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Mat has been an active property investor since 1993, for the most part whilst holding down a career in the Royal Air Force. At first, due to an overseas posting, he became an “accidental landlord” for a small property in the town of Reading in South East England. When work required him to move, he could not sell the house and was in negative equity so was forced to rent it out. He rented that property and bought more each time the military posted him to a new location. It started through necessity but it became quickly obvious that this business, which took very little time, was making more money for his growing family than from his Royal Air Force could ever do. Mat was in a position to give up his day job by 2003 but lacked the confidence to make the leap until 2006 when, having accrued a portfolio of over 50 properties, he became a full-time investor and retired from the military. Enjoying his new found freedom, Mat continues to grow his property portfolio, now standing at 170 properties across Europe and USA. Mat now helps other investors meet their goals, whatever they are, through property. A small team of like-minded investors make up the team “ProVenture” and love meeting new investors and helping where we can. Our current area of work and example properties can be found at:
Fourth Edition All prices and rates correct as of March 2011 Copyright © 2011 by Matthew Littlecott All rights reserved
Introduction.......................................................................................................................... 3 Chapter 1 - Why Property? ..................................................................................................5 Chapter 2 - Outcomes for Property – What Do You Want to Achieve? ................................9 Chapter 3 - The Location Hunter ........................................................................................14 Chapter 4 – Purchasing Well – Evaluating and Securing an Investment .............................20 Chapter 5 – What to Buy and From Whom ........................................................................31 Chapter 6 – People Not Bricks – The Secret to Success ......................................................40 Chapter 7 – The Management of Risks...............................................................................45 Chapter 8 – You are a CEO ..................................................................................................48 Chapter 9 – Finance and Currency - Getting bang for your buck .......................................54 Chapter 10 – Location, Timing, Location – Bringing it all together ....................................56 Chapter 11 – Selling Your Investment ................................................................................62 Appendix 1 – The German Property Market ......................................................................63 Appendix 2 – The UK Property Market ..............................................................................70 Appendix 3 - The US Property Market ................................................................................73 Appendix 4 – About ProVenture Property ..........................................................................76
What will you get out of reading this?
I pride myself in aiming to be the best landlord in the business, having bought the most profitable properties on the market, after having undertaken the most comprehensive research possible. Of course, there is always room to improve your performance in such a fluid business but I am always striving to minimise risk and maximise profit from property in the most professional and, dare I say, ethical, manner. If you are the sort of person who sees potential in making money from property but is reluctant to take the ‘gambler’s’ approach in the capital growth speculation game, then read on. I like hard, logical facts and figures but like to keep things simple; I need steady, significant monthly income to feed my family and keep my wife in shoes, and the capital growth comes as a pleasant addition, and my strategy works. Let’s hope it will work for you. Thank you for setting your valuable time aside to read this book. I intend to repay your investment of your time by discussing in-depth every aspect of property investment. This book has been written to investigate:
• • • • • • •
What makes property special as an investment class. What kind of Investor you are and what you want to achieve. Techniques to locate great property that fits your objectives. The tools used to make sure an investment will make you money, now and in the future. Why people are so important in a business involving bricks and mortar. Getting your finances and tax positions right to maximise your return. How to sell your property, eventually, for the maximum gain.
That’s a lot of subjects to cover, so I will get to the point very quickly in each chapter but develop the ideas in a logical way. Of crucial importance are the exercises at the end of each chapter. Please try to do this in full or at least consider the exercise in your mind before moving onto the next chapter. In this way, you should arrive at a plan of action at the end of the book to go forward into or continue your property career.
Why I Wrote This Book
In the last 10 years how many books and ebooks do you think have been published regarding property investment? Quite a few! How many were written during the 10 years before that? Very few, and I know because I was looking for books to read around 16 years ago on the topic of property investment. Now why is that? Well across the world during the last 10 years we have experienced an abundance of easily-accessible credit that just had to go somewhere. Books on all aspects of property development and investment were written (and indeed countless others on a range of subjects on how we could spend our hard-earned cash or our unearned money from our property appreciating in value). Of the property investment books issued in the last 10 years, most (not all) focused on building portfolios of property by a system of re-financing current mortgages in order to take on new mortgages. They focused on capitalising on the new freedom with which the banks had with the money which they lent. I remember calling a mortgage broker in 2005 to apply for finance (on bended-knee)
for a property in Scotland. The response, on the telephone after 5 minutes, was:
Interesting times over the past few years! Great times if you bought things that went up in value with the bank’s money, not so good if the things you bought has gone down.
The more recent tomes on property investment, now this glut of “free money” has dried up, focus on the ability to buy “Below Market Value” if there is such a thing. The story goes that if you can buy from someone stupid (or desperate) enough to sell their home to you for up to 50% of what its worth, then you can present the property to a bank, gain a mortgage, and not need to provide a deposit as you bought it so cheap. I am not going to even get started on this topic which is questionable in logic and also in ethics. If you make money in this area then I wish you luck. So what’s this book going to do for you that all the others haven’t managed? Well, I will be honest, possibly nothing. You may have built up experience in business and investment to a point where you will find the ideas of this book of vague interest but perhaps not compelling enough to change your own investment behaviour. In this case, I am sharing my stories and ideas in business with you and I would love to hear yours. This is not a vague statement – I mean it! There are people reading this book that know far more than me regarding property investment, perhaps its just that I have the time and inclination to put finger to keyboard. Well let me know your stories and ideas and the good ones will be included in the next edition, with your permission. For others however, this book will hopefully prove of value at your stage of your personal and business life. If it hits you at the right time in your life then some of the ideas that I have collected in this book could be of great value. And it is to you whom I am writing. I am writing to the person I was 16 years ago who was looking for some guidance but found very little available that I found relevant or that I could understand. I would like to collect my experiences of the last 16 years (not all positive!), mix them with some of the very best ideas and approaches to investment that are out there, and come up with some easy-to-read chapters on the topic of property investment. The chapters are designed to be read in order, with a logical story developing through each chapter. At the end are some case studies on some markets around the world, taken in context of the ideas within this book. Hopefully, if I get it right, the book will be of equal relevance to the person I was 16 years ago, to all investors since this time and for all property investors in the future. The ideas therefore, do not rely on particularly favourable market conditions but just sound principles that you will hopefully find compelling enough to take with you in your investment future.
Chapter 1 - Why Property?
You will no doubt have your own ideas about why to choose property over other forms of investment to generate a cash flow or to provide an asset you can use at some future point in your life. You would not be reading this book otherwise I suspect. So what would be on your list as to why to choose property? After all, property can rise and fall in value as dramatically as the stock market (OK, perhaps at the speed of months not in minutes as on the Stock Market on occasion.) Property can also be a hassle. Roofs leak, heating boilers stop working (always at the weekend) and carpets need renewing. What about your beloved customer – the rent-paying tenant of your property? Tenants can cause damage to your property through neglect and sometimes wilful damage. And what about the mortgage? That can rocket at a moment’s notice and leave you way out of pocket. So why are you choosing to take the responsibility of property on at all? Why not join the growing band of carefree tenants and kickback and let someone else have the hassle? Well, that just isn’t you is it? I suspect our lists will look fairly similar, but there could be some new ideas: 1 There is No Opt-Out. It’s an obvious point but perhaps the most compelling reason to choose property. After food and water, the provision of shelter is the most basic of needs. People will live in property, as an owner or a tenant, or they will live in the park under a newspaper. This gives a constant and steady demand for housing which other assets don’t have. You can opt in or out of shares in Apple at a whim, for example. One bad decision from the CEO or a change in the market, and the shares can be sold until they drop to zero. There is no such opt-out with housing, and demand to live under a roof only really varies with population levels and some social factors (such as levels of divorce creating more oneparent households for example). 2 Property = Wealth. The ownership of land and property has historically made the difference between those who live hand-to-mouth (tenants or tenant farmers) and the lord of the land (Landlord) who uses the asset to his advantage, generating wealth from this asset which can be used to support his life and then be passed on to future generations. Most people on the Times Rich List made it through property and land. The other lucky ones who had good business ideas and exploited those ideas to create fortunes have probably exchanged or will exchange their new wealth into property and land in some way or another as a method of retaining and building their wealth. The point of note here is that these wealthy people often buy and hold land and property for generations and so do not rely on the release of the capital value to support their lifestyle (although I am sure it helps their credit rating!). Wealthy people clearly exploit the property or land by charging people to use it and then give it back to them, in the same condition. It is this money, or rental yield that provides for them and supports their lifestyle. 3 Property is just another Business. This is true and a useful idea. You as a landlord will be the “CEO” if you like of your own business. This idea helps to think of other landlords as competitive businesses and makes you good at what you do. Not all Landlords think in this way and are actually very poor at what they do in my experience. However, the big point here is that the business of property is fragmented like no other. There are millions of property “businesses”. Most people in the property “business”, the private buyers and sellers of houses don’t even consider themselves to be in business and quite right too. They buy and sell their homes according to circumstance and sentiment. Without these
drivers, you as a property professional have a distinct advantage and can take opportunities as they arise, not just when you need to move. Equally, the business of property rental is hugely fragmented with no one player (other than the council or social rented sector). Most Landlords have less than 5 properties and many only have one. You as a property professional can exert your knowledge and motivation to create a competitive advantage over these property “part-timers”, even if you only have one property yourself. 4 Use of Other People’s Money. It is often sighted as the most important aspect of property investment. You can use other people’s money, usually a bank, to increase or leverage the effect of your own wealth. It is common practice, when banking times are stable, to be offered 80% of the price of an investment property by the bank and you as an investor must find 20%. This increases by 5-fold the price of a property you can purchase. This sets property apart from other assets where you would usually require the full purchase price to buy a stock or bond. Sounds good? Well it is, particularly if you are reading this book and do not have access to huge amounts of money but can prove to the bank that you are solvent and a good risk. The typically conservative banks only make this exception with property as it has been the route to the banks riches also over the centuries and is a safe bet. The only point to make is that although your potential profits are greatly increased through the use of someone else’s money, so is your exposure to making much bigger losses (there had to be a downside!). Profits and losses are only generated when a property is bought and sold and the timing of this will be discussed later in the book. 5 Property Goes Up in Value. Because of the scarcity of property and the reason that it cannot be opted out of, property tends to increase in value at least in line with the rise of incomes over time. This is certainly true in areas where the ability to build on new land is limited and the population is stable or increasing (and the property is of good building construction that will last). Over the last 30 years, property in UK for example has increased, in real terms over inflation at around 2.5% per year1. There are huge fluctuations of course in values as the graph shows, for example buyers around 1988 needed to wait around 12 years before the real value of their house returned to the original price they paid. Those who purchased in the summer of 2007 may have to wait a similar period of time, just to break even. So purchasing purely for expected short term rises in prices can be foolhardy in the extreme. In this book we will focus on the long-term performance of property and the monthly returns from rentals that you will receive. MONTHLY CASHFLOW IS KING. It is the ability to time the (fairly transparent) property market and treat it like a business that will ensure you minimise your exposure to the downward market trends and make a profit each month. This is what this book will focus on.
Latest statistics for UK are produced at http://www.nationwide.co.uk/hpi/historical/
Okay, so we get a list. We could add more reasons. The point is to look at the list, make your own list, and then understand and exploit each point as far as you can. If these are the reasons to choose property then taking each reason to the limit will maximise how good you get at this business. Equally, making a list of reasons not to buy property, and then hedge against them is an equally useful exercise. Let’s do an example:
Reason not to buy Property – unplanned property maintenance
One common unplanned maintenance task for all types of property is roof repairs. It is an aspect of a property that is difficult to inspect and generally the first indication of problems is a dripping noise. So how could you hedge yourself against this risk? You could suggest:
• Taking adequate insurance to cover all losses. • Purchase only property with the best type of construction (ie not a flat roof). • Purchase only property which has been recently re-roofed, or is a newly-built property. • If part of a communal block, buy apartments below the top floor so if the roof leaks it
will not affect your tenant and you will not lose rent.
Again, the list could go on.
The final idea I will leave you with is one that I developed around 8 years ago to convince myself I was doing the right thing by investing in property. It was around the time I was considering leaving the comfort (and restrictions) of full-time employment and I was trying to reconcile the associated risks with the move. As I saw it, property could go up and down in value quite dramatically. I had seen that with my first property in Reading which slid into negative-equity and stayed there for 5 years. How could I provide a sustainable income from property if this was the case, never mind the costs of property ownership such as maintenance and finance costs.
Is Property a Gamble?
The conceptual idea I developed was that I, as a property investor, was living the life of a professional gambler sitting in a high-class casino playing roulette. Just like the roulette wheel stopping on red or black so property prices rise and fall and I am taking that risk. Sure, in property there tend to be more uptimes than down, but still like roulette. Perhaps I should stay in my job! But then I thought about the gambling stakes and who was providing the “chips” for each spin of the wheel. It wasn’t me, it was my tenant. Every “spin of the wheel” costs one mortgage payment but the rent my tenant paid bought me enough “chips” for each spin of the wheel. Indeed, when I got it right, the tenant paid me much more than was required for “the chips” and there was money left over to buy “drinks at the casino bar”. I could now afford to just keep spinning the roulette wheel as the tenant was paying for the table and also my drinks. The risk of capital value increases and decreases had therefore been removed
and, eventually, I was content to leave my job although I could have had the confidence to do it years early if I had read a book like this. For those versed in investment, okay the above is a long-winded metaphor for what a cash-positive investment looks like – sorry! Maybe thinking of the principles in this abstract form rather than numbers on a spreadsheet can be helpful though in focusing your energies, giving confidence or helping to explain your way of life to others. We will pick up on the idea here throughout this book.
My suggestion at this point is for you to make a list of the advantages and disadvantages with property ownership, to whatever level of detail you find useful. Then, consider what you can do for each advantage to maximise you benefit from it and minimise your exposure to all your listed disadvantages. I would then keep this list with you when property hunting. It is very easy to get carried away when viewing a property but does it meet the fundamental criteria you have? These should not be compromised. Advantages Disadvantages
Chapter 2 Outcomes for Property – What Do You Want to Achieve?
Let’s stop talking about property for the moment and turn the attention to you. What do you want to achieve and why? When entering any business or venture, it is of course worthwhile to set out a plan for what you would like to achieve and when you would like to achieve it. Property investment is no different in this respect. Working backwards, setting out a clear objective (or set of objectives) that you would like to achieve from property investment will be useful for the following reasons:
• • • •
Determine the type of property that you purchase. Guide your decisions towards financing. Provide a measure of progress towards your objectives. Will provide feedback when you have reached your goal.
There are a huge variety of reasons investors cite for starting with property investment. From the investors I have known and worked with, typical reasons have been: 1 2 3 4 5 6 7 8 9 10 To provide a passive income to supplement current income streams2 (i.e. wages). To provide a passive income to replace current income streams. To provide an income stream in retirement. To provide capital to draw on in retirement. To speculate on potential capital growth to provide a short term cash flow. As a tax-efficient shelter for savings. As a tax-efficient shelter against income. To exploit low interest rates or favourable currency rates between locations. As security to provide a home in times of uncertainty in resident country. To provide an asset which can be passed-on to future generations.
Understandably, all the motivations are for financial reward or security in some regard. It still surprises me that potential investors very rarely make mention of the core of the business that they are about to enter, namely the provision of housing for people or premises for business. Of course it would sound just a little unbelievable if an investor said: “Yeah, I am getting into property so I can give people a decent roof over their heads” But perhaps it is by doing exactly this, and doing it better than anyone else, that the real financial rewards come. More of this in Chapter 5.
The ‘Rich Dad Poor Dad’ series explain this concept well: www.richdad.com
Taking the reasons for investment further, we can examine the effects this will have on your likely investment strategy. In graphical form:
And making some attempt to position each of the motivations on the chart:
1- To provide a passive income to supplement current income streams3 (i.e. wages). 2- To provide a passive income to replace current income streams. 3- To provide an income stream in retirement.
3 The ‘Rich Dad Poor Dad’ series explain this concept well: http://www.richdad.com/
4- To provide capital to draw on in retirement. 5- To speculate on potential capital growth to provide a short term cash flow. 6- As a tax-efficient shelter for savings. 7- As a tax-efficient shelter against income. 8- To exploit low interest rates or favourable currency rates between locations. 9- As security to provide a home in times of uncertainty in resident country. 10- To provide an asset which can be passed-on to future generations. Where do you think you fit best on the chart? Which number or combinations of numbers best describes your investment motivation? Most investors should be able to identify with one if not more of the investment motivations listed. So far, so good. We have an understanding of our motivations to invest and some thoughts about the yields sought, the time taken to gain a return on our investment and the associated risk. Most of you would already have this worked out in some form or another, perhaps this just introduces you to a new way of expressing your intent. However, it is very surprising to me how few investors have got an overall plan for how they will meet this intent, in real terms.
So, What does a Plan Look Like?
