We are in a low interest environment. When I say low interest I mean below 8% base rate and 9.5% actual borrowing rate. Now you may think this is high but this was what deals were be struck at back in 1997 when I first started. Back then you could buy a studio flat within the M25 for less than £30,000 and rent it out at £350 per calendar month. Looking at this equation the profit would have been:
Mortgage@85% Loan To Value @ 9.5% Interest only £202
Service Charge £40
Now this does not seem much. Looking at the gross yield its:
£350 x 12 = £4,200 = 14% yield
Which is fantastic and lets look at the return on cash:
£108 x 12 = £1,296 = 29% ROCE
£30,000 x 15% £4,500
So borrowing at 9.5% interest rates back in 1997 was a good thing EVEN though rates were so high! So even at a 9.5% borrowing rate you can still get a 29% return on your money. If you had left the money in the bank you would have received only 8%. So by borrowing and investing in property you more than treble your return. The key to all of this is that the gross yield is in excess of 12%.
Correlation between Yield & ROCE & Interest Rate
So why do I say 12% yield. I’ll be honest with you. The main reason is because its easy to calculate whether a property is a 12% yielder. Let me show you:
If you see a property advertised for £50,000 and it’s a 12% yielder it should rent out for £500 pcm. i.e. you knock off the two zeros of the purchase price and it gives you the expected rent. So if you find out that it rents out at £600 pcm you buy it without looking at it! If you find out it rents out at £300 pcm you put the property out of your mind – no matter how pretty the property is!
Now for the science. Look at the following table. It details the ROCE based on the yield and interest rate being charged. I’ve assumed full occupancy, no repairs and £10pcm buildings insurance.
|ROCE Based on Yield & Interest Rate (85% Gearing)|
If you look at the 5% interest rate row (which is the approximate buy to let borrowing rate currently) you can see the ROCE increases with yield. If you look at even closer you will see that with every 1% increase in yield the ROCE increases by between 6.6% and 6.7%. It actually increases by 6.667% but due to rounding it is either 6.6% or 6.7%. This means for every 1% increment in yield your ROCE increases by 6.667%.
This is why yield is important. Its easy to think ‘oh there’s not much difference between an 8% yielding property and a 9% yielding property’ but there is – 6.667% ROCE!
So why do I say 12% yield? Well look at the 12% yielding column. At current interest rates of 5% your ROCE is 50.9% which is very nice. But at interest rates of 10% your ROCE is 22.5% which is still very nice even though you are in a high interest rate environment. If you had bought at 8% yield, which is still quite a respectable yield, your ROCE is -4.1% i.e. loss making. This assumes full occupancy and no repairs! In a rising interest rate environment investors that have bought between 4% and 6% yields will be forced to sell, as they will hold a liability (as it will cost them money to hold) rather than an asset (supposed to put money in your pocket) which is what they first thought they were buying!
Okay, so we’ve established that a 12% yield threshold is what we should be aiming for, but what about the level of borrowing? Well look at the same table above but this time only 50% level of borrowing:
|ROCE Based on Yield & Interest Rate (50% Gearing)|
Looking at the 5% interest rate row we can see that the ROCE for a 12% yielding property is 18.8%. Compare this to the ROCE for 85% gearing above of 50.9%. You can see that if you raise your borrowing by 35%, i.e. from 50% to 85% gearing, you almost triple your ROCE!
Now look at the ROCEs for a borrowing level of nil, 50%, 85% & 100% for a 12% yielding property.
|Interest Rate||Nil||50% LTV||85% LTV||100% LTV|
So we can clearly see that the ROCE increases rapidly the more we borrow. If we do not borrow all we can expect to make on the ROCE is the yield itself – which is not that exciting. We can see that the ROCE is higher for 50% gearing and even higher for 85% gearing. We can also see that it grows from 50.9% at 85% gearing to infinity at 100% gearing. It seems strange that this extra 15% level of borrowing would make such a difference – but it does!
