Out of the properties that you might find, which one(s) do you purchase? In short, the ones where the figures stack up. To explain this further, you must view your property investment as a business and not just some form of gambling. Like in any business, you need to know that you will be making money and not losing money; the bottom line tells you if you are running a profitable business. However, the property market contains several risk elements, as do most types of investment. However, two high-level categories of ways to profit from property investment are explained here.
Investment Types
Capital Growth – Appreciation
This is the most common way people think of earning money from property, usually because it is the property they own and live in. This type of investment is buying property for one price and selling it later on for a higher price; the difference is often referred to as Appreciation. This profit method usually takes time over which the value of the property increases. However, you can add value to the property by doing work 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, 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. This means that if you add up your mortgage payments, management fees, and cost of repairs, the total should be less than the rent paid by the Tenant across the same period. For example, if you pay out £500 per month on overheads, you want to leave the place for at least £550 to make a profit or positive cash flow. 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. They are not necessarily mutually exclusive, so it is possible to find a property representing both investment types. Most parcels will have some appreciation. However, some areas have had zero growth over the past few years, and, indeed, some areas have had negative growth, which means a property’s value has dropped.
Similarly, Positive flow 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 guaranteed.
Plan for Voids
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Void Periods, referred to simply as Voids, are 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. You must build Voids into your cost structure or overheads. This is why the most common Buy To Let mortgage is worked out at 130%; the lender expects Voids and incidental costs and is building a simple safeguard for their financial exposure to you. By anyone’s standards, 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 high-competition areas, your property may be empty for several months. It is a good idea to set aside around three months’ mortgage payments for your Buy To Let property in case of Voids.
The more properties you have in your rental portfolio, the less chance 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 areas to avoid income loss if one particular spot is impacted. 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, you have reduced your chances of having all five properties empty simultaneously. Better still to have these five properties in the different cities 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 how they spread out, there is always a slim chance they might all simultaneously suffer Void Periods. This normally happens anyway, as various Tenants come and go at different times. It would help if you had a plan in case this happens, but you can lessen the chance by staggering your Tenancy Periods so they don’t all start and end in the same month.
Yields and Profits
People use many methods to calculate what they call the Yield. Yields are the ratio of income a property generates 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 about how much of a Yield is worthwhile. Some assess the potential income by performing complicated calculations and arriving at this Yield percentage; they already know their limits and may accept an 11% Yield but reject a 10% Yield.
But when you look at the big picture, most Yield calculations are 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, even if it is only 5%. There are practical considerations, but you must remember that these figures can change daily and completely depend 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, then an income of £490 per month is Negative cash flow, but a payment of £550 is Positive cash flow. As mentioned above, it all comes down to what you are comfortable with and how much you need to establish a Void buffer.
Do not get bogged down with hairline percentage variances where 10% is bad, and 11% is good; focus on real income and what this means to your property business.
T the end of the mortgage. One way of improving your income is to have an Interest-Only mortgage instead of a standard repayment mortgage. This is often an ideal method when you only plan to have a property for 5 to 10 years of a 25-year mortgage, as when you sell it, you would hope to repay the principal mortgage amount anyway. Still, in the meantime, thiscan mean considerably lower monthly repayments, but beware, at the end of the mortgage, you will have to repay the principal loan amount in full. Ad to pay less each month. If the Capital Growth in the property is good, then at the end of the mortgage term, you may be able to refinance or sell it and pay the principal back with enough left over to reinvest in something else. It depends on your long-term plans, but interest-only mortgages can be valuable for Property Investors and Landlords.
Different Deal Types
There are probably infinite ways to structure a property deal; 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 use 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 options and 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 want to invest as little capital as possible. Considering this option carefully, it soon becomes a very unappetizing property investment method. Upfront, it appears that you will get something for nothing, as we all know this is a scarce 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 property by not putting any money into the contract; if this were true, then everyone would be out getting a property for nothing. There will normally be some deposit to be paid 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 field without parting with a penny, it may have considerably changed in value by the time your property is built and ready to complete. 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 to make their supposed discounts appear very attractive. But when the properties are finished, the market can suddenly turn your investment into a nightmare. This is because the standard Let mortgage is based on a ratio of 130%, as explained above, resulting in the Lender offering you a much smaller mortgage than you were expecting. The result is that you are contracted to buy something you don’t have the money for. At this time, you only have a few choices :
Option 1: Try finding the deposit money plus any additional funds needed to complete 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 must pay the deposit but cannot afford the balance to complete and, therefore, lose the property and your stake.
Option 3: Find someone to buy you out of your contract. Even if your warranty is transferable, this is like blood to sharks; once someone knows your 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.
Back-To-Back
This type of deal has a few variations, but the basic concept is to arrange a purchase and subsequent sale of a property so that the inbound purchase and the outbound sale are completed on the same day. The idea is to make a profit from buying low and selling high.
Back-to-back deals are more easily carried out on newly built properties, allowing a good lead time to locate a buyer. In many cases, established properties can also be bought and sold this way. 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 have to have something in demand and buy it cheap.
Cash Back
This type of deal is quite straightforward. However, it still has certain inherent dangers. The basic concept is that you find a property with a market value higher than the purchase price and 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 Let Mortgage will result in a loan of £85,000, giving you £10,000 cashback 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. It would help if you remembered that your solicitor is responsible to the Lender to ensure that mortgage fraud is not happening.
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 property’s value or purchase price in the first place. From time to time, some Lenders offer up to 125% of the value of the property. Sometimes, they will release the funds as part of the basic mortgage upon completion. Other times, they will release funds towards payment of works or improvements on the property. In the case of modifications, they usually want to see invoices or receipts and may pay directly to the supplier of the goods and services.
The only point of note regarding this type of mortgage is that your property finance will be termed “highly geared.” This means 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 issues generating Positive Cash flow from that particular property. It may also mean it takes much longer to achieve any Capital Growth in the property.
Property Expert Lea Beven has 14 years of experience buying and selling properties 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. Now working part-time with regular clients who want to make money, she prefers to keep business small and personal. She shares problems, pitfalls, and deep secrets in property investing with the public, even down to personal information on her deals.-