Business Plan writing software is abundant and is extremely good at producing plans running to at least 100 pages, with graphs, that will bamboozle any Bank Manager. For some, producing a long and detailed plan may fit with how they approach the business and the individual investments. Everything is captured and, hopefully, uncertainty modelled sufficiently. Such a plan would include items such as:
• Executive Summary • Description of Business • Product Summary • Business strategy • Financial Summary • Market Research • Market Trends • External Research • Market Estimates • Business Location • Business Organisation • SWOT Analysis • Competitive Analysis • Customer Segments • Customer Demographics • Sales Strategy • Pricing Strategy • Marketing Plan • Advertising Plan • Objectives & Plans • Resource Allocation • Budget Allocation • Startup Budget • Forecast Profit & Loss • Forecast Balance Sheet • Forecast Cashflow
And so the list goes on. Perhaps this is why people don’t tend to set out a plan for what they want to achieve. Beyond the need to set out a plan for the purposes of finance, I would argue that if a business aim and strategy can be captured and distilled down as short as possible then a plan which satisfies this can be correspondingly short, and certainly less than than a whole page. Back in November 2002, it become clear to me that we had the opportunity to become fulltime property investors and give up full-time employment (so I am a reason 2 from the list). We had built up a small portfolio of property and had it under successful management and seemed to have the skills and discipline to run the businesses efficiently. It was time to scale the operation. At the time, I had in the following overall concept in mind:
Aim: To create a passive income stream through property sufficient to service our lifestyle. Strategy: Purchase property that achieves 12% rental yield, or more4.
Based on the above, I arrived at the following plan (I still have it, on a small scrap of paper in my desk):
Monthly Income Stream Required: £4,500 pcm Number of Properties Required: 30 Net Income Per Property: £150 pcm Typical Property: 1-bed for £30,000 (perhaps with some work to do in better areas) Finance: 80% Loan-to-Value Target Date: Nov 2006
There were a few sketches on my plan, which I am embarrassed to share, but other than that the above captures what focused our activity for the next 3 years. It may seem oversimplistic but the plan captured exactly which properties we should search for, how we should finance them and gave feedback on when we had reached our objective. The plan also highlighted to me the need to generate around £180,000 (plus costs) in cash over the 3 year project to finance the purchases. This was a huge sum of money to us then, around 3 years wages! It really focused our efforts and highlighted the need to keep working for this period (and save, save, save!), buy, develop and sell some properties and flip some properties “off plan” to raise the finance required over the 3 year project. Some flexibility was required on our part towards then end of the project as purchasing 1-bed property for £30k become increasingly difficult but other than that we stuck to the plan and achieved it a few months earlier than the target. Keeping my aim and plan very short and pithy enabled me to take the plan everywhere in my head and even in my sleep for the 3 years on which it was executed. It was possible to judge every action undertaken in those 3 years very easily against the plan and how it contributed to it. Now, let’s be honest, I kept the plan in 2002 short because I was lazy. I was very lucky
4 Why 12%? See Chapter 4
I did though as it provided a constant focus that a 100-page multimedia epic business plan would have failed to do. Of course, for some the more comprehensive plan on paper will be the way forward as by going through the process confidence and knowledge of the plan is built.
Think about what sort of investor you are and what your investment aim and strategy should be. Make a plan (as long as you like!) to include:
• • •
What type of property you will buy Prices and / or yield required When you are going to complete the plan
If you want to get the most from this book, it is wise to do this activity even if only in a very draft form before proceeding. You can then develop the plan as you read the rest of this book and refer to it in the future.
Chapter 3 The Location Hunter
Once you have made the decision to consider property as an investment vehicle for your future and you have a rough plan, the next step will be to conduct some research into the areas which could fit your objectives. You are very much like a hunter at this stage, looking for your own particular prey and using your own weapons. The more weapons in your armoury (and the sharper they are) the more likely you are to be successful of course. Additionally, if you select prey which have fewer hunters stalking them then you stand a chance of making a kill. Perhaps this is why you are reading this e-book. I would like to break down the hunt into two areas, first the broad location of the hunt (which may yield a number of results) and second the detailed search, on the ground treeby-tree so to speak. Enough of the hunter metaphor? Sorry, I am enjoying it.
What to Hunt?
At this point, before the search, we should define what each of us is looking for in broad terms. Different investors in different stages of life (with different cash positions or life goals) could be looking for very different property. We will cover this subject in more detail in the following chapter. However, at this stage, I am going to make the assumption that we are all looking to make money from the investment, it just depends on how quickly we want to make this money and how much risk we are prepared to take to make it.
Finding Where to Hunt
Unless you are fortunate enough to live on the doorstep of a rich hunting ground that fits your objectives, then remote research via the internet and publications are likely to be your first weapons. Indeed, I would argue that even if you are adamant that you are living in the middle of a property hotspot that is waiting to explode, it would still be prudent to look around you just to be sure you are seeing the “wood for the trees”. Communication links coupled with cheap and accessible travel options mean hunting grounds further afield are available. So how far are you prepared to go? Some investors I have worked with say that the best
place to buy is on your doorstep as you know the detailed breakdown of an area and where tenants are likely to choose as a preferred location. This is undoubtedly true. However, each of the locations I have invested in were relatively new to me and if I had taken heed of the “local knowledge” too much then I would never have invested a bean. Reputations and legacy issues connected to an area or suburb may have been relevant years ago (and still in the mind of locals) but are not relevant today. This will be obvious to anyone coming from outside, new to an area and applying some general principles. One example of this from my experience was when I was investing in the city of Aberdeen in north east Scotland in 2002. The received wisdom of all letting agents and estate agents was to buy properties in the best areas and avoid “like the plague” some less well-developed areas of the city. I followed this advice for about 6 months and acquired 5 flats in good areas for around £30,000 which gave a good yield of around 12%. Pretty good, but I found my limited funds drying up very quickly and was still drawn to areas (Torry in particular, if you know the city) where properties where around £15,000. To me, the properties looked the same and the rents were very similar, so a yield above 20% was possible. Taking the advice of a very good contact and friend who knew the city very well I decided to take the plunge in this more risky but lucrative area. Over the next 2 years I was lucky enough to purchase another 20 flats at this lower level and found the rents were sustainable, if well-managed. Looking back, it was these cheaper properties that really allowed our business to take off as their capital values increased at a far higher rate than the more established areas. At the peak of August 2007, the values of the more established areas had increased by around 300% but the riskier investments had actually increased by 500%. For me, at my early stage of investing, it made more sense to take the higher perceived risk for the higher potential return which resulted, counter to the advice that many locals were giving. So sticking to received wisdom may not always be the best method, your investments must fit with your own personal objectives. In terms of distance to research, I would consider your time available, your proximity to transport links and costs of those links. As we will discuss in Chapter 5, it is likely that you will want to visit your area of investment on a regular basis and it would be an advantage to be able to do this quickly and cheaply if an emergency arose. For me, this is of great importance. Even though I have a good control of time at my disposal, I do not want to feel I cannot control my investment (and therefore business – see chapter 7) in an effective manner if I am too remote or seen as too remote from those involved with my investment. So for me, being based in Europe, I will [mainly] stick to investments that are available in Europe as long as they are available. We are blessed with quick and cheap air travel across Europe which means attending your investment from anywhere to anywhere can be achieved in one day or with just one overnight stop. That’s not to say I have not been tempted to investment further afield. So having considered distance to travel, where should you start to look? What about consulting the media or talking to other investors that have success stories from locations you would never have considered? This approach will certainly broaden your horizons and may open your mind to pastures new. Indeed, I will include some areas from my research in the Appendices which will do just this. But a word of warning here. Are these stories of a successful historic “hunt” a good indication that the hunting ground will remain fertile in the future? Is there anything left for you, that fits your objectives? This is a really tough and important point. Past stories of success (and sometimes failure!) are easy to find and will come to you without effort, being printed in the media, displayed flamboyantly
at exhibitions or spoken about around tables at dinner parties. These stories are of great interest to any hunter of course. How did they select the area? What methods of purchasing and finance did they use? etc. But are there genuine reasons to copy the actions of the hunter in the story in the same location or has time moved on? This is highly likely and appears to be directly correlated to how loudly / often the story is told as the number of successful “hunts” over time increases. In contrast to this, the pro-active 2 stage approach we will lay out in this chapter involves some effort, be warned. By following this approach I would say your chances of success are greatly increased.
Let the Hunt Begin – Stage 1
Okay, you have selected a number of areas (perhaps countries or particular cities or regions) in which you would like to carry out some detailed research. What next? As it is likely you do not live in the location (or even if you do) it is time to sit down in front of the computer and do some work. Here are some sources to use that are likely to yield some results:
Google – carry out a search with terms such as “property market in ...” or “property statistics
in....”. More detailed research with terms as “property for sale in..” will lead you direct to selling agents but it would be good to keep things more general at the beginning. Of course, like any search on Google, you will be presented with “natural listings” on the left hand side of the page based on relevance and also paid for advertising links in the right hand side (and perhaps at the very top of the left in a shaded section). Again, it may be best to stick to the material in the natural search which Google has deemed most relevant at the start of your research and use the whole of the results page as your research progresses.
General Area Research – To find out statistics on an area such as population trends, income levels and housing trends. Good sites could be:
OECD: www.oecd.org EU: europa.eu/index_en.htm Governmental sites (city councils etc) Buy Association (some good podcasts): www.buyassociation.co.uk property.timesonline.co.uk/tol/life_and_style/property/overseas/article2227766.ece
Blogs and Forums - To get (hopefully unbiased) feedback from other investors in an area.
There are thousands of these. Here’s a couple that I have found useful: www.propertycommunity.com www.overseaspropertymall.com
Property Portals – A fantastic way to research and compare large areas or regions in a very
efficient manner. Portals are everywhere now and cover complete areas, regions, counties and even global coverage. If you know an area, you will know which portals people of that area use. If not, why don’t you find out? Blogs and relevant forums should help with this. Here’s one that I have found useful in the past, there are many more: www.themovechannel.com
Specific Area Research – Hopefully from unbiased sources which can give the low-down on particular areas. The printed press have good on-line presence (ft.com for example) and can be a useful, easy to search source of independent information.
Here’s a link I have found useful in this area: Global Property Guide (very good!): www.globalpropertyguide.com/ Of course, not everything can be achieved on-line even at this early stage of the research. Perhaps you would consider meeting other investors face-to-face at a property club or seminar that is in your area. What about attending a property exhibition that has exhibitors that are relevant to your area of research? As with the research conducted on-line, it is always worth considering the level of bias in the opinion given and the person’s motivation for giving the opinion.
Results So Far
The aim of the work so far has been to generate an area or a number of areas that merit further research. Hopefully you have found somewhere that “ticks all your boxes”. Those boxes may include:
• Proven rental income that fit your investment criteria. • Investment objects in your price range, after gearing if applicable. • Sustainable rental income due to such factors as inward investment, job creation and an • • • • • •
equilibrium (or shortage) of supply of rental housing vs demand for rental housing. Population trends which are favourable to the area (hopefully increasing). A robust local legal system to ensure and protect your property rights. Finance in place from local or international banks to the level of gearing you seek, if applicable. An acceptable level for finance interest rates. A tax regime that you can live with (remember that paying tax means you are making profit – a good thing!) Acceptable travel routes in terms of cost, time and frequency.
You will undoubtedly have some more boxes of your own which must be ticked as part of this initial research. Depending on your criteria and objectives this initial phase may have resulted in a number of potential areas or no areas at all. If you cannot find any areas, do not be discouraged. If your objectives are set correctly then you must take your time and develop your research techniques. It took me 12 months to find my last area for investment before I began investing and I consider myself to be quite spontaneous! If you find yourself searching endlessly with no progress then maybe your objectives are set a little unrealistically or maybe that property investment is not for you (in the areas which you would consider) at this time. Hope fully the process has still been valuable and can be followed up at a later date, maybe when your circumstances or the market conditions have changed in your favour. If you have found some potential areas – lucky you! If you have found many potential areas then it maybe that
your objectives could be reviewed or the areas designated a priority order to enter the next phase of research. Finally, well done for doing this work. It is by applying the effort at this stage, before talking to agents or others who will make money from your investment decisions, that will have the greatest impact on the lifetime success of your investment and your success in this business.
Detailed Phase – Stage 2
Although some more detail can be carried out on the internet (by visiting property agents sites for example), it is probably now the time to hit the ground in your area(s) of choice from the early research phase. If practicable, on your first trip it would be best to do this with the minimum of input from sources on the ground that have excess bias and will make money from your investment. If this is not practicable, then using a number of sources should level the bias out to some extent. The aim of this phase (which will involve a number of trips perhaps) is to:
• • • •
Determine if the area confirms the results from your earlier research. Find out if the area is somewhere where you would like to do business. Evaluate different micro-locations for potential against your objectives. Decide if travel to the area is a realistic option.
This can be a lonely time if you travel by yourself, and are in a country or region that you have never been to before. Be brave! When in this phase I like to stay in a variety of places (and levels of comfort) to find out more about different areas and what levels and standards locals expect. When travelling around I will prefer to use the public transport and watch how well it is used, which areas are particularly busy and what kind of people are getting on and off the transport. When walking the streets, I am looking at the type and number of cars parked in the street as an indicator of relative wealth. I look for signs of optimism in an area. This would include recent or ongoing new-build projects, active refurbishments (skips and scaffolding) or sights designated for imminent future development. Another good indicator at street level is the number and type of commercial outlets in an area. If it is a region which has a large number of local stores (i.e. not dominated by out-of-town retail) what do these stores sell and what level of the market are they servicing, compared to other areas locally, not your home town. Other good indicators at the street level are outlets for locals to spend their disposable income for example pubs and restaurants, theatres and the like. Do these outlets match the kind of tenants you are seeking and is there a trend for new outlets opening or are things on the decline? Looking at potential investments in the area, do they match your expectations from your searches on the internet? What is the typical condition and level of refurbishment of buildings in the area? Do properties show signs of being comparatively well looked after by owners and residents? The state of the communal areas of properties and the surrounding land can be a good indication of this. On an individual property level, are the means of access to the building (if multi-family) well-secured or can passers-by gain access easily? This may sound trivial, but I would consider it to be a very telling signal of the attentiveness of owners and residents. This is of particular issue if the property is located in an area that is frequented during the evenings at pub, clubs and the like.
Once you have done this work, and you are content to proceed, you will need to engage with local sources to take your work right down to potential investable objects. In doing so you will:
• • • • • • •
Refine your knowledge down to the micro-location level. View example properties that meet your objectives. Determine what tenant sector(s) are serviced in your area of choice and the current level of demand. Evaluate the typical demand for tenancies in the area and average void periods. Decide if the property can be effectively managed, particularly if you are remote from the investment. Gain an indication as to your ability to finance the investment, if you seek finance locally. Determine the costs associated with the purchase and management of the investment.
At this stage you will be working with a number of people on the ground, all who hold the keys to this final aspect of your search but will be making a charge for their services in some way. More about this crucial people dimension in Chapter 5. Let’s leave the idea of the property search there for now. We need to get some more tools together before we can go into any further detail. Hopefully, already you have seen the kind of work you as a property investor will be doing to make your investments and get ahead of the pack. It is this work, before any purchase is made, that will determine if you are successful to the greatest extent.
Carry out stage 1 of the location hunt. If you already have a location in mind, try to evaluate the area from a fresh perspective using the ideas in this chapter. Try to come up with a number of potential locations that you could take forward to stage 2 of the location hunt. Now keep these locations in mind as you read on.
Chapter 4 Purchasing Well – Evaluating and Securing an Investment
Continuing on from Chapter 2, the plan that you have drawn up should provide some guidance as to what type of property you are to select. Chapter 3 hopefully provided some thought for the location of such an object. We are now going to put these ideas together and discuss how to secure the investments.
Timing the Purchase
I hear time and again from seasoned investors that the critical success factor in any property always goes back to the purchase price paid. Pay too much and you will be either chasing unrealistically high rents to cover finance payments or achieving rents that do not put you in profit each month, after all costs. Get the property at a good price and the term of ownership becomes a less stressful experience as the rents you need to make a good profit are easily achieved in the market place. Indeed, you may be able to charge slightly lower than the market rentals and therefore encourage longer residence time from tenants and so achieve a “win-win”. OK, so far, so logical. But really what is a “good price” and how is it achieved?
Three Critical Factors - Yield, Yield and Yield
It is probably time we spoke about yield as it is the critical ratio that investors use to categorise and select investments, indeed it is arguably to keystone upon which all the other work is placed. Many other ratios have been devised to describe investments and returns but for my money, nothing beats simple yield.
What is Simple Yield?
I am not going to turn this into a maths lesson, I promise. Simply stated, the yield on a property investment is:
Annual Rental Income Generated Value of Property
The idea of yield is important when evaluating new investments and also the investments already held in your portfolio. Come to think of it, if this is the cornerstone of the property investment world, this is really simple! I will make it even simpler in a moment.