Okay, I want you to follow this one simple rule and then you’re ensured a steady path to property millionairedom:
IF THE YIELD IS IN EXCESS OF 12% THEN BORROW THE MOST YOU CAN!
Look at this graph:
You can see that the closer you get to 100% LTV financing your ROCE tends to infinity. So if you want to maximise your ROCE you should aim as close as you can to 100% financing. I started with £500 7 years ago. I bought a house worth £49,000 with my £500. This equates to 99% financing. If I sold up now I would net £3m after clearing all my borrowings. My ROCE over the seven years is:
£3m/£500 x 100 = 600,000%
Now 600,000% is not infinity but its not bad!
Achieving 100% LTV Financing
So how do we reach close to or true 100% financing? Well lets look at how you are expected to fund a buy to let property:
|15% Personal Funds|
85% Mortgage Lender
So the majority of the purchase price comes from a mortgage lender and the rest from you. There is a very good reason why the banks expect you to contribute. Look at this next graph:
This shows the ROCE if the tenant didn’t pay you any rent at all. You can see that as the borrowing increases the ROCE tends to minus infinity! This is how people go out of business very quickly. If they are over borrowed and cash doesn’t come in on time or at all then its game over. The banks job is to make sure you’re not over-borrowed. The way they do this is by lending you only 85% of the purchase price and making you come up with the rest to ensure they don’t encounter a minus infinity situation.
Making you come up with the other 15% however restricts you to the number of purchases you can make. So if you wish to buy a £100,000 property then you need to come up with £15,000 out of your personal funds. This is not an easy thing to do. On an average salary of £20,000 it would take you at least 9 months to do if you lived on the streets and ate only bread and drank only water! More realistically it would take you 3 years to save this kind of deposit. If you could only buy a property every 3 years then you should keep the day job. It won’t be until retirement age before you could say good bye to the rat race and retire on the income produced from your property portfolio.
If you did find a lender that would lend to you 100% then you could theoretically buy all the properties in the world subject to your credit limit. There would be nothing to stop you earning what you desired. The only thing that would limit you is the time to actually acquire all these properties! What a luxury to be only constrained by time and not money. The truth is that this luxury is achieveable but you have to be brave, believe in your abilities and be willing to persist.
Achieving The Other 15% Deposit
If you want to grow quick then you need to access the other 15% quick! As detailed in my other book, The Buy to Let Bible, I told you how to raise a deposit quickly in 4 ways:
I Vendor Incentives – Vendor Gift or Cashback
This is where you basically get the mortgage lender to pay most of your deposit! This is best explained by the following example of Vendor Gift below:
Gavin has agreed to buy a property advertised for £60,000 for £51,000 but he has no money for the deposit. He tells the vendor to sell it to him for £60,000 + £9,000 vendor deposit.
|Without Vendor Gift|
|With Vendor Gift|
|Deposit Required (assume 15% of purchase price)||8,100||9,000|
|Gavin’s Actual Investment||0||0|
|Shortfall Of Investment = Deposit Required minus Gavin’s Actual Investment||8,100||9,000|
|Vendor Contribution = Advertised Purchase Price minus Actual Purchase Price||N/A||9,000|
|Actual Shortfall = Shortfall Of Investment minus Vendor Contribution||8,100||Nil|
Without Vendor Gift Gavin has a shortfall of £8,100 so he cannot buy the property.
With Vendor Gift Gavin has no shortfall. The vendor gets:
£60,000 - £9,000 = £51,000
The inflated purchase price - vendor contribution = original asking price.
His first property costing £51,000 for no money down. His borrowings are however greater than 85% loan to value. His borrowings are 85% of £60,000 = £51,000. This equates to 100% loan to value. In effect Gavin is borrowing all of his deposit from the mortgage lender. Note he is not borrowing any of the deposit from the vendor as the vendor has got his full asking price of £51,000. The vendor deposit figure is purely a notional figure. So Gavin’s buying power has risen from nil to £51,000 without changing any level of his deposit, income or creditworthiness.
