serious about creating their own wealth.
When put simply, compound growth is the growth of an investment value from reinvesting the income you receive from an asset. In its simplest form as compound interest, you can think about it like this… If last year you opened up a savings account and bank $100 and it earns $2 interest, this year you will be earning interest on $102. And so forth, and so forth. So, it is interest earning interest. Money being generated without investing more than the original amount. In property, it plays a critical role in building a portfolio.
The value of this property increases as the mortgage you owe decreases creating more equity so you can buy a second property. This added to the capital growth of the asset can generate equity quite quickly. You then buy a second property and you use the equity generated on the first and second property to purchase a third. This snowball effect is what we call compounding growth because the more properties you purchase and leverage, the more equity you are able to generate in your portfolio as the value grows itself.
For example, if you purchase a property for $400,000 and it has a capital growth rate of 5% per annum, it will be worth $650,000 after a decade. If it had a capital growth rate of 7% (as some inner-city suburbs have recently experienced) it’s value is now $787,000. This gives you more equity in your property over time as your loan to value ratio decreases and your portfolio gains more compound growth momentum as it grows.
So, when you take the principal of compound growth, it proves one thing. There is never a time too early to get into property. The faster, the better because the only thing compound growth is reliant upon is time.
When we work with young people – first home buyers or first-time investors – we look at three key things;
- Creating a deposit to secure a mortgage.
- Generating a positive cash flow so equity on the original property purchase can be boosted by investment returns to obtain the next.
- Finding another property to add to the portfolio.
These three things are how we work with our clients to create wealth through property and compound interest lies at the center of it.