For the time being, let’s look at the equation and examine what it says (and what it doesn’t). First off, looking at annual rental income, there are a number of ways of expressing this. Do you quote the gross or net figure here and what is the difference? For me, I like to capture the expected annual rental income with any deductions which must be made to make the investment work. So, for example, I would deduct the cost of any routine maintenance (boiler, lift for example) and also the cost of employing a factor or managing agent if this is applicable. I would also deduct the cost of insurance as this is unavoidable. I would not include unplanned maintenance at this stage or indeed the cost of a letting agent. The work of a letting could be conducted by yourself for certain properties so at this stage is not included. Secondly, the value of the property should be the current market value of a property you intend to buy or hold in your portfolio. It is not a fantasy figure you have about what a property could achieve, but what other similar properties are achieving in the prevailing market. Anyone who has met me knows that, within a few minutes and regardless of the situation, I would have mentioned the word yield probably 5 times or more. This makes me extremely dull company, I know. However, it is refreshing (for someone as dull as me anyway) to hear more and more investors discussing yield and the resultant cash flow more frequently now when discussing property. For some reason we forgot this in the years of booming capital values5. Every investment made has an associated risk (more in Chapter 6) and will also require some work for which you should be rewarded as an investor. Property investment is no different. Indeed, investing in property is very “hands-on” in terms of tenant and property management and the investment is very illiquid. That is to say you cannot cash your chips in on a profit as easily as you can, say on the stock market. So what should this reward be? Well clearly, depending on the type of investor you are, the rewards you seek will be higher the more that you require a monthly cash flow to support your lifestyle. It is therefore logical that the higher rewards are made for the investor taking higher risk. At the very lowest level of risk, large investors and funds purchase commercial property to provide a level of return on their cash holdings. A widely-held approach is that the level of reward here is around 2% above the prevailing 10-year bond rate issued by their government. That is to say, as opposed to buying safe government bonds, commercial property of a good standard is attractive once a 2% reward is in place to cover the more intensive and riskier ownership of property. So, as I write this page, government bonds issued by the US, UK and EU governments stand at around 3%. Therefore, an investor in commercial property could take a position in a project when yields reach or exceed 5%. Commercial property of less than premium quality would perhaps require a corresponding increased yield. Due diligence into the project would reveal the risk level and the “fair value” reward required.
Actually, the reason is extremely well-laid out in ‘The Property Clock by Ajay Ahuja ‘ – a must read.
So, in figures, a £1 Million AAA-quality commercial investment might stack up if:
Annual Rental Income Generated Value of Property
£50,000 £ 1,000,000 Yield = 5% What about residential investment? The cold view of the commercial investor is widely used in some residential markets around the world where owner-occupation level is historically low. However, it is has not been used so widely where competition exists from owneroccupiers where the hunt for a home rather than a return on investment is the objective. I would make an estimate as a Yield to Break-Even Point (YBEP) for residential investment, funded by finance as follows:
Unfurnished Property = Finance pay rate +2% Furnished Property = Finance pay rate +3% Houses for sharers / students = Finance pay rate +4%
This loading makes account for void periods and costs associated with ownership (including property tax and letting agent fees but not income tax). The figures are based on the actual holding of my own in UK and Europe since 1993 and the holding of fellow investors, to provide a guide. Current investors may work off slightly different figures, as may holders of varying types of commercial property. With finance pay rates for investment finance averaging around 5% over the last 5 years this would mean a YBEP for the respective properties:
Unfurnished Property = 7% Furnished Property = 8% Houses for sharers / students = 9%
Now, the above is only a guide but it has served me well as a basis for my investment decisions in the last 5 or so years and will continue to do so. So, what does it mean to you as an investor?
E V E RY T H I N G
Going back to chapter 2, we examined what kind of investor you were and what returns you seek as a consequence. So, let’s look at that list with this in mind. For those that require some level of income from the investment from rentals, the yields achieved will need a margin above the YBEPs before. For those holding property for reasons other that creating an income, the levels above may be sufficient and would generally result in the purchase of less “risky” properties, other factors being equal. Lets look at couple of investor types:
Investor Type 1 – Supplementing Income
For an investor looking to merely supplement income, a margin of perhaps 2% may prove sufficient over the respective YBEP. In figures, for a £100,000 unfurnished property, you would require a yield of 9%. Annual Rental Income Generated = Value of Property x Yield In this case: Annual Rental Income Generated = £100,000 x 0.09 (9% or 9/100) Annual Rental Income Generated = £9,000 So, this investor would be seeking property generating £9,000 (or £750 pcm) in rent for every £100,000 property they purchase. Their supplementary income would be the 2% or £2,000 per annum. Let’s call this margin the “Yield Reward”. Not a king’s ransom in this case, but positive income which can be scaled if further similar properties are in the market and finance available.
Investor Type 2 – Replacing Current Income
For an investor seeking to replace their current income with a passive one generated through property things, justifiably, get more challenging. Nothing is easy in life and if you are looking to say goodbye to working for someone else, effort is required. This is the category of investor that I fall into and the category of many of the investors my company works with. There is some variability as to the level of return above the YBEP I seek which depends mainly on the prospects the property offers in terms of sustainability of yield, ability to finance and a view on future capital growth6. In general, I look for deals that will reward me with 4% above the YBEP and offer stable yields without excessive maintenance with good tenant demand. So, for a furnished property £100,000 this time, I want to achieve a yield of 12%. Annual Rental Income Generated = Value of Property x Yield In this case: Annual Rental Income Generated = £100,000 x 0.12 (12% or 12/100) Annual Rental Income Generated = £12,000 So, I would be seeking property generating £12,000 (or £1000 pcm) in rent for every £100,000 property I purchase. The supplementary income, or yield reward, would be the 4% or £4,000 per annum. It was investing in this way that I achieved the goal of generating sufficient income in the 3 year project outlined in Chapter 2. Higher yields are of course sometimes available – great, you may reach your goal that much quicker. But can the deals be financed to the same level? Are these deals more management / maintenance intensive or are longer void periods likely? What about the tenant sector? Are you relying on low-paid
6 Just like crystal ball gazing in its accuracy perhaps! Be warned of models relying on capital growth
or social tenants that may have more sporadic rental-payment attitudes? All factors to be considered. I will make a confession here. Didn’t the maths look a bit easy in the last example? Looking for 12% deals is easy (well, easy to spot them when they are there). We needed £1,000 per month in rent to make the £100,000 property fit our objectives in this case. So, when searching for property under these criteria, just remove the last 2 zeros from the purchase price and you have a target monthly rent. This is easily done, in any currency, and can be done by just glancing at an estate agent’s window (who offers both sales and lettings) and just slowing down the walking pace a little as you pass. On a web-based search, entire websites can be evaluated in seconds. And so the confession. My whole business has been built on this idea. The only “clever” bits have been finding and then managing the investments and I will share my thoughts on this throughout this book. Hopefully, from the above you can identify the kind of investor you are and the type of income or yield reward that you require. From this, we have everything, We now know what kind of property to look for and how much finance we are going to need to be successful.
Please note that no regard has been made to projected capital growth in this model. We have been discussing generating income from property. In truth, the real rewards in property are the capital appreciation of the asset held over time. However, this “paper profit” or indeed loss does not put food on the table. However, when realised through selling or re-financing an appreciated property, this growth can provide useful injections of cash to support lifestyle or finance subsequent deals. Finding the Deals
If you have spent any time looking for deals with yield to the higher levels discussed, you will know that it is hard work. This is the work that determines the success you will make as an investor. A quick search of your local market will probably provide an abundance of potential investments, most of them around plus or minus 2% the prevailing finance rate. For example, I have just been on the net this week and found an offer near to a property I own in Grantham so I know the area well. It is a brand new 3-bed house with garage offered at £109,000. It will rent for £500 pcm. I have been offered the property for £95,000 for a swift completion, based on one phone call, such is the market. The same houses were £150,000 24 months ago so sounds like a good deal. Perhaps it is for long-term capital growth as you could take a view that it must return, at some point to its 2007 price level. However, let’s analyse it quickly in terms of rental income. Will it bring money into my pocket or remove it?
Annual Rental Income Generated Value of Property
£6000 £109,000 Yield = 5.5%
Current finance rates, if you can get it, are around 5.5% on an investment product so the YBEP for an unfurnished let would be 7.5%. This is typical of deals available in the market when supply and demand is in equilibrium or supply exceeds demand. The YBEP is reached, if that. This house will need to be £60,000, and ready finance in place, before it becomes viable. This is unlikely to occur. And this is the point. In a market that is in equilibrium or that has excess demand over supply, it is unlikely we will find property that provides the “yield reward” we seek over the YBEP. So when is the best time to buy? When supply exceeds demand, as in the Grantham case above, we may get closer to YBEP and may even beat it but it is likely due to market principles that capital values are falling. The capital losses, in the short term, will dwarf rental income. The time to arrive in the market therefore, with your superman cape on, is when a flat period occurs over capital values have dropped and the rental incomes (due to wage increases) have recovered to a point where the yield reward is in place. This condition does occur but it lasts a relatively short period of time, particularly when banks recover their confidence to lend again to a good level. On the next page is a graph showing the yield reward first for a typical 2-bed unfurnished rental property property in the south east of England and second for a 1-bed furnished property in north east Scotland between 1990 – 2011 Q1. I have chosen these areas because my investment history was in these areas and data is readily available from governmental websites. For me, this graph tells the whole story. Let me repeat that! This graph captures perhaps all my thinking on property investment in terms of when and what to buy. There is nothing else, that’s why I keep looking at this graph, or graphs based on other locations, nearly every day. So what do we see? First for south east England, the results show that the purchaser buying using the Yield Reward criteria would have been very busy around 1995-96 and could have been tempted back into the market around 2002-2003, seeing rewards above 2% at these times. I remember back in 1996 that yields of 12% were quite common, even in London which seems remarkable when considered today. The market was quite different for Scotland with yield rewards above 3% (for a furnished property) from 1996 – 2004, with spectacular rewards of around 7% between 2000 – 2004. Buying at these times would have ensured a steady cash flow was achieved and is still being achieved from the properties. From a capital gain perspective, it is interesting to note that times good for the Yield Reward investor these were also times when capital values saw steady increases or were just about to experience strong growth. This is unsurprising when we consider the interest that investors would have, regardless of owner-occupier sentiment, at the times of high Yield Reward. This interest from investors when Yield Rewards are high (often at a time of low owner occupier confidence in the market) provides a floor to values and provides an additional demand element.
From my own perspective, I look at these 2 graphs with interest at my own investment history. My first property I purchased (my own home) was in 1990 in SE England. These were woeful times and I fell into negative equity, coinciding with the point on the graph when yield reward was below zero. I became an accidental landlord in 1993 and after a year or so found myself making money from the rental of that property all the way to when it was sold in 2000. I enjoyed capital growth of around 100% during this period of high Yield Reward. In Scotland, I was perhaps late to the “Yield Reward” party, entering in 2002. I purchased using the idea of Yield Reward right up to 2006 when deals became harder to find. Again, this was a time of high capital growth and the properties have all been cash flow positive every month that they have been owned. Looking at the graphs, it is also interesting to see what happened to investors buying at times below the Yield Reward criteria. For example, 2006-2007 were years when the Yield Rewards were near or below zero in both markets. The Yield Reward investor would have missed out on some spectacular capital growth during these periods, as values soared by owner-occupiers with ready finance taking the market to unbelievable levels. However, we are now seeing a correction in this market with all these gains being lost. For the speculator, timing is everything and money can be made when lady luck is on your side. For the Yield Reward investor, a steady cashflow is ensured every month and the points when property is purchased is rarely when values are about to collapse. These ideas can be applied to any property market around the world when carrying out your analysis. And now a very painful confession. I have strayed from the “Yield Reward” path only twice in my investment history, both times when greed and expectation of capital growth took over. The first time was in 2006 when a property in Berlin caught my eye. A 1 bedroom property in the centre of a capital city for 30.000 Euro seemed too good to be true – surely it must go up in value! Buying with a yield reward of only 1% was not so clever and the property has not gone up in value significantly and taken money out of my pocket every month since I owned it. The really embarrassing one was a purchase of a new build flat in August 2007, just before Northern Rock collapsed and speculation was rife. Again, the Yield Reward was a whole 0% and the property has gone down in value from the day I bought it, around £25,000 as we sit
here today in October 2010, if I could find a buyer at all. I will learn from these mistakes, I hope. Why don’t you pick up the lesson for free? We spoke in Chapter 3 about locating property. In the appendicies to this book, I will examine particular markets to discover where in the world the yield rewards can be found for a range of investors today. One further method to analyse the market you are researching is to look at affordability, either from a buyer or tenant perspective. Should the rent levels be cheap compared to wages then this is a possible indicator that rents have some upward pressure, other factors being equal. Different marketplaces and tenants will bear a higher proportion of their take home pay going towards their housing costs than others. For example, tenants in London can pay up to 50% of their take-home-pay towards their rent and associated costs. In Berlin, 25% is more typical. But it is the comparison of this figure over time that will reveal any latent upward [or indeed downward] pressure in rents. A similar affordability index can be researched for owner occupiers, ie how much does their housing costs soak up of their net income. An interesting feature will be if you discover that owning a property is far cheaper than renting, as this reveals latent demand for owner occupation [just another way of stating yield reward]. Finally, a measure to reveal any potential pressure in capital values is to look at the House price to Earnings ratio. Below is a graph showing this index over the past 30 years.
It is clear, from the graph above showing average house values, that purchasing at any point when the index was far below trend was not such a bad idea.
Closing the Deals
Just a short note here, on the topic of negotiation. There are lots of good books that cover this topic to a far greater level than I could dare. However, I am going to look at a particular aspect of negotiating in a “hotspot” for a yield investor. Let’s say we have found an area abundant in property that meets our objectives. It is likely that, particularly for the higher yield deals, you are early in the market and fully welcomed by estate agents and sellers alike. As the market develops, other investors (and owner-occupiers) will join you and demand increase. So, what should your approach to negotiation be? My experience with many investors is that “a deal must must done” i.e. some mark off the asking price must be achieved, regardless of conditions. The approach in a Moroccan Bazaar if you like. This could be a valuable approach, particularly if you are truly alone in a market or seeking only a limited amount of property. But as demand increases, this approach may have a disastrous effect. So a story: When I was purchasing in Aberdeen, Scotland I was fairly lonely in the market with the only real competition from owner-occupiers in the better residential areas. Prices for the 1-bed flats we sought ranged £20,000-£30,000. Our early deals were closed very successfully and we achieved a few thousand off the asking price in each case, applying ‘Moroccan Principles’. It felt good, even though purchasing at the asking price we still generated in excess of the 12% yield we sought. But after 6 months we started losing deals and this lost us time in the developing market. Quickly, we changed tack to paying what the owner wanted or even slightly more to secure the deal. To the owner, it was great as they still remembered the bad times of the last 5 years of falling or stagnant prices. To us we still achieved 12% yield and were growing. To the estate agents, well they loved us as they knew we were good for the money and paid ‘top dollar’. Now the point is, I knew a band of investors that came in and were doing just the same as I was and who can blame them. However, they seemed to be fixated on “doing a deal” and shaving a few pounds off where they could. The result is that I beat them nearly every time in securing property in the developing market and grew very quickly at a rate of one purchase every 3-4 weeks, my maximum really as I had a full-time job at the time. They, on the over hand had a very frustrating time losing deal after deal to me or owner-occupiers and picked up only the poorest quality property that no-one wanted. I sometimes pull the sales expose which I keep out of my filing cabinet to look back at what happened. At the peak of activity, a typical deal for £30,000 I may have paid £32,000 (rent for £325 so don’t cry). Fellow investors found this to be foolhardy at the time. However, with
the benefit of perspective, these properties peaked in value in 2007/08 at around £105,000. The deciding success factor was not if you could save a few pounds at the point of purchase but how many properties you could secure while the market fitted the yield objective. The investors I consider to have lost ended up with poor-quality properties which are hard to fill and they continued to purchase as the market moved up and away from them and overpaid. A useful lesson if you are looking to purchase multiple properties over a time frame that includes an increase in market activity.
Determining Yield Reward is an interesting exercise to carry out for a market you know well (perhaps in your area) or a market you are researching. You need to know finance rates, rent levels and property prices for a given year, that’s all. If this data is not to hand, the data for property in today’s market is easy to find and should help you make investment decisions. So, find out some typical Yield Rewards in your area over a given time and some Yield Rewards (today) for an area you are researching. The results could be surprising.
Chapter 5 What to Buy and From Whom
In previous chapters we have looked at your reasons for investment, locations to support your investment and timing in your entry into the market, based on yield criteria. We now turn to what types of property are available that can produce an income and the pros and cons with each type. A general list of property that could fall into the income-producing category are: • • • • • • • Long term rentals, individual flats or houses or apartment blocks. Commercial rentals – letting to businesses. Short term accommodation – letting property on a nightly to monthly basis. Leaseback schemes. Fractional ownership. Purchase of land. Purchase of development property.
Let’s look at each type of investment now, and discuss how each may fit into your investment strategy.
Long term Rentals
The most common type of investment, servicing the area of greatest demand. Typically, your tenants in this sector will be based and employed near your investment and have expectation to occupy the property for 6 months or more. The variability due to local market conditions tends to centre around if property is typically offered on a furnished [a more migrant population] or unfurnished basis and the typical residence times for each tenant. Both factors demand close inspection as they will affect your cashflow and also the stability of the investment. Let’s take a few examples.