This trick is completely legal but relies on the property being valued up to £60,000. This is likely because of three reasons:
- Valuers do not like to down-value a property - unless there is something wrong with it! If they think the purchase price is only slightly higher than what it is worth they will always value it at the purchase price. This is because the valuer knows that valuations are not an exact science. Valuations are based on what people will pay for a property and he will assume that if you are willing to pay £60,000 then the property is probably worth £60,000. A 15% gross inflation of the purchase price is not a lot considering you are only talking about an inflation of £9,000. Even if they do down value it you still get some vendor contribution which takes you closer to 100% financing. For higher value properties (greater than £200,000) I would suggest a 5% vendor deposit contribution as £10,000 purchase price inflation could be contested.
- You may be getting a bargain property - i.e. the property is worth £60,000 but you are actually getting it for £51,000, hence it values up to £60,000.
- Valuers are under pressure to value properties at the purchase price - Lenders make money by lending money. If they instruct a firm of valuers that keep on down-valuing properties then it becomes difficult for the lender to lend and hence make money. The more the valuer values property at the purchase price the more money the lender makes. Especially in the current rising property price conditions, even if the valuer thinks that the purchase price is 1% or 2% inflated he will assume that it will reach the valuation in a few months anyway.
Cashback works in the same way. In the above example the deal would be structured as:
£60,000 purchase price + £9,000 cashback.
So when you buy the property you put down £9,000 as your deposit, which you may have borrowed on your credit card, and get £9,000 back when you complete the purchase enabling you to pay back your credit card company.
There are tax issues. The vendor has to declare the inflated sales price to the Inland Revenue and thus will have to pay more capital gains tax as his gain is deemed to be higher. For the vendor this may not be a problem as the Inland Revenue gives you an allowance in excess of £7,900 for a capital gain. If this inflated price does not take the gain above this allowance then there is no increased capital gains tax to pay.
II 100%+ Mortgages
If you find saving too painful then there are mortgage companies that will lend you the whole amount. There are even lenders out there that will loan more than the value of the purchase price. The excess amount over the purchase price can be used to improve the property thus pushing up the value of the house. You have to aim to live in it however. So the theory is to buy the property as a residential property and then inform the lender after the deal is completed that you want to let it out.
This is best explained with an example.
Joanne, who has no deposit, decides to buy a property for £100,000 but the kitchen and bathroom is in poor repair. She gets an estimate for the work and she finds a builder that will do the complete job for £5,000. Joanne decides to go for the property and apply for a 105% Mortgage. This will mean that she will get:
£100,000 to purchase the property
£5,000 to repair the property
After the repair the property will be worth between £110,000 to £120,000 as the property is more saleable now as the property is more presentable to the market. Now depending on the lender she can inform the lender that she wishes to let it out. If they agree they will charge her anywhere between £nil to a 2% loading on the interest rate. If the fee is too much she can then remortgage the property on a buy to let mortgage. If it gets valued at £120,000 they will lend £102,000. This will clear most of the original £105,000 balance leaving a shortfall of £3,000 which she will have to contribute to. So in effect she gets a £120,000 property for £3,000. That’s 97.5% financing!
You can get one instantly by simply borrowing it! I would suggest that you only take on this credit (if you are borrowing from a credit card or bank) after your mortgage application has been submitted and you have been credit checked otherwise this borrowing will show up. This in itself may not be a problem but if you can try and get it after submission.
You can get the deposit from the following sources:
|Remortgaging Current Assets|
|Credit Card Companies||Now credit card companies have had a lot of bad press in the past and present and will continue in future for as long as they’re around. The reason why that get bad press is not because they do anything wrong, it’s the cardholder that does wrong.|
Certain cardholders spend the credit granted on items but have no plan on how they will pay the credit card company back. Is this the fault with the credit card company or the cardholder? I would say the cardholder. Others would say these companies give credit cards to anyone and they make it too easy. Making it easy is a good thing! Why make something hard if you can make it easy.
