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The power of compound growth

Friday, 13th Jul 2018

Taking the step towards starting a property investment portfolio can be a daunting prospect for aspiring investors. With other financial priorities such as starting a family, organising that much-needed holiday and paying off existing home repayments, many end up delaying the start of their investment venture, with the majority never making it to their second purchase.

With issues of immediate affordability at the forefront of their minds and retirement a far cry away, many people overlook the long-term benefits of investing in property, and their goal of achieving financial freedom suffers as a result. In reality, however, there are huge potential benefits to investing early and giving your investment portfolio time to grow, and the secret lies in a concept called compound growth.

What is compound growth?

Compound growth is when an asset generates earnings which are then reinvested to generate their own earnings. Whilst compounding is commonly associated with interest, it’s also an incredibly powerful concept when applied to the capital growth of a property. For example, if an investor purchases a property valued at $500,000, and this property grows 5% per year, the property will increase in value to $525,000 over the first year. After a second year of growth, it will then increase further to a value of $551,250, and this trend will continue, with the value of the property (and the equity in the asset) increasing exponentially over time.

The snowball effect

Whilst many investors are familiar with the concept, a lot of people don’t understand the actual power of compounding when put into practice. Whilst it may not take a huge effect immediately, compound growth increases by larger and larger amounts each year, and this snowball effect can have huge implications for property investors who hold onto an asset long enough to reap the rewards.

Compound growth graph

Let’s look at that same property – with an annual growth rate of 5%, the property would be worth over $814,000 after ten years, marking an increase of over $300,000 compared to its value upon purchase. Whilst a non-compounding asset would have only increased in value by $250,000 over the same period of time, in this case the $250,000 in growth has created its own $64,000 in equity due to the compounding nature of property. The equity created from this growth could then be leveraged to purchase a second investment property, which will in turn start to accumulate its own equity through compound growth, and so on.

Time is key

The key to profiting from compound growth, and property investment generally, is time. The earlier an investor starts building their property portfolio, the longer they can hold onto a property, and the faster they can accumulate wealth. Going back to our earlier example – if the investor holds onto that property for a further ten years, it would be worth over $1.3 million after a period of twenty years. Now imagine the potential implications of this if you had multiple properties in your portfolio. Pair this with the fact you would  be paying less and less towards your properties as rental growth and loan repayments take their toll over time, and it’s easy to see how compound growth can become an incredibly lucrative strategy for investors.

Choosing the right property

When it comes to compounding value, choosing a property with high growth potential is integral to success. As an investor, it’s really important you consider the potential growth drivers of a property before completing a purchase. With the right research, strategy and support in place, there are huge potential gains to be made from compounding growth. And the earlier you start to build that portfolio, the greater the potential returns.

Momentum Wealth is a fully-integrated, research driven investment consultancy dedicated to helping investors build wealth through property. Backed by our in-house research team, our buyer’s agents are committed to helping investors identify investment properties with high potential for growth. If you would like to discuss your property needs with one of our Perth buyer’s agents, book a consultation with the Momentum Wealth team today.