Long Term Tenant in UK
The tenant market in the UK, much like markets in most of the developed world, service tenants that for whatever reason are unable to purchase property. The purchase of property and the general appetite for owner-occupation in this market is high and is often achieved by those in work and a stable location. Therefore, typical tenants will be students, young professionals, migrant workers and people “between” houses due to a job move, divorce and the like. Whilst owner-occupation is on the decline in UK and has been for 5 years or so, these tenants are the mainstay of the market and will continue to be so. Consequences of this are that the average residence time is between 7-13 months in the UK, depending on location and many units are offered on a furnished basis. So what does this mean for the investor? Well, in terms of cashflow, any units offered on a furnished basis clearly take more
time and effort to get right. A 10% allowance on the gross rental is made by the taxman for running such investments, and it is likely to cost around this in reality. Therefore, as pointed out in Chapter 4, the rental income needs to be reduced as a consequence. Additionally, the shorter residence time will inevitably lead to some unplanned voids albeit these may be short in active tenant markets. Finding new tenants and to move previous tenants out also comes with a cost. All in all, around 1-2 months’ rent should be expected to be lost each time through vacancy and management input required to find new tenants and conduct the move. With residence times perhaps just short of 1 year, this reduces the effective yield further by 10-20% per year. You will have your own figures to work with here, but make sure you apply them, and don’t gloss over. Nuances within this market could be letting of property to sharers [so called Higher Multiple Occupancy or HMO in UK] and rentals to tenants within houses. The HMO structure has been a real growth area in the UK, and where tenant demand dictates, it can be a very successful model. The watchword here is effective management. The property will inevitably take increased wear and tear through the tenancy, dispute can occur between tenants and it can be difficult to keep control of the occupants as they come and go. I have 2 HMO properties in UK and have found them to be higher yielding than a standard let, perhaps by 3-4%. The increased workload and maintenance has in truth eradicated most of this uplift, so are they worth it? If you are able to manage the units without undue stress, I would say a resounding “yes”. Getting the rents to a much higher level makes the properties more attractive to investors and so increases their capital values when they are eventually unloaded. Just don’t underestimate the work! Finally within this section, there is the rental to tenants in houses, typically families. This can be a very lucrative market, if the purchase prices are right in the first place. At one end of the market, you could be renting a 2 or 3 bed terrace to a family that are unable to access the mortgage market. If well-referenced, they could be very good tenants and their stability gives a stable return. On top of this, the longer occupation time should, though not always, result in the tenants really looking after your home. Some of the best rental stories I have heard fall into this category. The tenants and landlords have a great working relationship, and often managers in between become unnecessary. At the other end of the market, affluent migrant workers who do not want the bother of going through a house purchase can be found when the location is right. These tenants could be paying £2,000 or more each month, and expect a quality property in return. Tenancies in affluent parts of UK have this feature, but it is so often the case that the purchase price of a property in the area results in a paltry yield of 3-5%. In addition, the demands of the high-paying tenants can be high, and this can reduce the apparent yield yet further. It is hard to get this end of the market into cashflow positive territory, although extensive research could unearth what is perhaps the best find in the industry. Let me explain. In Aberdeen, as you know from previous chapters, I was looking for property that yielded around 12%. This usually meant me hunting in the lessfavoured areas of town and taking lower-paying tenants to make it work. In 2005, I stumbled across something of a sweet-spot in the market, but ignored it as it was “off brief”. What an idiot. The properties in question were newly-built 4 bedroom, 3 story town houses in an increasingly popular part of town. Demand was below supply at the time and prices had been reduced from £250,000 and could be had if you bought 3 houses together at a price of £200,000. The really interesting bit is that wages are very high in the area and characterised by a high proportion of wealthy migrant workers servicing the oil sector. Rents of £2,000
pcm where achievable. The holy grail of 12% being achieved in a very low maintenance unit. So why did I not buy? My consideration was that this part of the market was fragile and dependant heavily on one part of the economy. If I lost a tenant, my yield turned to zero and I had a big mortgage to service. It was too risky in my mind, from a cashflow perspective. Do I regret not buying? Yes I do. Properties of this sort really must come up very rarely, as a series of circumstances needs to be in place for it to occur. I feel in retrospect I was correct in assuming the voids were an issue and cash flow may not have been as good as the tried and tested 1 bedroom flat market. But from a capital gain perspective, these units by their very nature are a ticking time bomb for growth. 5 years on, after the biggest crash in prices in the UK for a generation, the units are prices at £420,000 even today. The lack of a few months’ rent due to voids along the way seems and is irrelevant for once. Hindsight you might say. But it is a trick that will work time and again should the yields and purchase price be in place anywhere again. I will learn from this mistake.
Long term Tenancy – German market
Most markets in the developed world bear close resemblance to the UK story outlined above, but I will introduce the features of the German market as these are sufficiently different. Due to lower rates of owner occupation across the country, typically between 15-45%, the tenant market is turned on its head compared to that of the UK and many countries across the world. What we find in Germany, and some other markets around the world of low owner occupation rates, are longer length of the typical tenancy, tenants covering the spectrum of the population and a market typified by institutional investors purchasing on bulk. So what does a typical tenancy in this market look like? As a contrast to the shorter tenancy periods in the UK, tenants in this market can be students, migrant workers, professionals, families and even retired workers. The average tenancy is more like 5 years, with some tenants staying for 30 years or more not being uncommon. Now that is stable! Tenants consequently treat the rental as their home and unfurnished property, even down to the provision of kitchen and other fixtures down to the tenant. In addition, depending on the part of the country in question and the state of market, units can be bought as a multiple so the whole apartment block or a number of apartment blocks. Investments are bought on a far more commercial basis and priced for investors, based on yield. When I first entered this market in 2005/ 2006, I found it all a little too good to be true. Not only were the features above in place, and management of a complete block of 20 apartments more straightforward than the management of a single apartment in UK, the ancillary costs of running the property were calculated in a far more transparent way. Effectively, all the side costs associated with the running of the investment such as: House management, buildings insurance, ground tax, boiler and lift maintenance, etc were effectively paid outwith the rental yield of the property by the tenant, directly to the management company. There really are few deductions being the collection of rent [around 5% of net rent] which need to be factored in. Still all sounds too good to be true? Well, it is not a gift. The useful due diligence in terms of property condition and location as in previous chapters needs to be conducted, as well as effective management in the next chapter. I have met many investors who have entered the German market based on low capital values alone and who have either lost their shirt or at best temporarily misplaced it. I remember well the meeting with an investor from the UK who came to our offices in Leipzig with a Lidl carried bag full of keys from a “development” in a
small town in East Germany. He had bought 120 units for around 5,000 Euros each at an auction in London. There of course was a reason the seller needed to take the property to auction in another country! There were around 10 units rented when he bought them, and the costs needed to get the others in a rentable condition was around 30,000 Euro per unit. He was cashflow negative from day 1 and there was no way out for him, apart from take his Lidl carrier bag back to London and see if he could “pass the parcel” with the problem. A sad case. But overall, the German market offers a real opportunity for an investor to access the market quickly, invest in a significant number of units and get managed in a truly arms-length manner. With yields of 8-12% not untypical, it is a marker which demands further research.
From the outset here, I will confess to a limited experience in this market. Having invested in only a few smaller units myself and only having introduced a limited number of investors to such property. This is perhaps a blindspot, due to the huge sector which it represents. The reason behind my lack of exposure to commercial property probably lies to the significant difference in this kind of asset and the manner in which it is purchased and managed. Commercial property ranges from a small shop or office unit below a residential block right the way through to supermarket complexes and large industrial spaces. What they all have in common is that the risk of the investment lays not only in the occupied state of the unit but also in the ongoing success and viability of the business that occupies it. Determining this risk is clearly a crucial part of the due diligence process that residential investment does not involve, with macro-economics being more the factor there. That said, commercial investments can be a very transparent offer and come with long-standing tenants in place. Additionally, it is typical for contracts running between 5-20 years to be in place, giving some security of tenure with maintenance issues being taken care for by the tenant. Much like the economy itself, the appetite for commercial investments can be very volatile, and property suffer greater falls [and experience faster increases] than residential property. For example, commercial property in most of the developed world has recently seen drops of around 40% or more, whilst the economy is is decline. Purchasing commercial property therefore in the current phase of the cycle could prove very rewarding if the tenant in place remains viable. Yields in strong markets can be around 6%, whilst more risky investments can bring 10-12% net yield. Against the current backdrop of low interest rates, and knowing that the running costs of a commercial investment can be very low, it could be a tempting market to enter. From my limited experience, I would tackle such an investment based on the viability of the incumbent tenant’s balance sheet and attempt to buy a type of premise in a location that would support a swift re-tenancy should the incumbent leave for whatever reason.
Short Term Accommodation
Okay, back to an area I have more experience in, so hopefully I can provide a few more thoughts for you.
Have you ever watched “A Place in the Sun” or flicked through a property magazine in a dentist’s waiting room and found the allure of owning a second home almost irresistible?
Seems a great way of using some of that spare cash you have and putting it to good use, not doing much in the bank after all. And the promised cherry on the cake is letting the property out when you are not using it for your own short breaks. The fag-packet calculation reveals that you could buy the property and rent it to guests who will essentially pay for the mortgage [if you take one] and all the running costs. Hey presto, a free holiday house. You pat yourself on the back for being so clever, go into the dentist’s chair and think on it some more. On reflection, it seems too good to be true. Why doesn’t everyone get up to this wheeze? Let’s take a look at the fag packet in more detail, using the usual boring metrics our regulars will be used to.
As usual, the daddy when it comes to criteria in evaluating the viability of a purchase of any property, in this case a second home purchase. But rather than using the usual tools to determine demand from long-term tenants, we are looking for the short term market [let’s agree that to be 3 months or less]. Different ways of tackling this one. Here’s some ideas, all internet-based so you can keep your buttocks firmly where they are right now: • Research a number of travel sites to determine where people are going for short breaks. This will give some ideas mainly about the leisure market. • Look at fast growing regions where the employment base could be very transient [and therefore unwilling to go for long-term accommodation]. This could include sectors such as off-shore energy [short stays onshore], near film studios where only temporary accommodation is sought or more typical seasonally-based activity. • Try and find areas where business people come and go a lot. These could be near convention centres, universities or research areas and just an area undergoing a lot of development. The internet really can save so much time in research. When I was researching the viability of a UK short term property, I found the Travelodge website very useful for example. Travelodge operate all over the UK, and have small hotels which service short stays for the range of clients. What was very useful was to see which Travelodge’s were the cheapest [check out Grantham or Dundee, for example] and where the dearest were [London, Edinburgh, Aberdeen rank high]. In fact, the Travelodge in Aberdeen really stood out. Due to the oil industry, and a thriving economy, rooms were fully booked right out to 3 months, and then the maximum £70 per night for the rest of the year. Dundee, only 60 miles south, had rooms available year-round for £19 or so. This really was a good first indicator of the viability of short term accommodation. Closer investigation on the ground showed that Aberdeen didn’t have enough beds in the city, but property prices were on a par with nearby Dundee. Short term accommodation really took off in the city a few years ago, local property owners eventually catching on. And really, this is what this section is all about. Any fool can tell you that the capital cities such as London, Paris and Berlin have a lot of demand for short-term accommodation. But how much do you have to pay for the property in the first place? This is clearly key. Property in London or Paris is often around 5,000 – 10,000 Euro per sqm. In Berlin, central property
can be had for 1.000 Eur – 2.000 Eur per sqm. That’s a bit different! And whilst long term rents usually have some correlation to the price of a property [the rental yield], the price paid by a short-termer is often more closely related to the price of hotels in the city. Now that is interesting.... Finally, a bit of competitor analysis in the market could be useful. Is there someone else in the area you are looking at doing just what you want to do? Perhaps they will chat things over with you. If not, their availability calendar on their website [check it for a few weeks] will show demand fairly well.
There will be different property types in different locations and markets in which you are researching that will be the “golden ones”. In a holiday resort, proximity to beach and such amenities are often crucial to avoid long void periods. In a city servicing tourism [like Berlin or London], proximity to tourist attractions and transport will be valued by clients. Whilst long-term tenants may be more particular over which floor the apartment is on [ground floor being a no-no perhaps] or does it face south, short termers will pay less regard usually. For city lets, can the property be configured to allow a maximum number of guests for the given space. For example, does the property have a large lounge that could accommodate a bed-settee for example and push the potential occupancy up by 2? Clearly a lot of your research into location will feed in to this part of your work. One tip I will share on location is perhaps most pertinent to short term lets for business people, but could apply anywhere really. The point is that your competition a lot of the time will be purpose built accommodation for short termers such as hotels or apartment-suites. These often come with additional benefits to travellers such as meeting rooms, dining and leisure facilities such as gym and swimming pool. But here’s a good one. Why not ensure your short term apartment or house is located right near one of the great hotels in the area. You can often negotiate some level of collaboration between you and the hotel, where the guests use the hotel facilities as part of your cost, or as an additional package. If you negotiate well with the hotel, you may even be able to piggy-back off their reception and have keys collected and deposited there. You can then give the added perceived value of staying in a hotel to your guests [and market this] whilst having the space and convenience of an apartments. A real win for all.
Maintenance and Running
The property will of course take more of a pounding from short-termers. That’s just a fact. You will also have to provide everything within the apartment or house, as appropriate to the market. This will often mean towels, toiletries, IT and internet etc etc. Lots of overheads you don’t get with long-termers, but of course you will make some use of all these lovely facilities when you stay at the property. In terms of running of the property, the level of client expectation [usually related to what
they are paying!] needs to be considered. Obviously, you are going to present the property spotlessly clean and having a good cleaning team on board that will work when you are not in town. But how are your guests going to access the property, especially out of hours. Will a key box suffice outside the property, or should clients be met? Things to consider. How will the clients expect to pay? Do you offer credit card payment [expensive] or are your guests happy paying cash, or better in advance by PayPal? And what about marketing? Of course the internet will be the most useful way for you to start, before you build a word-of-mouth following. Research will tell you if the market is competitive enough to need to market through portals [such as Expedia] or you are in a niche location that you can service well from your own internet site, perhaps with links from local service providers such as exhibition halls and the like. A whole article is needed on the marketing of the property really, but suffice to say it is here that the investment, if bought in the right location, will live or die.
We should cover this type of property, not so much because it is a sector that can produce income but because it is often sold as such. Quite simply, fractional ownership means you buy a share in the use in a property either by a fractional entry on the deeds or by some agreement under a lease. It sounds a lot like timeshare, and in practice it bears a close resemblance. The advantage of fractional ownership is that the cost of entry are that much lower and can be achievable without the need to take up finance. You can therefore assert that fractional ownership only becomes popular towards the end of a property cycle when capital values are out of the reach of buyers and banks have pulled back on lending levels. Perhaps it is a good indicator that it really is not time to buy into the market. Where the scheme could work, is in achieving the purchase, albeit shared of a size of property that you could not otherwise afford. Your level of share will obviously dictate the amount of usage you are permitted. Ok, so as an alternative to renting a holiday villa there could be something to say for the scheme. As an income-producing venture, the topic of this little book, it is unlikely to meet even the loosest of business plans. Just weigh the realistic income that can be produced during your permitted time against the high running costs and maintenance that will be required. It would be good to see some records of similar property in the area and the cashflow actually produced. Once you have a handle on the actual cashflow, put this into context with the total cash you are putting in and come up with a rental yield. If it stacks up, then perhaps look into the scheme further. It is unlikely you will find reliable rental yields in this sector, and the chance of offloading the property to others at a profit is a real gamble.
Property for Development
As opposed to making profit on the regular income from a property rental, the basis of this book, profit can of course be made through developing property and selling at an uplifted value. Countless TV programmes and newspaper articles have been dedicated to this topic in the boom decade of 1997-2007, covering a topic that was once the preserve of professional builders. So is there any sense to enter this market right now, post-property boom in most markets? Well, it is a risk unlike the income model we have covered so far. How can you be sure you can achieve an uplift in value and find a ready buyer in good time? Is finance availability for such projects in place? What skills, over and above competitor professionals, do you bring to the party? Despite the difficult markets currently, it is possible that you do have an advantage over the bigger builders. Your local knowledge may put you at an advantage, perhaps you know of a forthcoming infrastructure development in the area that has not hit the press as yet. Maybe you know the seller on a personal level and can negotiate a price without presenting it to the market. So perhaps there are angles you can take. Some basic pointers to give you the best chance of making in a profit in an assumed flat marketplace: • Can you add value to the property in an easy way some how? This could be in a number of ways. For example, can the land that comes with the property be sold off separately and reduce the risk of the main project? Are you acquiring the property with a restriction on the lease for example that can be lifted post-purchase and can therefore add value? That could be a great way to make money without doing the work, if you are well-versed in local legals and planning rules. • Can you extend the property in a cost-effective manner? Perhaps the property is a bungalow that can be readily extended in the attic. Maybe there is land sufficient to support a one or two story extension? I suppose the point here to make is that laying a brick in a poor part of town costs the same as laying a brick in the best part of town. The value of that laid brick could vary up 3 times or more in many locations. So the location of the site, as ever, is paramount. • Are there some local infrastructure improvements to be made in the area, and will that benefit be obvious at the time you come to sell the property? You may have heard a rumour of a new train station or new school, but the trouble with rumours is that everyone else has probably heard it and it may come to nothing by the time your development is finished.
• Can the use of the property be easily converted towards a sector that values the property higher? For example, can an old commercial building be converted into residential use? If so, what are the difference in value per sqm for each sector in the area and is there enough of a margin to take the risk you will get permission. Alternatively, can a residential property be converted into smaller units, and sold at a higher level? Does the micro-location support this? So, this route, particularly in a favourable sellers’ market, could be a way of turning profit in a much quicker way than the alternative income model. But the risks and stakes are much higher. Really do your research, before turning up to what really is a casino-type wager. The more research you do, the more the odds will be in your favour.
Purchase of land for development or subsequent sale
The final sector we shall briefly look at is the purchase of land, without property on it. There is a lot of commonality between the approach here of course with that of development of property. Perhaps the big difference is the longer timescale it can take to realise the investment, land being very illiquid. The types of land that may be of interest to an investor could be: • Land for farming, in a country that has low land values and good crop yields. • Land that could have the use of it changed, such as approval for residential building. • Land that could be leased to a high-paying tenant, such as a mobile phone aerial or TV. • Land that can be leased as a commercial area whilst approval for a change of use is granted. A favourite one is buying a city centre patch of land, and renting out for long term car parking space to local residents or businesses. The yield can be higher than that of other property types, there is little maintenance and you could be sitting on a gold mine should permission to build be given. Timing of land purchase is critical, even more so than built property. The fluctuation in price is far greater and aligned [albeit usually with a lag] to the general state of the economy.
