By Lacey Filipich, BEng(Hons), MAICD
In last week’s post, I expounded on my theories about how Monopoly (the board game) is like real life property investing. In the interest of balance, I’m following up with this post about the ways in which Monopoly is NOT like real life property investing.
It’s hardly surprising that a board game does not fully capture the intricacies and nuances of something as complex as property investment. I know you’re not silly enough to think you’ll get $200 every time you go around the block, and your kids probably aren’t that silly either… at least I hope not. However, it’s best not to fall into the trap of thinking Monopoly can teach you everything you need to know about property investing. Here are six ways in which Monopoly misses the mark…
1. We all start as equals
The Bank gives every player $1,500 at the beginning of the game. The rules even specify the denominations each person should receive. This is blatantly nothing like the human experience.
As Warren Buffett puts it, there’s an ovarian lottery. Where you were born and your upbringing has an effect on your life. In terms of property investment, this is significant. Unless you are pursuing some form of sponsorship, or you have a heap of equity in some other form, you will need to contribute some cash as a deposit when you buy a property. And unless you have 100% of the purchase cost and associated fees in cash, you will likely need a loan to make the purchase.
The initial cost of the property you can buy is limited by those two items: how much deposit you have, and how big a loan you can get. This is where Person A differs from Person B. The amount they have saved, their equity, their spending commitments and their income will be different, therefore the amount of money they can access to purchase a property will be different.
The good news is that it doesn’t really matter in the long run. I bought my first place for $103,000 with a $75,000 loan. I’d scraped together my deposit over five years of part-time work and stingy living at my mum’s house. At the time I went for the loan, I was only employed in the summer holidays. I had two more years of university remaining before I’d get any real cash. It wasn’t easy, but I bought a two-bedroom apartment and rented out the second room to cover the mortgage, all without requiring a guarantor. There were plenty of other students in my class with access to more cash (mostly from their parents) and with more income, but they rented. I was the only one who bought.
I still have that apartment. The equity in it helped me secure two further investment properties with next to no cash deposit. The hard part is getting started. Once you start, the momentum that builds with sound decision-making and some luck is enough to catch up whatever you think you were missing in the beginning. The ovarian lottery becomes less and less important as time goes by.
2. A mortgage = no rent
Thankfully this is not the case. If it were, no one would buy investment properties with a mortgage! However, if your property is negatively or neutrally geared (i.e. your tax deductible costs are greater or equal to the income from rent) you will effectively receive no rent because it will all go to covering the mortgage and bills.
In reality, you can have a mortgage and be positively geared. This means you make money from rent over and above your tax-deductible costs. The two-bedroom apartment in the previous example became positively geared after seven years and continues to provide me with some income, even though I still have a mortgage of $50,000 on it (why the mortgage still you ask? I’ll cover that in another post in the future). Positive gearing is, in my opinion, the best possible case scenario for property investment where you don’t plan to sell often. People get confused about positive vs. negative gearing, and I come down heavily on the ‘positive is best’ side in most cases because the risk is reduced. But that’s a story for another post…
3. Tax is paid on asset value
In Australia, the tax system that we all know and love (not!) assesses your income. It doesn’t matter to the Australian Tax Office (ATO) whether your property is worth $10,000 or $1 million. All that matters is how much money you made in rent, and how much money you spent on the tax-deductible items, including interest accrued.
However, each state has it’s own land tax, with the notable exception of the Northern Territory. Each state has a different calculation and basis, but they are mostly marginal tax systems similar to the income tax brackets we have. Most also have a threshold under which no land tax is paid. Those wanting to reduce or avoid land tax can implement strategies to do so with their portfolios, such as spreading their purchases across different states or buying properties with comparatively low land values (like the apartment I keep mentioning in my examples).
4. Only Banks can loan money
My mother took a loan from her parents to purchase the home she and my father shared when I was born. Dad was starting his own business and Mum wasn’t bringing in any income because of me so they weren’t exactly prime mortgage candidates in the bank’s eyes. Mum’s parents were the only option for a loan, and it was lucky for them that my grandparents were keen on the idea. My grandparents were keen because it allowed them to decrease their assets enough to be awarded full pensions, while topping up their income with the repayments and interest my Mum and Dad paid. In retrospect it was probably a bit dodgy and I doubt the Australian Tax Office (ATO) would have been thrilled to learn about it, but that was 30 years ago and my grandparents are dead so I think I’m safe sharing this story with you.
The point is: getting a loan from a bank is not your only option, but it’s probably the easiest and by far the most common option available. Don’t let that limit your creativity in seeking alternative options. Can you take a loan from a family member or friend? Can you access your superannuation to purchase the property? And although it’s something of a technicality to claim a credit union is not a bank, can you approach your industry’s credit union instead?
5. Interest is simple and finite
I really wish this were true. Compound interest is heaven-sent when it’s being paid to you on your cash, but when you’re the one who’s paying it’s a pain in the proverbial. I can’t help but sigh when I’m signing a new mortgage agreement outlining that I will eventually hand over twice the original value of the loan because of the interest I will accrue while repaying it. I sign anyway, but only because I haven’t found a creditor willing to charge only simple interest.
That said, I see why the rule is for simple interest only and set at a rate that’s very easy to work out (10%). If Monopoly charged compound interest, I’d need a calculator to play. That doesn’t sound very game-like, it sounds more like a maths test.
6. Bankrupt? No worries!
You gambled, you lost everything… so what? Bankruptcy is no big deal in Monopoly world. Just go back to the beginning, get your $1,500 from the bank and continue on your merry way. No problem-o.
Oh, if ONLY life were this simple.
Bankruptcy is permanently recorded in Australia on the National Personal Insolvency Index (NPII). You are considered bankrupt for at least three years, and your assets will be liquidated to meet as much of your debts as possible. Your credit record will show you were bankrupt for at least five years – good luck getting any money out of the bank then, and kiss credit cards goodbye. Your wage will be garnished for a period to repay any excess debt. In short, it’s a painful affair. It’s something you’re better off avoiding if at all possible.
And just to prove it to you, in a future post I will cover interviews with three people who have gone bankrupt, about what the experience was like for them. It’s surprisingly reassuring – all three got on with life and seem to be happy – but they are willing to share their stories as a cautionary tale for you, dear reader.
Next time you’re playing Monopoly with the kids, you could pass on these tidbits of information as you play – they might not appreciate it, but you can try. Alternatively, you could consider bending the rules to more closely match real life. You might need a calculator to work out the compound interest payable (or a slide rule if that’s your vintage) but it’s an option. Let the games begin!
Are there any other Monopoly rules you think fly in the face of reality? Please share your thoughts below 🙂
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Lacey Filipich is the co-founder and director of Money School. She helps parents raise financially savvy kids and helps adults get on top of their finances. Connect with her on LinkedIn and follow Money School Facebook to learn more.