Out of the properties that you might find, which one(s) do you actually purchase? In short, the ones where the figures stack up.
To explain this further it is essential that you view your property investment as a business and not just some form of gambling, although the property market contains a number of elements of risk, as do most types of investment. Just like in any kind of business you need to know that you will be making money and not lose money, it is the bottom line that tells you if you are running a profitable business or not. However, there are at least two different high-level categories of ways to profit from investment in property, these are explained here.
Capital Growth – Appreciation
This is the most common way that people think of earning money from property, usually because it is the property that they own and live in. This type of investment is the act of buying property for one price and selling it later on for a higher price, the difference is often referred to as Appreciation. This method of profit usually takes time over which the value of the property increases. However, you can add value to the property by doing some kind of work to it, like refurbishment or an extension. In other instances you may be lucky enough to buy something for less than it is worth and sell it the next day for market value thereby making a profit on the ‘turn’ or ‘flip’. You will normally have to pay Capital Gains Tax on the increase of the property’s value when you sell it.
Positive Cashflow – Income
This is the type of profit usually made by Landlords where the overheads of owning and letting a property are less than the income generated from same. What this means is that if you add up your mortgage payments, management fees and cost of repairs the total should be less, across the same period, as the rent paid by the Tenant. For example, if you pay out £500 per month on overheads, you would want to be letting the place out for at least £550 in order to make a profit, or Positive Cashflow. You will normally have to pay Income Tax on the profit made from rental.
The above two types of investment are not the only two and they are not necessarily mutually exclusive, that means it is possible to find a property that represents both types of investment. In fact most property will have some kind of appreciation, although there are areas that have had zero growth over the past few years and, indeed, some areas that have had negative growth, that means the value of property has actually dropped.
Similarly, Positive Cashflow is variable and can rise and fall with market conditions, you can only make your best, informed decision on the day, for the day, with all the available information. Historical trends may point towards a potential future, but this is not any kind of guarantee.
Plan for Voids
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You must build Voids into your cost structure or overheads. Void Periods, referred to simply as Voids, are the times when your flat is not let out but you must continue to pay the mortgage and associated costs like Service Charges, in the case of a Leasehold property. This is why the most common Buy To Let mortgage is worked out on a factor of 130%, the Lender expects Voids and incidental costs and is building in a simple safeguard for their financial exposure to you. By anyone’s standards the factor of 130% is a good rule of thumb, this means that your actual rental income should be 130% of your mortgage payments.
Many Investors and Landlords have been caught out by not accounting for Voids and suddenly running short of money when they have to pay their mortgage with no rental income to balance the outgoing cash. In areas of high competition your property may be empty for several months. It is a good idea to have around three months worth of mortgage payments set aside for your Buy To Let property in case of Voids.
The more properties you have in your rental portfolio the less chance there is that you will run short of cash for the mortgage payments, as you balance the risk of Voids across the entire portfolio and not just on a single property. However, this assumes you have sensibly spread your rental properties across various different areas to avoid loss of income if one particular area is impacted for some reason. For example, if you have five flats in one apartment building, they will all suffer from the same local market conditions. In times of low demand and high competition you will have not one but five Voids to contend with. If you had five rental properties in different suburbs of the same town or city then you have reduced your chances of having all five properties empty at the same time. Better still to have these five properties in different towns altogether. As the old saying goes, don’t have all your eggs in one basket.
It is important to remember that no matter how many properties you have and no matter how spread out they are, there is always a slim chance that they might all suffer Void Periods at the same time. You should have a plan in case this happens, but you can lessen the chance of this happening by staggering your Tenancy Periods so they don’t all start and end in the same month. This would normally happen anyway as various Tenants come and go at different times.
Yields and Profits
There are many methods that people use to calculate what they call the Yield. Yields are essentially the ratio of income generated by a property in relation to the initial capital input and costs associated with obtaining and letting the property. Yields are normally represented as a percentage figure and depending on the area and the person you ask you will get a different story as to how much of a Yield is worthwhile. Some people assess the potential income from a property by performing a series of complicated calculations and arriving at this Yield percentage, they already know their personal limits and may accept an 11% Yield but reject a 10% Yield.
But when you look at the big picture most Yield calculations are really a waste of time as the conditions they have based their calculations on will change tomorrow. Furthermore, the idea in business is to make money and not lose it, therefore, generally speaking, any income is good income even if it is only 5%. Obviously there are practical considerations but you have to remember that these figures can change from day to day and are completely dependent on how you calculate your Yield.
The preferred method of establishing the viability of a Positive Cashflow type of investment is simply looking at how much profit you have after your costs. If your flat costs £500 per month to run than an income of £490 per month is Negative Cashflow, but an income of £550 is Positive Cashflow. It all comes down to what you are comfortable with and how much you need to establish a Void buffer as mentioned above.
Try not to get bogged down with hairline percentage variances where 10% is bad and 11% is good, instead focus on real income and what this means to your property business.