Where to buy Property
The choices of where to search for property will depend on the market conditions and the prevailing culture in the marketplace. In a buoyant market, distressed sales will be few and far between and most sales will come direct from sellers via an agent. In more difficult markets, property will be offered by sellers, banks holding the finance which may be in default or institutional sellers who hold banks of these “non-performing” loans. In most markets, the easiest route to delivery will be through an estate agent or realtor. These agents will generally have good presence both on the high street and also on the internet, perhaps having lisitings amalgamated under national or regional portals. There’s not much to add from me here. You will no doubt be accustomed to the agent process.
Perhaps the only tip would be, especially in a fast-moving market, to try and establish good links to an agent or a select number of agents. Good deals that do come up, maybe needing a quick sale, are the ones to go for and you want to be sure you are sent these first! Not only should you seek to strike a good working relationship with the agent, but also demonstrate to them that you are in a good position to move quickly on any deals. This will convince them that you will maximise the chances of closure and perhaps minimise the work they have to do in terms of marketing. In more difficult markets, the options are more varied. It maybe that auctions are a viable place to search or getting near to the institutional sellers of non-performing loans outwith auction is possible.
Again, a complete book could be written on this topic and a search of Amazon will prove this to be the case. I will add only my own experiences of auctions, having bought only 3 properties in such a way. What can be said for auctions which are concluded in a competitive manner [ie more than 1 person bidding] is that the true market value is being paid for the object. In a difficult market, the supply of property to auction may well exceed buyer demand and prices paid can be a lot lower than listed through agents. This relies on realistic reserve prices being set. Buying at auction in a buoyant market can result in paying over what is available in the open market, with buyers placing additional value on assured delivery. Not a good place to be! As a general rule of thumb, if bidding is competitive and closing prices continually reaching above the guide price, then perhaps you have wasted a day, and you should keep your hands in your pocket. On the other hand, an empty auction house, particularly near the end of the day can be a great place to pick up units as long as you have done basic due diligence on the object and have ready finance to close the deal.
Buying From Institutional Sellers
Unless you have a lot of money to spend, it will be difficult to get direct access to the best deals that institutional sellers offload. It is more typical that a specialist agent will be able to give you access, as they have a good working relationship with the seller and deal with them on a bulk basis. Some real bargains exist here, and it is where I have bought a lot of property and will continue to do so. The “no free lunch” is the poor delivery of such objects and the wasted time chasing down 5-10 deals to achieve only 1 sale. Perhaps this is fine for property professionals who have the time and tools to undertake such a delivery route, but more difficult for private investors who have the burden of a day job. Our company, ProVenture, assist clients to purchase such property and there are others in the various markets around the world. The point to discuss as an opening conversation with such agents is to gain facts on the delivery success they have enjoyed over the last 12 months or so, and to get a realistic picture of what to expect of delivery and price. Once you have this clear in your mind, then you will know if this is a route to market for you.
Chapter 6 People Not Bricks – The Secret to Success
Indulge me as I climb on my soapbox and describe what I think is the area in which many investors make their biggest mistakes. Clearly, the business of property investment has at its cornerstone (pardon the pun) the acquisition of bricks and mortar to build value and cash flow. However, I am going to argue that it is the people who you interact with in the acquisition and ownership of those bricks that are the key success factor. Looking at the people surrounding the business, I would arrange them as follows:
I have used a model with concentric circles to explain, in my mind, where I see the greatest importance in relationship building with the various parties. So let’s start at the middle, the area of greatest importance.
It really surprises me how little regard some property investors and landlords pay to this most critical relationship. This is clearly where all cash flow and profit are generated, the key (and only!) customer of your product. When I talk with fellow investors regarding tenants, we invariably end up talking in short time about “tenants from hell” and what a nightmare they can cause us lords of the land. Frequently, the conclusion of such conversation seems to be that the business would be very easy if it wasn’t for the tenant! Like any relationship, there are responsibilities on each side to ensure harmony exists. So what should be done in the case of this relationship to avoid the “tenant from hell” approach? Well this depends on if you have a letting agent or other third party managing the tenancy on your behalf to some extent. We will talk more about the relationship with these people shortly. However, regardless of who manages the tenants, the relationship should involve the following:
• A clear outline and what is and what is not expected from both sides at the start of
the tenancy. This will usually be drawn up in a written contract, but in all honesty who reads contracts from top to bottom? Far better would be to discuss the agreement face-to-face, particularly if the tenant does not speak the local language as the mother tongue, to ensure no misunderstandings exist before the outset. This also gives the tenant an opportunity to voice what they expect from the landlord and / or letting agent. It may be that their expectation differs to yours, perhaps due to different
cultural backgrounds, and these differences can be addressed at the start. Any special conditions for the tenant can also be discussed and agreed.
• Regular communication, not just communication in response to necessity.
This communication should be planned and respect the privacy of the tenant. The intent of this communication should be to ensure the tenancy is progressing well and no problems are building up. Circumstances change in everyone’s lives and it is best to know about these changes for your tenant as soon as possible. Are maintenance tasks up-to-date for example? Is the tenant expecting any financial issues that may affect rental payment? Is the tenant looking after the property? Do they wish to stay in the property for a longer period than signed for? This communication is probably best to be conducted at a planned meeting at the property, although communication at short notice can be conducted well by telephone. Email, and all its impersonal effects, should best be left to include detail as a follow up to a phone call or inspection visit. be increased at every opportunity. However, it is valuable to keep the tenant regularly up-to-date with market rental levels for their type of property. It may be that you will reward tenants that stay longer in a property with below market rental levels, but it is still worthwhile making point of this as a demonstration of your goodwill and recognition of their responsible approach.
• Regular review of rent levels. This is not to say that rents should
In summary, it is not necessary to be “best friends” with your tenants and this could actually be counter-productive (when serious issues need to be faced and over-familiarity can cause problems). However, regular communication, from yourself as landlord and / or your letting agent, will ensure that this most crucial of relationships is effective and serves the business need.
It maybe that your property investments are located near to your place of residence and their number is not too great that the task of finding and managing tenants can be carried out yourself. This clearly will reduce the overheads as typical fees amount to around 10% of gross rentals if entrusted with a professional letting agent. The task, if carried out properly, should not be under-estimated however and can be time consuming and reactive to problems which can occur at any time. If the task if outsourced to an agent then this is a key relationship, providing the “face” of your business to the tenant as outlined above. Striking a good relationship should bring the following benefits:
• The letting agent keeps you abreast of current market rental levels and achieves this,
where appropriate, across your portfolio.You are kept up-to-date with routine planned and unplanned maintenance tasks and ensure the property remains in a good condition for continued rental.
• Your agent could advise on the best properties to renovate, to maximise returns,
or indeed advise on properties which could be considered to be sold at the most advantageous point.
• Your properties are favoured when showing prospective new tenants a selection of
Clearly, this relationship is key to ongoing profitability of your business and it should be considered how the relationship can be fostered in the best way. It will always be a good idea to remain pro-active as a landlord and react to maintenance issues in a timely manner. This will ensure that the letting agent’s job is easier as they will be managing less-problematic properties. Regular communication with the agent will ensure that your properties are always in their mind when looking for new tenants and this is key, particularly in a soft rental market. And finally, regular visits to the Letting Agent will always be useful in building of rapport in particular in the first 1-2 years of your relationship.
Another key relationship, if you are buying multiple investments in a given area over a period of time. The selling agent can provide an invaluable insight to the market and often be passed deals which do not appear on the market, and pass them to you first if you are a good contact. Depending on the market conditions, the selling agent will be more or less motivated to work closely with you. In a buoyant market, the agent can sell his property easily and will be more likely to be working closer to the buyer as they are bringing a scarce commodity, good property for sale, to the market. In a slower market, you will not find it difficult to become the agent’s best contact and you will both benefit from the activity and transactions you bring. A consideration on this point is how many agents you will use. Using multiple agents may be perfectly acceptable (and usual) in some markets, but may provide a conflict of interest in markets where good property is rare and offered to a variety of agents. A selling agent in this case who discovers you have employed a number of other agents, who all find the same or similar property, will be less motivated to work on your behalf for the obvious reasons. However, if you select one agent and motivate them well to find property to fit your investment criteria, this will usually serve everyone well as you build trust and understanding and above all else create a history of successful purchasing. Like all of us, the agent will be motivated by completing successful sales with minimum fuss as this maximises their return. Therefore, the ultimate sales price offered by you becomes less relevant as the volume of sales you bring delivers regular commission. In the best case, regardless of market conditions, you can be offered property that fits your objectives well before it is presented to the market and place offers that may be below that would be achieved if offered to the open market.
Legals & Banks
Whilst achieving a good relationship with professionals in this area is unlikely to bring big cost savings, the service you receive could really benefit. A good relationship with your bank for example will serve to build trust in your business and the viability of the properties you are attempting to finance. For me, as I tend to finance properties to a high level where possible,
this is crucial. The advantages of building a good relationship with your legal contacts is that a timely service can be delivered and deals go through at a good speed, minimising the risk of losing deals due to time spent getting through to the exchange of contract stage. In building relationships with these bodies, it can be very good if you can deal with one point of contact within the bank or legal firm. These firms maybe very large in size but by building a relationship with one member of staff, hopefully at a high level within the organisation, service can be very good and improve over time as successful deals mount up.
Oh boy, is this bit tricky! We all have stories of dealing with builders either at investment properties or on our own homes. Most of these stories fit neatly under the “nightmare” column. This has been my experience in a number of different countries so why is it so and what control over the situation can we expect to achieve? Well perhaps unlike the relationships discussed thus far, relationships with tradesmen can often be of a less professional nature and an enduring relationship is not always sought by both parties. Good builders have frantic work schedules and this means that work can be carried out in a sporadic fashion (going between different jobs as they progress) and the need to find repeat business is low on the builders “to do list”. So how can a positive relationship be fostered that will benefit all? Well, like in the previous cases, proving yourself as a good client and paying promptly with minimum fuss will differentiate yourself as a good client to some extent. Perhaps equally important is providing the builder with clear guidance at the outset of any project and visiting the site (without being too intrusive) can work well in building a professional relationship of mutual respect. However, even when all these things are done, builders can often abuse this relationship and see you as a source of ready money. You do pay promptly after all! Quotations and costs for materials find themselves going steadily upwards. This is not always the case and I am sure you have some good examples to the contrary, but all too often it happens to investors I work with or the letting agents who employ the tradesmen. Perhaps one good approach, particularly if you are not an expert in every aspect of construction, is to appoint and pay an intermediary to work on your behalf. This intermediary should have a greater knowledge of the building trade than yourself and offer credibility and to some extent power. For small routine maintenance tasks (say up to changing boilers etc) perhaps your letting agent if you use one will be a useful intermediary. If they are an agent of reasonable size, they will have a good handle on the going rate for typical routine tasks and how long they should take. The agent has a vested interest in getting the work completed and also offers a lot of potential work to the tradesman through the size of properties they hold under management. Under a fully-managed contract, a letting agent will often conduct these tasks as part of the contract. For more involved projects (kitchen / bathroom replacements, changes of layout etc) a project manager could be employed to ensure the relationship between you and the builder is the most productive. A project manager could be a professional, an architect used on the project or a key tradesman involved in the project. The project manager could even be your letting agent where appropriate skills and time exist. The point is that the function of a project manager is highly valuable work and should be rewarded. Do not expect your letting agent to oversee a complete refurbishment of a property for example, without additional
payment, and expect things to go swimmingly. This is not their core business and you have not paid for this service. In the best case, the letting agent will attempt to recover costs by overcharging for elements of the building work and in the worst case the work will not be completed to a satisfactory standard as a result of insufficient oversight.
As in any relationship, you should seek and provide feedback as your relationship develops to ensure you grow stronger together. There are simple ways of doing this, through regular face-to-face meetings for example. Perhaps in some cases a simple feedback form could be appropriate, thinking here of feedback sought from you by your tenant for example. You may not know the tenant that well or use a letting agent so face-to-face contact may not be possible. I always seek feedback, particularly from letting agents that I use. I work with a number of letting agents and have always told them:
“I want to be the best landlord on your books. Please, tell me when I am not.”
I apply this mentality to my approach to tenants. I want to be the best landlord they have ever experienced. I would do this by actions, surprising them in the care and speed I give to rectifying maintenance issues for example. And finally, when appropriate, remembering to give honest feedback yourself (although it is rarely requested!) can be useful. If a tenant has proved to be one of the best on your books, paying regularly and sorting problems on their own initiative, tell them they are the best. Reward them is appropriate in some way. Conversely, if a tenant falls short of what is expected, tell them before the point when legal action is required.
List the relationships you see as important in growing your property investment business. How are you going to develop these relationships and what do you expect from your relationship. Relationships: ….....................................................................................…........................................................ ….....................................................................................…........................................................ .............................….....................................................................................…........................... ..........................................................…..................................................................................... ….....................................................................................…........................................................ .............................….....................................................................................…........................... ..........................................................…..................................................................................... ….....................................................................................…........................................................
Chapter 7 The Management of Risks
In common with any other form of investment, property has risk associated with it. Clearly, rises or falls in capital value occur and if an investor seeks capital growth to generate profit then a whole list of risks could be listed, based on micro and macro economic and political factors. Remembering the example of the roulette wheel in Chapter 1 with the gambling stakes being paid by the tenant, the rise and fall in capital values is very well hedged against, as long as the investment is held. In keeping with the rest of this book, we will focus on the profit generated through monthly cash flow from rental payment. There are 3 primary risk factors posed to this income stream and are as follows.
Risk 1 - The Property Lays Empty
This is the one that really keeps me awake at night! It really is not the idea to purchase property and let it stand empty for any extensive period. Not only does the income stream stop completely but also security of the property, maintenance and validity of building insurance become questions. So what can be done to mitigate this risk? Prior to purchase, the critical factor will be to determine the level of rental demand in a particular area location and in the type of building being considered. This is a critical piece of work that can reveal an apparently suitable property in terms of yield reward to be an overly risky investment. Discussions with letting agents on the ground and research from the web will be the key. Some questions to be answered at this stage:
• What’s the typical population in the area? Are they tenants or owner-occupiers? • Is the population growing, shrinking or stable in the area (key question)? • How many properties have been let successfully in the last 6 months? How long did it
take to let the properties?
• Do tenants stay longer or shorter than the average in the particular location?
Hopefully, by asking questions such as those above, you will choose a good location in terms of rental demand in which to invest. Post-investment, keeping your property let and producing income relies heavily on the relationships you have built-up as we discussed in Chapter 5. Having a good relationship with your letting agent and / or tenant will ensure that communication is regular and friendly and each of your interactions are a “positive” experience for all. Enjoying these relationships will tend to improve how quickly a letting agent will let your property and also how long a tenant may stay at your property. In addition, the level of rent set can effect the length of time your properties stay voided. Setting levels at the market rate but offering some incentives such as a parking space or 1st month rent half price can be very effective in a competitive rental market. Additionally, setting rental levels just below the market rent (say 5%) can be an effective method to attract a long-list of prospective tenants in a area or sector where price sensitivity is high.
Risk 2 - The Property Falls Down
Well, that would be very dramatic! This section deals with non-routine maintenance tasks and costs. Clearly a lot of work can be completed prior to purchase to offset some of this risk. Activities such as:
• Instruct a comprehensive survey to highlight any significant faults. Price these faults
into your offer price or walk way.
• Determine the construction type used. Is it a building structure that should be durable
against time? Does it have any particular features (i.e. flat roofing or non-standard building construction) that make it vulnerable? Do any of the major items require imminent replacement (heating, windows for example)? common parts maintained and looked after?
• If buying a part of a building with common parts for other users, how well are these
Once purchased, during the course of ownership only general routine and corrective maintenance should be required if the property is well-managed. It is worth making a list of these activities and when they should be carried out (and what time of year, for example external work should be carried out when the weather is favourable of course). You may employ someone to carry these tasks out but make sure they are completed by regular inspections to the property yourself. This is always a good use of your time and can highlight any other issues at the building that you were not aware of (or potential properties for sale near yours!). In terms of planned maintenance, a building of typical construction in good management should cost around 1.5% of its value each year to keep in a good standard. Some years will cost more and some less, depending on the tasks undertaken in that year. Finally, insurance can be taken at various levels against varying risks. You should consider your attitude towards risk, and your cash holdings held against these risks, when deciding which insurance cover to take.
Risk 3 - Financial Risks
The biggest single outgoing for many investors will be the monthly payments required to service their loans. The good news is that there are many ways to reduce your risks in this area.
Type of Mortgage – At the most flexible (but also most risky) end of the standard mortgage
range is to be placed on the bank’s variable rate. This does what it says and varies with the prevailing market conditions, often from month to month. For an experienced investor this could be a good choice as the variable products often offer full flexibility to over pay and pay off the loan or lock into another product when the conditions are deemed advantageous. At the other end of the spectrum can be found long-term fixed rate mortgages with terms up to 30 years. A longer fix often suits less experienced or more risk-adverse investors as they are able to plan with more certainty what their cash flow is likely to be for a long period. These products are clearly less flexible and can be costly if redeemed though sale or equity release.
Between these 2 products lie a million and one other type of finance deals which are fixed, variable or somewhere in between (capped / collar). It is wise to take proper financial advice in this matter but worth considering before you do what kind of investor you are and what level of risk you are prepared to take with fluctuating repayments. Additionally, the method of mortgage repayment can be set at the outset of the agreement to suit your needs. The first type (interest-only) involves paying only the interest of the loan each month and leaving the capital borrowed to be repaid by another vehicle or eventual sale of the property. A repayment mortgage will ensure that the capital element is repaid by the end of the term of the mortgage. Sometimes the repayment element is constant through the term of the mortgage or it can start very low and increase as time goes on (and your rental returns increase). Finally, it will be wise (crucial!) to hold some cash reserves against the level of your investment to ensure you can sustain a cash flow in the business. The cash flow will be affected if you suffer void periods or significant unplanned maintenance tasks. The amount of cash you hold will depend on your attitude to risk, the type of your investments and their rental history. It is important to keep some of your holdings in cash as equity in assets, in particular property, can be illiquid (difficult to get hold of) and can depreciate in value just when you need the reserve. As a rule of thumb, I like to keep between 4-8 month’s gross rent from across our portfolio in cash at any one time. Even though our borrowings are big, this financial cushion enables me to sleep very well at night.
What are the main risks you see in growing a property business? How risk adverse an investor do you think you will be? List the measures will you take to offset your risks, based on your risk profile. ….....................................................................................…........................................................ ….....................................................................................…....................................................... ..............................….....................................................................................….......................... ...........................................................….................................................................................... .….....................................................................................…....................................................... ..............................….....................................................................................….......................... ...........................................................….................................................................................... .….....................................................................................…....................................................... ..............................….....................................................................................….......................... ...........................................................….................................................................................... .….....................................................................................…....................................................... ...............................….........................................................…....................................................
Chapter 8 You are a CEO
There is a danger, especially if property investment is embarked upon as a supplementary form of income or for capital appreciation only that it can be approached in a less than business-like manner. That is to say, less regard can be paid to the income flows inwards and outwards than would be paid to any ordinary profit-making business. This is a mistake and an approach that many smaller investors make in this very fragmented market. Adopting the persona as the CEO of the business and making plans and decisions in a business-like manner can only increase the profitability and long-term success of the venture, So what would make the difference between an investment venture run as a hobby as that of a business?
Paying Regard to Competition
One of the key activities of CEOs in successful companies is to keep a key eye on competition. What are others doing well or not so well? What are your competitors charging? Where are they buying or selling? In the market of property investment, the marketplace can be very fragmented with no clear market leader or player with huge market share (other than social housing provided by the government). This is true to more or less of an extent depending on factors such as owner-occupation levels. Typically, the lower the owner-occupation levels resulting in the presence of larger investment institutions. Perhaps surprisingly, it is very infrequent for a “brand” to exist in the market that clients (tenants) are aware of and are drawn towards. This provides the obvious advantages of ease of entering the market as a small player, perhaps investing in just one studio flat and making a profit. Just imagine trying to break a market such as the soft drinks industry and compete with market leaders such as Coca Cola. Huge capital and risk is required. Notwithstanding this feature, it surprises me the lack of business approach that is adopted by property investors, even the so called “big boys” who I have seen make huge mistakes (by having just a broad overview of a market and investing in perhaps a lazy fashion). The big boys can be beaten by very small investors that employ more competitive tactics and strategies. Equally, smaller players looking merely to “provide a pension pot” or some other vague notion based on capital appreciation display a very loose attitude towards monthly cash flows and growth strategies (perhaps they are busy people!), providing the business-focused investor huge opportunities for competitive advantage. Analysing the competition will reveal an abundance of factors that can be used to align your business approach. For example, what are your competitors charging for their rentals? Have they kept rent levels static for years and fallen behind the market rent (a common mistake) or is your competition attempting to achieve unrealistically high rents based more on the return they seek than the market will bear. This is a common mistake of investors that have paid at the peak of a property cycle and attempt (badly) to cover the costs of a doomed investment. Analysis of pricing, available from letting agents and the media, will
guide you to price your property at a level which is competitive and achieve a successful letting. Perhaps inventive pricing structures can be implemented, beyond the flat monthly payment to induce potential tenants and keep them. Not seen often, offering low monthly costs at the beginning of a tenancy and providing incentives to stay (including managing their property well!) could pay dividends. This process is of course ongoing as the market develops. So that’s the income side. What about costs? Again, careful analysis of your costs versus typical costs of your competitors will increase profitability. Statistics are more difficult to reveal, your competitors are less open and willing to show your their balance sheets. Perhaps a good approach is to make good relationships with the suppliers of your services and attempt to achieve low costs (perhaps as low as the big boys do through their scale) by “win win” negotiation or by teaming up with other investors to present a stronger front. Typical costs in the business will include:
• Property management fees • Property buildings insurance • Finance • Routine property maintenance • Non-routine maintenance • Furnishings and fittings
Maximising Cash Flow
The positive flow of cash in any business is key to its ongoing success and your property business is no different. Hopefully you will achieve good purchases at high yields to ensure a good cash flow exists. By making efficiency measures as detailed above, your expenditure should be reduced to a minimum and so should the periods that your property stands empty. It is a good idea, once a property has “settled down” after a few months of ownership to capture the cashflow it brings and what this contributes to your overall cashflow across your growing portfolio. By listing individual properties against monthly income and outgoings, each property can be analysed for its benefit to the portfolio and highlight potential “stars” or “dogs” within your portfolio. It is inevitable that some properties will out perform others in a given month, but is this a continuing trend? Tracking such flows of cash will help make decisions such as taking streamlining measures or making further acquisitions of a certain property type / location or disposing of under-performing property.
Planning for Acquisitions and Disposals
In growing a portfolio, regular decisions should be taken to whether to acquire or dispose of particular property or types of property as time passes. Analysis of cashflow as outlined above will provide a clue to which properties you should consider to add or reduce from a income perspective. Additionally, the trends of capital growth of properties in your portfolio and property on your “watch list” should be researched on an on-going basis to help make crucial decision regarding timing of buying and selling.
Thinking “like a CEO” will encourage you to use the data you build on your portfolio and the market conditions to make decisions, just like at a monthly board meeting (perhaps just with yourself!). It maybe for example that a particular property in your portfolio was purchased some time ago and was purchased at a good yield-level, a fact you are proud of. Over the length of ownership, the property has performed well and produced a regular positive monthly cashflow. However, by regular analysis of the market, it is revealed its capital value has increased and the yield on present value is now much lower. A decision should be taken by the active CEO. Should this capital be released through sale of the property or refinance to invest in other markets that are performing well? It is very easy when less actively managing a portfolio to miss these crucial buy and sell triggers and it could hold you back in growing your portfolio to a size that will achieve your overall financial objectives.
The most significant aspect to most property businesses in terms of financial planning is the conditions under which you raise mortgages to acquire and support your investments. Again, this could be an “agenda item” at your regular board meetings. Properties held with finance should be examined regularly for their payments and terms of the finance. Aspects such as incentive periods when rates are kept low may expire and rates revert to a higher “standard variable rate” may occur. This should be regularly reviewed and action taken as appropriate within a few months of the product reverting to the higher rate. Additionally, the mortgage market should be regularly analysed to discover any changes in lending terms or rates and thereby keep you one step ahead of the game. Decisions should be taken about which lender to use for new purchases based on their loan-to-value levels, arrangement fees and product types available. Finally, a view should be taken on when to opt for a particular product in the financial cycle. Is it best to go for a tracker, suspecting rates will trend downwards over your product term or has the market flattened out and a long-term fixed rate becomes more attractive. A key eye on national bank rates, inflation and predicted GDP growth or contraction rates will give some guidance in informing these decisions. I use the following rough guide to determine which way rates go:
Bank Base Rate Level (tends towards): GDP growth(or contraction) rate + current inflation rate
So, for example, in Q1 of 2008 the UK: Bank Base Rate Level (tends towards): a GDP of 2% + 4.5% inflation = 6.5% At the time base rates were 5% and increased to 5.5% during this time. The view could be taken that bank rates were set to increase, GDP and inflation figures remaining as they were. If fix rates were available at around 5% (which they were) this could have been a good bet. Taking the current position in the UK in Q1 of 2009: Bank Base Rate Level (tends towards): a GDP of -1.5% + inflation 3% = 1.5% Indeed the current bank base rate was 1.5%.
The bank rate maybe 0.5% currently but investment mortgage pay rates are still usually above 5% for investment finance. So should a fix rate be more suitable or a tracker / variable rate? Well looking once more at the equation, with the 6 month forecasts for GDP and inflation, we would get (October 2009): Bank Base Rate Level (tends towards) – GDP of 0.2% + inflation 1.6% = 1.8% We live in strange times, but the current bank rate is unlikely to drop below 0.5%, if the above is followed, and should drift upwards as long as GDP and inflation predictions hold. When the margin that banks charge over base rate reduces, perhaps a fix in the medium term at these historical lower rates would be prudent. It is a judgement call of course, but by using this guide provides a system to inform the decisions which are made. I have used this system and currently have 60% of my finance arranged on a tracker basis as we speak. These products were mainly set up in 2007 when deals that tracked below the bank rate (between 0.25 – 0.75%) were not uncommon. My current payrate across my UK portfolio is now around 2.3% as a consequence which allows for a substantial monthly cashflow, even as voids have now started to creep in as the economy worsens.
A crucial aspect to your planning of your property investment business right from the outset. Four aspects of the local tax system should be considered for you to be efficient in retaining profit generated.
Tax rates made at the point of purchase (sometimes to referred to as Stamp Duty) can vary wildly both between countries and within a countries tax system. If a flat tax across the piece is applied, there are very few decisions to be taken – you will end up paying it regardless. However, if you are analysing different countries in which to invest then if all other factors are equal this could be a critical factor if the purchase tax rates differ greatly. The purchase tax must be paid for by you, at the point of purchase, out of your cash holdings. Therefore, the payment of this tax reduces your working capital and potential to make further acquisitions. It is very common for purchase tax rates to vary between locations within a country and depending on the purchase price paid. Governments do this to encourage the purchase of particular types of property or property in a particular location which usually could benefit from the inward investment. This research is easily carried out on a country’s tax website or by taking advice from a tax consultant. It maybe that your research shows that buying a number of smaller properties rather than one large property ensures that you stay beneath the tax threshold and therefore pay zero purchase tax. Nice. Or you may find that a particular city or part of the city is designated for lower purchase tax rates for a limited period. Again, you can take good advantage of this, as long as the investment stacks-up in every other regard.
Strangely, although the least popular of taxes for the poor old employees who are taxed direct from their payslip each month, this tax need not affect the property investor unduly. Why? Most countries with developed tax regimes allow many deductions to be taken from
the gross income to reduce the income tax liability. Firstly, these allowances broadly cover any expenditure you make in running your property business, such as:
• Property maintenance (including items replaced on a like for like basis) • Travel connected with the property • Professional expenses (such as letting agent) • Finance interest payment (not including capital repayments) • Property insurance • Provision of furnishings
In fact the list goes on and on. To restate, in the usual case any expenditure related wholly to the property business can be offset against the income received. Of perhaps greatest impact is the offsetting of finance interest payments. The finance payable to service a loan can be considerable in relation to gross rent and so offsetting this element can reduce your tax liability considerably. Of course, it affects your cash flow in an equal measure! However, this point should be considered carefully if you are in a position to either buy a property with cash or raise finance against the property. Buying with cash will clearly give you a better net cash flow on the individual investment but your income tax liability will be high. Taking finance will reduce this liability and leave you with more working capital with which to make more acquisitions, if that is the plan. It is important to remember that the repayment element of the finance (if a repayment mortgage is taken) is not allowable against income. Perhaps for this reason, around 90% of investment finance in UK is taken out on an interest-only basis. Additionally, some tax regimes will allow for further deductions against income such as:
• Depreciation of the building, at a notional annual level. • Cost of re-finance if funds used solely in the property business. • An annual percentage of the income is exempt from tax.
Tax regimes differ considerably and change regularly so research should be conducted at the very outset of your venture.
Capital Gains Tax (CGT)
Although difficult to predict and therefore plan for with any real precision, the capital gains are likely to dwarf the monthly net income from property ownership. Therefore, the tax take on this potential profit should be considered. Questions posed should include: • What are the CGT levels? • Are capital gains levels the same of individuals and companies or do they differ greatly?
• Does CGT reduce over the time a property is held? This is the usual case.
Double-Taxation – the rule of residence
Double Taxation treaties exist between all major economies to ensure that tax is only levied once, unless the taxation made in the country of your investment is lower than your country of residence. For example, if a income tax rate of 30% exists in your country of investment
and 20% in your country of residence, only tax will be payable in the country of your investment. In the usual case, this higher level of tax must be paid and cannot be offset in your country of residence. Conversely, if a zero rate of capital gains tax exists in your country of investment and say 20% in your country of residence, you will be liable for the 20% tax in your country of residence. Finally, a word on the structure of your business. Another common feature amongst developed countries are the various structures of business and how these affect all types of tax discussed. These structures generally include: • Individual or Partnership – property is purchased and held under an individual or partners name. • Limited Liability – a company is formed with shareholders and appointed directors. The persons within the company have limited liability to defaults for example. In the general case, to encourage the establishment of business enterprises, tax regimes often favour the formation of a company and charge a lower rate of tax as a reward. This is not always the case and treatment of income and capital gains may differ. Additionally, the ability to finance purchases may be affected by the structure of the property business you form. Careful research is therefore essential.
To be honest, the subject of taxation deserves a book longer in length than this one in itself. And it is important to note that tax regimes change frequently, so basing an investment purely on tax benefits may not be prudent. Hopefully I have done enough to get you to research fully the taxation of the area that you wish to invest within and take professional advice. Activity 7
Imagine you are the CEO of your business and you have called a monthly meeting to analyse performance and make decisions on future growth and management. What aspects will be on your agenda for the meeting? How would you gather the data to present to the meeting?
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Chapter 9 Finance and Currency – Getting Bang for Your Buck
The point on what level of finance, or leverage, you choose has been made in Chapter 2 when we looked at what kind of investor you are. Put simply, the higher level of finance you take then the greater number of bricks you can buy for your given cash reserve. There are so many factors to consider when taking finance, as we discussed in the last chapter. Ultimately there will be a trade-off between long-term fixing of the rate and a lower initial pay rate for shorter term money. When looking at what your options are hear, it is good to see what the money markets are pricing different length of fixes at and how this fits in a historical perspective. One of the tools I use for this is at: www.swap-rates.com
An example output is above, for current rates for the Euro. So, what does this all tell us? Well, quite a lot. First off, the rates shown against the various length of fix shows what banks charge each other for that money. Your access will typically carry a loading to this rate, typically between 1-3% depending on the competitiveness of the money markets. So, from the graph, 10 year Euro fixes are based on an interbank rate of 2.63% as of 24 September 2010. You would expect as a client to achieve a 10 year mortgage payrate of around 3.6%, very cheap on an historical basis. You can check each individual length of fix for this rate and determine what fits for you. Additionally, you can check how this rate compares with historical trends and see if it is low or high. As we write, money is at the cheapest it has been for centuries, if you can get access to it!
Finally, the curve created by the graph overleaf, often called the yield curve when discussing returns on bonds or gilts, tells a great deal. The steeper the curve, the higher inflation and future rates are being priced into the future. Checking the gradient of this curve over time tells a great deal and informs your choice on length of fix and when to fix very well. There is a great deal of speculation here both in terms of the prices set for longer term fixes and the length of fix that will fit your investment horizon. My advice is to get into these figures to help inform your decision when you strike a finance deal. At the very least, you will be armed with knowledge and information that will help you negotiate with the banks you approach.
Getting the best deal on currency exchange can often make up to 2% difference on the amount being transferred. The “spread” that is used (the difference between the spot rate and the rate offered) can be very small with currency dealers in comparison with high-street banks due to the high volume of business that they do. The spread can be as low as 0.3-0.5% as opposed to around 1.5-2.5% with a bank for example. So for a transfer of 500.000 Euro, a saving of up to 10.000 Euro can sometimes be made, just by spending some time getting the best deal. Additionally, some companies do not make transfer charges which will often save you a considerable amount of money. Our recommended strategy is as follows:
• • •
Contact your own bank to determine their costs, to gain a “benchmark”. Apply for a trading account at a number of Currency Exchange Dealers on the day prior to proposed exchange (free). On day of exchange, ask for the ‘spot rate’ from various dealers and attempt to get the best deal. If you are quoted say 1.20 Eur/£ early in the day then perhaps ask then to book a rate when it hits a higher level, say 1.21 Eur/£. Book and pay for your rate by the close of play.