One way of improving your income is to have an Interest Only mortgage, as opposed to a standard Repayment mortgage. This can mean considerably lower repayments each month, but beware, at the end of the mortgage you will have to repay the principal loan amount in full. This is often an ideal method when you only plan to have a property for say 5 to 10 years of a 25 year mortgage, as when you sell it you would hope to repay the principal mortgage amount anyway, but in the meantime you have had to pay less each month. If the Capital Growth in the property is good then at the end of the mortgage term you may well be able to refinance or sell it and pay the principal back with enough left over to reinvest in something else. It very much depends what your long term plans are, but Interest Only mortgages can be a valuable tool for Property Investors and Landlords.
Different Deal Types
There are probably an infinite number of ways to structure a property deal, in fact there are very few rules and you can be as creative as you like provided you operate within the constraints of any lending criteria if you are using mortgage finance. So there is no way we could not possibly list and define all the various options, but we have chosen to highlight a few of them here to show you the kind of options that are out there as well as the pros and cons of each.
No Money Down
This is the most common type of deal sought by Property Investors who are new to the market or wanting to invest as little capital as possible. If you think about this option carefully it soon becomes a very unappetizing method of property investment. Up front it appears that you will get something for nothing, as we all know this is a very rare thing in life, even more so in business.
For a start, the name of this type of deal is a bit of a misnomer as it infers that you can own a property by not putting any money into the deal, if this were true then everyone would be out getting property for nothing. There will normally be some kind of deposit to be paid in order to secure your interest in your chosen plot. There will eventually be conveyancing fees to pay and possibly some other incidental costs. But even if you manage to get the rights to buy a plot without parting with a penny, by the time your property is built and ready to complete it may have changed in value quite considerably. This can be good, but often is just the opposite.
When new developments are pre-valued (valued before they are built) the developer often has little more intention than to sell the bulk of the properties to Investors and will push to obtain a high valuation in order to make their supposed discounts appear very attractive. But by the time the properties are finished the market can suddenly turn your investment into a nightmare. This is because the standard Buy To Let mortgage is based on the ratio of 130%, as explained above, which can result in the Lender offering you a lot smaller mortgage than you were expecting. The end result is that you find yourself contracted to buy something that you don’t have the money for. At this time you only have a few choices :
Option 1 : Try and find the deposit money plus any additional funds needed to complete on the purchase, this often means taking out a loan from somewhere or borrowing money to cover the purchase and then finding you have to make mortgage payments on something that will not let out either. This can lead to a downward spiral in finances.
Option 2: Accept that you have to pay the deposit but cannot afford the balance to complete and, therefore, lose the property and your deposit.
Option 3: Try to find someone to buy you out of your contract. Even if your contract is transferable this is like blood to sharks, once someone knows you back is to the wall they will tie you down to an absolute minimum and you may still walk away from the deal a few pounds poorer.
Option 4: You might be lucky, given the short notice period to complete, to find an onward buyer who will back-to-back the deal, but this is unlikely and quite rare.
This type of deal has a few variations but the basic concept is where you line up a purchase a property and the subsequent sale of the same property so that the inbound purchase and the outbound sale complete on the same day. The idea is to make a profit from buying low and selling high.
Whereas back-to-back deals are more easily carried out on new-build properties, thereby allowing a good lead time to locate a buyer, in many cases established properties can be bought and sold this way too. Sometimes it is down to good fortune and other times it is good management. If you can exchange early and have a long period until completion you can give yourself time to find a buyer, but you obviously have to have something that is in demand and that you have bought in cheap.
This type of deal is quite straightforward, however, it still has certain inherent dangers. The basic concept is that you find a property that has a market value higher than the purchase price and you obtain a mortgage based on the market value. For example, if the property is valued at £100,000 but you can buy it for £75,000, then your 85% Buy To Let Mortgage will result in a loan of £85,000 giving you £10,000 cash back on completion of the purchase. Some solicitors do not like this kind of transaction as they believe it is misleading the Lender, check that your solicitor will do this before you start. You must remember that your solicitor has a responsibility to the Lender to ensure that mortgage fraud is not taking place.
Most Lenders will only lend on the purchase price, this is called a Loan To Purchase (LTP), so you need to find a Lender who will lend on the value, this is called a Loan To Value (LTV). The other method is to find a Lender who will lend you more than the value, or purchase price, of the property in the first place. Some Lenders offer, from time to time, up to 125% of the value of the property. Sometimes they will release the funds upon completion as part of the basic mortgage, other times they will release funds towards payment of works or improvements in the property. In the case of improvements they usually want to see invoices or receipts and may make payment directly to the supplier of the goods and services in question.
The only point of note, regarding this type of mortgage, is that your property finance will be what is termed “highly geared”. This means that you have the maximum amount of equity squeezed out of the property. The problem with this is that it normally means that your mortgage payments will be higher which may cause you problems in generating Positive Cash flow from that particular property. It may also mean that it takes a lot longer to achieve any Capital Growth in the property.
Property Expert Lea Beven has 14 years in buying and selling a property and exposes secrets from both sides for your benefit.
As described by Trevor on ITV’s Tonight with Trevor, Property Tycoon Lea Beven has lost and made millions in property. She openly shares problems, pitfalls and deep secrets in property investing with the public, even down to personal information on her own deals. Now working part time with regular clients that really want to make money, she prefers to keep business small and personal.