Additionally, for future exchanges, you can take advantage of ‘booking’ a rate for some time in the future and making the payment downstream. This would work if you suspect you need the cash in Germany in say 3 months and want to take advantage of what you perceive to be a good rate. This costs nothing and you generally need only lodge a 10% deposit. You will find lots of companies on the internet with whom you can set up an account. Here are a few suggested ones that clients have used in the past with favourable outcomes: • • World First - 02078019080 Currencies Direct – 08453893000 (get them to call you back as its an 0845 no)
Chapter 10 Location, Timing, Location – Bringing it all together
There are a lot of ideas in this book hopefully that have got you thinking about how and when to make your next investment, and make it succeed. I want to leave you with one idea that hopefully brings this all together, before finally dealing in the next chapter with selling of an investment. So, let’s run off at a tangent for a bit. Something recently reminded me of my days spent in the military and the type of training were put through. One of the training courses, and it was done on an annual basis, was concerning the fighting of fires and the trainers successfully turned an interesting subject [lets set things alight] into one of the dullest experiences, year in year out. I do remember on the feedback form which was duly passed around after a particularly dull session, some bright spark had written: “If a nuclear war is announced, and we have a hour to live, I would like to spend it with Corporal Jackson [the trainer] as this was the longest hour of my life” The crowning joy of the fire training was the obligatory “fire triangle”, you are probably familiar with it but I put it below in any case:
The idea is that, for a fire to start and take hold, the 3 elements around the fire need to be in place. Take one away, and the fire cannot start or is extinguished. A useful little idea perhaps, but oh did it get painful on my 20th annual training day when the Corporal first asked us the 3 elements, and then removed one at a time and asked us what might happen. This was always delivered in the style of a magician, the instructor believing he had some passed on some hidden truth or indeed “Fire Station” Alchemy. All very tedious. Anyway, property. Well, as it is a useful model [and I know it fairly well] let’s use it for our work to summarise the book. Lets transpose our ideas into the diagram overleaf: Let’s look at each element, describe it a little further, and see what conclusions we can make:
Fuel - Investor Confidence
We can think here about the conditions which put the investor confidence “fuel” in place. Conditions typical for this are: Recent capital gains, which are well-published in the media in the later stages Economic improvements, unemployment falling or wage rises Increasing population, often characterised by rising rent levels after a time Investor successes in other markets, and looking to replicate their success A sure sign that this is in place can be when conducting property viewings. In extreme cases, you could be joining a line of ready buyers all looking around the same property. And the auction houses are either empty, or auctions are being used to bid buyers up well above usual levels. Estate agents in this period get lazy, and often don’t call you back. That sort of thing.
Oxygen - Positive Yield Reward
This element is provided by the ideas we covered in Chapter 4. When a strong positive yield reward is in place, monthly cash returns from day 1 are good, sometimes very good. Interestingly, when yield rewards are very high, it really is a buyer’s market. Auction houses and full of stock and empty of buyers. Estate agents welcome your arrival with red carpet treatment, and you have the pick of an abundant stock. Great times. As the market reaches a more stable state, yield rewards drop and usually go below zero for a long period, a good period to hold a property perhaps but not such a great time to be entering the market.
Heat - Favourable Finance Conditions
The heat is provided by financial institutions, namely lending banks. A favourable condition may be that 60-80% lending is possible for investor finance. A nice stable situation. Too
much “heat” is characterised by the 100% lending, on sometimes questionable property values. A sure sign of things to come, as we all know from the financial crisis of 2008. Another good sign of overheating is the number of new dwellings being completed per1000 inhabitants, per year. In Europe, 20 new dwellings per 1000 is about normal. When new dwelling completions go much above this, it is a good indication that lending to developers has extended beyond demand and are backed by over-exuberant banks. In Ireland for example in 2006, there were 430 new dwellings being completed per 1000 inhabitants. This was 20 times the European “norm” and a very good indicator that finance had overheated, and a very useful “sell” indicator.
Fire - Capital Gain
We place this in the middle of the model, as it needs the supports, to some extent to initiate it. Without all 3 outer elements in place, the capital gain will not start. If the 3 elements are in place but weak, then the capital gain may start but frequently die down. Perhaps the fire can keep going, and even roar for a time without other elements but soon goes out dramatically. We will look at this case in a moment. So, can we use this model in helping us discern different markets and investments within markets and make better decisions? I think so. I think you can use the ideas in this model to analyse any particular market you are looking to invest within, and it is a model I use when considering new investment areas in which to operate. Lets look at the case of the UK, set out in Chapter 4, and also at Germany and the USA which are dealt with in more detail within the Annexes to this book, set against this model.
Using the ideas of the fire triangle, perhaps best to look at is property in Aberdeen, Scotland. After all, we had very strong positive yield rewards from 1998 – 2004, but no capital growth. Well, we can say that this micro-location enjoys confidence on one big factor – oil price. Aberdeen is the capital of oil exploration in Europe and the local economy relies heavily on the price of oil, which is expensive to extract from the North Sea. Yield investors in
the market would have been buying quite happily from 1998, enjoy positive monthly cash returns but flat capital values. That’s not a bad place to be. With finance in place to around 80%, 2 sides of the triangle were very much in place, and investors from other parts of the UK, having enjoyed good growth in other cities such as London had confidence to buy, as I did. But it was not until the third side of the triangle, investor confidence brought about by higher oil prices as they rose from $30 to over $100 from 2004-05, that capital growth really was “set on fire”. The timing of any investor to buy around 2005 was almost perfect in hindsight, although the model makes this quite clear. It is just a case of working out what will bring investor confidence to any particular market. The model also makes the point to sell clear in this market. All 3 sides of the triangle fell, first the yield rewards went negative in 2006, next access to finance started to fall away in 2007 and finally the fuel of investor confidence dropped off in 2008-09 as oil prices plummeted and finance more difficult to obtain for investors. So the model gives us some ideas for the timing of a sale also, well done to the investors that cashed-out in 2007-08. I wished I had this model to hand, and understood it in 2007. I still hold most of my Aberdeen portfolio, and watch its value drop each month, although of course I still have a good yield based on my good fortune to enter the market at the right time.
Germany – Berlin
Well, the story of Berlin and its property market is fascinating and could fill a whole book. Lets restrict ourselves to the property depicted in the graph, a typical 50sqm in a suburb close to the centre. Firstly, we can see the yield rewards have been positive for most of the last 20 years. The collapse of the wall delivered property initially at a very low price level, and is still very cheap today [50.000 Eur for a nice apartment in a European capital city anyone?]. So, yield investors have enjoyed themselves here for 2 decades with few exception. Next, access to finance has been in place for much of the past 20 years with perhaps over-lending occurring during the mid 90s to local buyers and to international buyers between 2005-07. So, 2 sides of the triangle pretty much in place for 20 years, give or take a few minor blips. So it
is not surprising that capital growth has been steady and in some cases very good. Finally, investor confidence is very interesting here. Confidence was very high between 1990-1997, the optimism for the re-born capital was the story. But reality set in for some over-exuberant investors in the late 90s, finance payments were high and the support for the plethora of new builds from a steady or declining population not in place. Local buyer confidence dropped heavily, and growth flattened or went backwards. However, a second wave of confidence was brought to the market in 2000 onwards from international buyers, increasingly pricedout of their markets back home. The 3 sides of the triangle were again in place and capital growth took off again, until the financial crisis took hold. Today, you can say that all 3 sides of the triangle are in place, albeit yield rewards are low. However, the chronically low rents that are typical of the city [around 200-400 Eur per month for a city centre apartment is typical] are bringing new upward pressures to yield reward and it should be an interesting market for many years to come.
Oh my god. Where to start? Well, it is interesting to note first off that the USA property market does not normally do a great deal to excite. Prices are fairly predictable and rise with the general economic conditions. More on this in the Annex on USA. The period 2000-2006 famously did not follow this path!!
The chart above shows yield reward over the last decade for Orlando property, an average value of rent and capital value has been used as there are huge variations in this market. What a sorry read it is too for any yield investor. With rent levels moderate, but costs of ownership such as taxes and home owners associations and the like, net rents are really not great. This all translates into a negative yield reward for the whole decade pretty much. That is to say, any property bought here for the last 10 years will have been taking money out of your pocket month in and month out, and capital values have collapsed into the bargain. But what of the stellar price increases in the period 2001 – 2006 - 100% capital increase!! Well, using the idea of the triangle, we would have predicted no capital growth, as yield
rewards were negative during this period. But when we remember the financial policies of the time, 120% finance was available, and investor confidence sky high then the lack of “oxygen” of high yield reward made no difference that it was absent. Perhaps stretching the model a little too far, but we know that some fires, depending on the chemical of the fuel, can burn without oxygen for a time. But this chemical fuel is not real and does not last for long!! Capital gains during the period of strongly negative yield rewards always tend to get wiped off or “corrected” eventually, and the market here is no exception. Capital values have dropped like a stone, below that at the start of 2000. So is it a good place to go shopping for an investor now? Well, yield rewards are now positive, and in some cases very good now in Orlando and many parts of the country. So that’s one side of the triangle. In terms of investor confidence, this is still weak, but again in parts of the country the real economy is doing “okay” and populations are still on the up, as are rents. So, in places, 2 sides of the triangle are in place. However, finance is really not available to investors to this day or is taken on very high terms, wiping off any yield reward. Perhaps somewhere to watch and research and await the creeping back of finance to investors as a sure sign that the market is worthy of consideration. So, hopefully this model has served as a useful summary to the ideas in this book and at least give you some new thoughts and tools when considering the timing of a purchase or of a sale, more of which in the next chapter.
Chapter 11 – Selling Your Investment
I have to put my hand in the air here and say I am not very experienced in this area. Perhaps you have more experience than me, just by selling your own residential homes. The fact is, I agree with the notion that property is held and not sold. The income from property you achieve will grow through the period of ownership, capital value will grow over time and you have an appreciating asset that be re-financed or inherited. During my investment career I have sold only 7 individual properties and all of them through forced circumstances such as a problematic building or the building being acquired for re-development. I truly believe that profit in property is by steady growth and sustainable monthly cash flows, not speculation on capital values increasing. However, through my work as a property consultant to other investors, I have built up some knowledge in this area, working with sellers to achieve deals that they need. Therefore, I will attempt to give some guidance to this final step of your investment. I suppose the first point we can all make is that a property should be sold, if not in forced circumstances, at the point that the market reaches is highest capital values. Easy eh? Well yes and no. Let’s look at the Yield Reward graphs back in Chapter 4 for some clues. Well, we have already seen that a period of high Yield Reward usually coincides with stable or rising capital values, the demand from investors joining the owner-occupiers pushing prices higher. So selling during a period of high Yield Reward, unless under forced circumstances is probably not the most clever approach. Perhaps the period shortly after a high Yield Reward is the point to sell. The rising capital values have pushed yields down but owner-occupiers and amateur investors buying with the expectation of continued capital growth providing a ready supply of buyers. I would agree with this timing, although it is difficult to predict the very highest point of the market. Other factors such as availability of finance, affordability ratios7 and the like will help refine your decision at which point to sell for maximum advantage. I suppose it would be useful to see exactly who wants to buy your property. If the only potential buyers are professional investors, using techniques such as yield reward, then it may not be the best time to sell! However, if your property attracts a range of buyers with ready finance to a high level of their income (in the case of an owner occupier) or a low yield reward (in the case of an investor) then perhaps it is time to hand the keys over. As a final consideration, your tax position or finance deal may determine to some extent when you consider to offload your investment. Capital gains tax may reduce significantly after a certain length of ownership or your finance deal may make a hefty penalty for early redemption. However, if you stand to make a large profit then please enjoy it – you have earned it! Perhaps you could spend the money on a new property. Now where should you look.......
The ratio of average house prices to average wages
Appendix 1 – The German Property Market
Over the last 10 years or so, property markets around the world have experienced rates of capital growth typically between 200-300%, fuelled by cheap and plentiful credit. There are few exceptions to this trend, one of them being Germany. Due to re-unification some 20 years ago, the property market in Germany, particularly in the old east, has been operating out of sync with other markets. Speculation by mainly western German buyers fuelled a boom which ended around 1996. As investors were chasing rents that were not achievable, the German market gave way and went into decline from around 1996 – 2001. This was the same time that most markets around the world experienced their greatest growth rates. Prices have stabilised in most areas from 2001 and shown some capital appreciation in certain areas, particularly the good locations in the bigger cities such as Munich, Hamburg, Frankfurt and Berlin.
The residential market differs considerably from other locations, with more robust tenant laws and longer typical residence times. Typically, a residential unit will be offered for letting totally unfurnished, without kitchen units, light fittings or even flooring. The incoming tenant will provide all their own furnishings and stay for a longer period, typically on average about 7 years. Tenants sign contracts of a defined period but are effectively on a lifetime lease thereafter, only needing to move out if they are not regular with their payments or the landlord (or close family) which to occupy the unit. Tenants must give 3 months’ notice to quit and will repair and decorate the unit to a good condition when vacating. Commercial tenancies operate in a typical way with leases of 10 years or more (often escalating with RPI) the norm.
Percentage of Owner Occupiers:
Between 10-40% (higher in the western part of the country)
Investment Finance in Place:
Finance for Nationals and international buyers is usually set around 60-80% loan to value. The level of finance depending on the client’s income and the rental value of the property. Typical interest rates are fixed for 5 or 10 years and around 1.3% above the Euro 5 or 10 year swap rate. So at present (Feb 2011) rates are around 4.2% for a 5 year fix and 4.8% for a 10 year fix.
Property, both commercial and residential tends to be priced per sqm and not by room or bedroom number. Therefore, investments can be easily compared by size, price and location. Residential property can be purchased either on a single basis or by purchasing a complete block of apartments. Purchasing a complete block tends to reduce the price per
sqm paid. Some typical prices per sqm in the major cities, depending on size and location: Berlin – 1.000 – 2.000 Eur psm Frankfurt – 2.500 – 4.000 Eur psm Munich – 3.500 – 5.000 Eur psm Locations to the east of Germany (Dresden, Leipzig, Chemnitz for example) have properties in a good refurbished condition from 500 Eur psm. Remarkable value and the most undervalues market in the world according to the OECD. Location in terms of sustainability of rent is crucial in these locations.
In the same way that property is marketed for sale, rental property is priced per sqm. The rental is often broken down in to “cold” and “warm” rent, with the cold rent being the income to the investor and the warm rent covering all bills including ground tax and routine property maintenance. Cold rents start at around 4 Eur psm in the very cheapest parts of cities to the east of Germany with cold rents in cities such as Munich reaching 12 Eur psm and above in many cases. Yields range between around 5% for single apartments in Munich, Frankfurt and Hamburg to around 10-12% when bought as a block in cities such as Dresden, Leipzig and Chemnitz. Berlin offers the complete range of yields and is a very diverse market.
Being a market of predominantly unfurnished letting, a Yield Reward of above 2% would ensure a good cashflow in this market. With typical finance rates of between 4-5% for a long term fix deal, a net yield of 6-7% or above would be of interest as an investment. Yields Rewards of 4% are readily available in markets in the east of the country and 6-8% Yield Rewards are not uncommon although the ability for the location to support sustainable rental demand should be determined.
1. 2. 3. 4. 5. 6. 7. A property is found through the use of an agent. The price is settled and a purchase contract drawn up. If purchasing with finance, a finance application is made with a local bank to ensure finance is available and terms agreed. A survey is carried out to determine the property value, primarily on rental values. Contract is signed by seller and buyer with a Notary. An application to place your name in the Land Registry as a “priority notice” is made. The purchase price is paid and rents collected from that date.
Your name is placed in the Land Register to prove you have charge over the property (together with the bank if the property is purchased with finance).
The complete process from step 1-7 can take typically between 2-4 months, depending a number of factors including time taken to arrange finance.
Costs can be slightly higher than the global average for the purchase transactions (although much cheaper when selling). A typical breakdown of cost is a follows: Property Agent Fee: Stamp Duty: Notary and Legals: 3-6% 3.5% (4.5% in Berlin) 1.5%
An average cost of the purchase is therefore around 10% of the property purchase price.
Costs during ownership are transparent and are comparatively low. The majority of deductions to run the property are taken from the “warm rent” or ancillary cost and should not be included in yield calculations. This includes basic building maintenance, communal area cleaning, buildings insurance and property tax. From the net rent, apart from unplanned maintenance, the cost of letting management is the primary deduction. There are a variety of fee structures for letting management including a flat fee per apartment or a percentage of the rent collected. Letting management typically costs between 5-10% of net rents, depending on area and fee structure chosen.
Positive Investment Aspects:
• Hands-off investment – long-term tenants, unfurnished property letting • Well regulated and robust tenant and property management practices • High rental yields possible, to fit all investor types • Good finance available, at competitive levels of interest • Reliable legal and land registry system • Transparent running costs
Negative: Investment Aspects:
• Robust tenant laws – a tenant cannot just be removed unless they do not pay rent • High purchase costs (between 10-12%) • High yielding properties can be subject to a forced sell and can be problematic to
View on Market:
Very good yields, underpinned by strong legal system and high levels of finance. Capital values very low in comparison with anywhere in the developed world. Truly unfurnished property allows for significant holdings to be built up in a relatively “hands-off” manner.
An Historical Look at Prices in Leipzig
A common question we get from investors is what has been the price history in the areas in which we operate. Whilst some good data is available in the capital Berlin, finding price history in cities such as Leipzig can be difficult to find in the public domain. Here, we will try and provide some guidance on price histories since re-unification and of the past 3 years in particular. We will then make some predictions on how prices will develop in the coming years. Between 1990 – 1996, when interest rate policy was restrictive for investment across most markets, a wave of speculation of the real value of property in the former East took hold. With the market in the East effectively held under a social regime and property ownership was not possible, the value of the property was unknown. A common-held view that the re-unified country would equalise in prices to a great extent as the East caught up with the successful development of the West during the period of separation. Investments flowed into the East from domestic and foreign sources and the appetite for investment was increased by high bank lending values and government-backed grants for development of historical property. What happened as a result is a familiar story of over-exuberance, albeit based on a unique event of the fall of the Berlin Wall. As investments were made through the period to 1996 or so, the performance of those investments became unsupportable. The expectation of rent levels being similar to those in the developed West were unrealistic, population fell in many cities and towns due to the pull of the more affluent West and the ability for free travel and high interest payments of the time began to bite. Many investments failed, or needed to be supported from external income to prevent foreclosure. Think about it, just as the developed world was gearing up for a decade in which property values increased by 200-300% on the back on low inflation and low interest rates, so Germany dropped like a stone. Prices paid for property in this time climbed to 1000 Eur per sqm or more, and often for unrefurbished stock which needed around another 800 Eur per sqm investment to get in a condition for tenanting. It is not uncommon to hear of over-exuberant investments to fall by 50-70% during this period. Despite the prevailing low interest conditions, particularly after joining the Euro, the incentive or ability to support these failed investments waned. Only the very toughest survived the markets of the East. What happened next? Germany went through a programme of fiscal reform and set a course for low-inflation and increased productivity. Wage bargaining was tough, and output of the prized high-value German goods increased. All parts of Germany stabilised and began the process of reform. In terms of the property market, equilibrium was found in most areas between 2000-2005, with prices in Leipzig around 400-800 Eur per sqm for apartment buildings in the various parts of the city.
So, what about the last 3 years? Well the story has been very interesting for investors in the area. During a period of falling property prices in much of the developed world, the market in Leipzig has held up very well due to the fruits of 20 years of government investment in infrastructure, good capital values recognised by investors and the business climate returning to decade high levels of optimism across Germany. In 2007, it would be typical to conduct a search in the average locations in Leipzig for apartment houses in the price range 450-600 Eur per sqm. Steady increases have been seen since then, with an increase in demand from local buyers with increasing access to bank finance. A typical search of the market today in the same areas of Leipzig will be for property in the 550 – 700 Eur per sqm price bracket. In most cases, property over the last 3 years has seen around a 20% increase in prices which is good going in this climate. There are exceptions to this, depending on sub location. Some of the areas to the east of the city such as Neustadt and Volksmardorf and Sellerhausen have seen little or no capital appreciation, the stock being characterised by inhabitants of working class or non-working people. Banks still find it more difficult to finance to any great degree in these areas. On the other side of the coin, property prices in Schleussig and Plagwitz have really caught investor attention, with increases of between 30-50% being seen. So, what’s ahead of us in terms of capital appreciation? Well, with good yield rewards in place. this depends on a number of factors: Investor confidence Investor access to finance Rental level development Increasing owner-occupation In turn, investor confidence will be the key to purchase prices increasing with all other factors being equal. Right now, an investor feels rightly rewarded with a net yield of between 7-11%. With interest rates for 5-10 year fixes at around 3-4%, there is still room for an increase in confidence pushing yields further down. Yields in a stable market would equate to around 2% over lending-rate, so around 5-6%. Should yields drop due to this increased buyer confidence, then prices have the capacity to rise by around 40%, should finance remain low. Access to finance shows now real sign of abating, certainly for local buyers. It is not unusual for projects to be financed to 80% [or even higher] for German nationals, and 60-70% for foreign buyers. These levels have remained reasonably intact through the financial crisis, and should remain for investments where rents cover finance payments by at least 125%, so called “rental coverage”. Currently, rental coverage is often 200% or more, so there seems no immediate threat to tightening financial conditions. Increasing rent levels are the typical trigger for capital appreciation in the more mature markets in Germany. As rents creep up 5% or so per year, so the capital value increases by the same amount, all other things being equal. The current rent levels in Leipzig are very low and have remained so for the last 10 years or so, whilst excess capacity has been worked through with the increase in population or through demolition of unrefurbished stock. Some real anomalies remain to this day. For example, rental levels across the city for professional tenants lie in a thin range, usually between 4-6 Eur per sqm, a small deviation. As popular areas are developing,, higher rents are now being achieved. For example, in Sudvorstadt and Schleussig and Gohlis South, rents in excess of 7 Eur per sqm are now not uncommon and on the rise. The development is having an effect across the city, with pressures on areas in demand or well-presented units with benefits such as balconies.
With wages increasing, the proportion of take home pay used to service rents is now very low, around 20%, and shows capacity for rental increases to be absorbed. Finally, the effect base level for rents, the amount the government pay for unemployed people has not changed in 12 years. The current level of 3.85 Eur per sqm is the lowest in Germany, and is seen as very out of sync with other smaller and less economically vibrant cities. For example, nearby Halle which is half the size of Leipzig has a social tenant rate of 4.35 Eur per sqm. Leipzig must catch up at some point, and when it does the floor on rents will rise over night. Finally, and perhaps of greatest interest, is a fairly unique feature of this market. In 1989, all property was held by the state and before the wall fell every inhabitant of the city was effectively a council tenant. Since that time, owner-occupation has risen steadily to around 15% today. Some may wonder why this has not risen quicker, particularly with the low capital values of recent years. An answer to this lies in the appetite and culture of those with sufficient funds to buy their own home in the last 20 years. Typically, it is those aged around 25 years old or more that aspire to home ownership. It has taken some time for the lack of a housebuying culture to work through the older generation and arrive in a new generation with funds to buy. For sure, many of today’s 25-35 year olds aspire to own their own place, much in the same proportion to the rest of Germany where average owner occupation is just below 50%. Today, it is typical for out of town suburbs with new build single family houses or the very best areas of town in apartment houses to support this growing sector. The real point to note is the typical much higher price paid by an owner-occupier to an investor of a complete apartment house. The property is not purchased on a yield-return basis, more on the ability to pay and service the mortgage through income. So, areas in Leipzig where owners occupiers are buying their own apartments are typically paying from 1.200 Eur as a very minimum to 3.000 Eur per sqm or more. This is between 2-3 times investors buying apartment houses alongside them are paying. Quite an odd situation!! So, as owneroccupation increases to a more mature level towards 50%, so the average to good areas of the city will see viability for investors to divide their apartment houses into individual units and dispose of them, in a good refurbished state, to owner occupiers at a very significant uplift to the original price paid. In some areas, this may take 3-10 years to be a viable option, in other areas such as Gohlis South, Sudvorstadt and Schleussig this is an option to do right now. A guide to prices in graphical form:
Finally, looking to the yield rewards for a typical 60 Sqm apartment in Leipzig, we see the strong yield rewards for the past few years, although the levels are now starting to fall. This would point towards a period of capital growth coming to the market.
www.moneyweek.com/investments/property/why-you-should-invest-in-german-propertynow.aspx www.property.timesonline.co.uk/tol/life_and_style/property/overseas/article2875619.ece http://on.ft.com/hF8jZz=1 www.proventureproperty.com
Appendix 2 – The UK Property Market
The market grew, with few exceptions, throughout the period 1997 – 2007. Capital growth during this period was around 200% - 300%, fuelled by easy access to credit and a new sector of buyers, namely private landlords (buy-to-let). Since around Aug 2007, the market has cooled rapidly with capital values falling between 15-40% depending on location and type of property. Capital values continue to fall or are stable to some degree with yields improving for cash buyers.
The UK market has a range of buyers with (usually) plentiful supply to credit in a sophisticated financial system. Planning laws have restricted supply of new housing which has come under pressure due to increased households (immigration, social factors). Owner occupation levels are falling due, serviced by an improved rental sector. Tenant law is less regulated than some markets with a 6 month short term tenancy agreement the norm, followed by a monthly rolling agreement between the 2 parties.
Percentage of Owner Occupiers:
Owner occupation levels are broadly the same as USA and some European countries at at 68%. This level has fallen over the last 5 years from a level of 71% and is predicted to continue falling as the culture of home ownership changes or affordability improves for firsttime buyers.
Investment Finance in Place:
Investment finance has been readily available for residential and commercial ventures over the last 10 years. The advent of the buy-to-let mortgage, with rates very similar to residential mortgages and loan-to-values of between 70-85% have been common. It is unclear whether the current removal of many of these products from the marketplace during the credit freeze is a short or longer term measure. The proportion of mortgage defaults for BTL loans as compared to residential loans will be an indicator of how this should play out. Currently, finance can be arranged at around 6% (October 2009) on a fixed or variable basis.
Priced by number of bedrooms typically, not per sqm although sq foot is becoming more common. The average cost of a house in UK is around £160,000 although varies widely across the country.
The most popular type of residential investment property remains the apartment. Even though there has been a significant house price correction, yields tend to be in the range 3-7% depending on location primarily. For example, in the prime locations of London yields are often around the lower end of this range whereas 7% or higher can be achieved in the midlands or north of England and in Scotland for example. Currently, investment in UK property to provide any kind of income beyond anticipated capital growth is very difficult. Perhaps the only area that can be viable is the Home of Multiple Occupation or HMO where
a number of sharers are on the lease, similar to a student house. There is more regulation to adhere to for these lets and the costs can be considerably higher through wear and tear and also whether bills such as council tax and utilities are included in the rent.
Currently, Yield Rewards are at or close to zero. Falling house prices and the prospect of lower rates of finance may improve this situation to levels above the 2% Yield Reward required for an unfurnished letting in the medium term. Currently, the HMO letting sector performs the best in terms of Yield Reward and around 4% is attainable in certain university cities with lower than average property values.
Some of the lowest costs in the developed world due to competition. The typical fee for a £100,000 2 bedroomed apartments let say: Agent Fee – nothing paid by the buyer (around 1%) Solicitor - £500 Stamp Duty – Zero (below £125,000) Survey and other legal costs - £1000 (or less) Therefore, purchasing costs can be very low, 1.5% of purchase price in example above).
Running costs can be quite high, depending on the level of furnishing provided and type of property. As a guide: Letting Agent Fee – 8-12% Buildings Insurance - £100 per year Property Management Fee (typically for newly-built apartment) - £600 per year Routine Maintenance (heating, electrical checks) - £100 per year Inventory Checks (for each tenant move) - £100
Positive Investment Aspects:
• A growing tenant sector • Housing still in scarce supply • Yields are increasing in most areas due to capital values falling
Negative: Investment Aspects:
• Volatile capital values of late • Short tenant residency time (average of around 8 months) • Finance is currently difficult to achieve and is relatively expensive
View on Market:
Beyond the HMO sector, which can be very intensive to manage, there is scarce evidence to enter the UK market at this stage. Yields may improve during 2010 – 2011 due to further falls in prices and a pick-up in rent levels (an improved employment outlook or strong inflation are required) which may produce a positive investment situation in some locations / property types. The tenant sector is increasing as owner occupation levels fall nearer to continental European levels due to lack of affordability and appetite to own property as an asset. If this trend continues and the love affair of the British to own property wanes a little, then more competition by tenants should underpin higher rents in the medium term.
www.nethouseprices.com www.zoopla.co.uk www.propertysnake.co.uk
Appendix 3 – The US Housing Market
What an interesting market to look at, as we write this piece in Q4 of 2010. The USA is the home of raw capitalism, and this harsh approach applies to the property market in much the same way as the money and equity markets. Despite the assets in question being people’s homes and security, they seem exposed to harsh write-downs more than other countries, and this brings sorrow and hardship for those shielding losses and inevitable opportunities for investors. Taking a historical perspective on the market, we see that the USA has typically had an average level of owner-occupation between 1960-1990 of around 60%. Home ownership was a realistic aspiration for many, but not an imperative like in other markets such as UK or Spain where owner-occupation rates have been as high as 85-90%. This led to, in most locations, a stable market to invest within and a ready supply of short to longer term tenants. The credit bubble of 1996-2006 changed all this. During the period of low rates, sectors of the population who up until then could not aspire to home ownership at their stage of life, if at all, entered the market on “teaser” loans, affordable for the first few years of the loan but become crippling as the loan rates reverted to usual market rates or higher. This greed on lenders’ parts, and their shocking lack of due diligence into individual’s ability to pay, had a now famous global effect. Currently 14% of the population are behind on mortgage payments or are in foreclosure. This is an average, and some markets have double this rate. That’s 9 million homes in trouble, double that are households sitting on negative-equity. So where are we now, and is the USA a place worthy of investment research? It is safe to say, the market is bereft of confidence and sharp declines have been felt pretty much across the board. But are there areas that have suffered steeper declines than are justified? Well, the USA is huge, and individual cities and states remarkably differing in their current phase of the property cycle. For the purposes of this appendix, we shall focus on thoughts on one of the 5 states that have suffered the post during the downturn thus far and survey was is left for investors. We shall focus on metropolitan areas of Florida, principally Orlando as a major conurbation on which statistics are readily available.
Orlando Property Marketplace
The Orlando region derives much of its economic power from tourism, business conventions, medial and hi-tech research and the “grey dollar” or those retiring to the warm climes from more northern states or from abroad. The property market has grown with the huge rise in population, up 30% in the last decade alone. Typical in this region have been gated developments and condominiums growing mainly to the south of the city and spreading at an alarming pace in the empty land. The city or downtown area is well-established with some property dating back 100 years or more, broken up only by the high-rise developments which seemed viable during the credit bubble.
Construction of property can be standard construction, or more rapidly built units from prefabrication section. Use of wood in structural elements is often seen. During the credit binge, Orlando was front and centre, financing and constructing homes to service both the local and tourist market. Depending on location and subdivision, property soared 200-300% from 1995-2005, unheard of growth rates in this market which has no scarcity value and seemingly limitless land in which to develop. Commercial development went just as mad. Business plans for “strip malls”, small malls by the road side took off. Some areas of the city boast 10 Taco Bell franchised outlets in a 1km radius. All sectors of the property market, even in downtown locations, could be said to be very over supplied. To analyse what is left for investors let’s look at distinct property types:
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One Bedroom Condominium Three Bedroom Vacation Villa Three bedroom Family Villa Two Bedroom Downtown Apartment
For each property type we will look at price histories and project forward using the commonsense approach of rental yield and sustainability, demand from population changes and long-term value.
One Bedroom Condominium
These vary from developments built in say 1960s-1990s servicing the local market in the main to developments built in the 1900s-2006 which were aimed increasingly at the second home and tourist market. As an example of property in this sector, here is a 1-bed condo, 50 sqm and built in 2005. The list price is $41,000, the property being in foreclosure having reached a value of around $140,000 in the peak of 2006-07. The property itself is in an area of good demand for long-term tenants, where a monthly rental of around $700 should be expected. Even after the home owners payment to the community and property taxes, a healthy yield. So what’s the due diligence points here, the yield criteria being fully met? The points on rental stability based on demand and population are perhaps the first points to consider.
Three Bedroom Vacation Villa
Davenport, 2001, $95,000, peak 2006 Q4 of $257,000, 3 bed 2 bath near disney, 140 sqm More of a risk here, as pointed out in the section regarding short term accommodation in this book. My due diligence would focus around the actual costs to run this investment and the realistic demand and occupancy rate that could be achieved through the year. Of course, occupancy rate will come down to your expertise with marketing the unit. If this is your “bag” and you can get the unit rented at a good rate for 35-40 weeks of the year, then you have a viable investment with some private use options.
Three bedroom Family Villa
Good schools and residential location to south east of city. 2006. $120,000, $257,000 peak, 180 sqm 3 bed 2 bath no pool rental $1,100 per month A really interesting unit here, a rare-breed of near 12% yield on a family property. The usual diligence is required, just to ensure your yield is real and you dont hold a big empty unit for much of the year. Basic research on these units carried out in Q4 of 2010 show that there are many cheap [$50,000 or less] family properties on the market, but rentals are hard. However, areas which have some “scarcity” value such as uniquely good schools or inability to develop nearby offer great value and should be given consideration.
Two Bedroom Downtown Apartment
2007 build / 120 sqm / 2 bed / $190,000 today, $430,000 on completion was paid. Rent $1750 per month I know this development personally, and saw the prices which were being paid “off-plan”. Clearly, the fortunes of investors off-plan has been an unqualified disaster. What has not changed is the demand to live in such a building, it is out of this world in terms of fitting and services within the building. Rental demand is extremely high and worth research for cash investors.
Appendix 4 – About ProVenture Property
Quite frequently in UK after-dinner topics when entertaining friends or colleagues notoriously turn to investment and house prices in general. Of course, I enjoy these conversations being a complete property nerd! An increasing number of my friends and colleagues asked me to help them with their first investment or help with some aspects of management of a poorly- performing property that they had purchased for rental. I really enjoyed this work and around the end of 2005 it spawned the beginning of ProVenture Property. ProVenture are now well-established in helping a variety of investors with their needs in markets around Europe, and soon in USA. To date, we have helped around 200 investors with their investment plans and assisted them in finding new investments or getting their current investments under more effective control. During 2011 – 2015 we expect to be mainly operating in Europe, focusing on Germany and to a lesser-extent some of the markets in Eastern European countries. We are also looking to USA for cash investors. Our focus is simple and remains simple and be captured as follows:
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We find unbeatable property offers in the most exciting property markets, on investors’ behalf. All of the investments we find are cashflow positive from Day 1. We assist investors with every aspect of the purchase and subsequent management, in line with the principles in this book. Through scale of operation and our excellent contacts we can offer our services to investors at a very low cost, sometimes for nothing!
Just let me or one of the team know if you think we can help you, in any facet of property investment. We enjoy our work and helping other achieve their goals.
1 richdad.com/ The ‘Rich Dad Poor Dad’ series explain this concept well: http://www.
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