The key to playing the credit card game is having a plan to pay them back. Many businesses have been funded by credit cards during the bad times and have saved companies going bankrupt – but you never hear about it in the press as it doesn’t make good news. I have several credit cards with a total credit limit of £13,000 which will only ever be used if really needed. I used my credit cards a couple of years ago to buy a really cheap investment property as they advance you the cash immediately. Careful use of my credit cards made me £15,000 profit!
Credit card companies are begging us to borrow. So much so they offer 0% for balance transfer. The trick to obtaining your deposit is to:
You have to start this process after you have submitted your application form and you have been credit checked by the mortgage lender.
But please, please, please note: CREDIT CARDS ARE EXPENSIVE when you either default or go over the introductory period. Have a plan on how you are going to pay back this balance and for how long. If you do not then you can end up in unmanageable debt and then the whole property investment game with all its associated debts will become a nightmare. [Barclaycard offer a lifetime period of 0% until the debt is repaid but this requires you to have a minimum spend per month].
One way to plan the repayment of the credit card balance is to take up a cashback mortgage which gives you cash when you buy the property on completion.
|Overdraft Facilities||It’s the same principle as the credit card trick above. You simply obtain the deposit from your overdraft provider and pay it back within a set time period.|
You may be able to get an overdraft facility from your bank. Simply ask! They will need to see your salary being deposited every week or month for at least 6 months. This should not pose a problem if they have been your bank for more than 6 months.
Unlike credit cards they do not offer introductory rates. They usually start from 5% above Bank of England base rates so at today’s rates they start from 8.5% and can rise to 15% so they do work out expensive. The beauty of an overdraft is that it can be redeemed whenever you want to. A good way to redeem it is like above with a cash gift mortgage like a cashback mortgage.
|Personal Loans||You can raise the deposit by simply taking out a loan. The loan will be paid back over a number of years in equal instalments. You have to consider whether you can pay back the loan and the mortgage in total otherwise there is no point! So for example if you need £5,000 to put down for a £95,000 mortgage then your total cost of borrowings would be:|
£5,000 Loan £ 111.45
£95,000 Mortgage £ 412.98
Total £ 524.43
So make sure you can afford both repayments. Unlike the credit cards and overdrafts a loan is less easier to redeem as there are penalties. Sometimes the penalties are not too extortionate so it may be well worth redeeming the loan with penalty to save on interest you will pay over the duration of the loan.
Some lenders require a second charge on your personal property. This is not a problem but be really careful of their redemption penalties. If they are in excess of 5% of the loan then steer clear as these penalties can ultimately trap you in your home.
Be sure to apply for the loan after submission of your mortgage application form.
|Loan from friend or family||I have been on both sides of this equation! I have borrowed and I have lent. In the first instance I borrowed £500 to kick start my first property purchase from my Mum. In the second instance I lent £1,800 to one of my good friends to clear their credit card debt. This friend immediately paid me back using his credit card cheque book when the mortgage completed!|
You’d be surprised how helpful the people are around you. I would suggest approaching your family members first and then move outside of the family once all avenues have been exhausted. Do offer them an attractive rate of interest as no-one does anything for nothing!
IV Get A Partner
The other way to raise the cash is by taking on a financial partner. This means that the financial risk is borne by the partner but you end up doing all the work. The partner will be entitled to a share of your profits and you will not be free to do what you want with the property. Equating the cost to you will depend on how successful the property is as the cost will be the share of profits made. Even though this is the most expensive way to finance a property business it can also be the cheapest way if the whole project fails as your partner has taken the full financial risk. If this is the only method you can use to get into property I would still advise taking on a partner as you will still be participating in a share of the property market.
Consider the drawbacks that joint ownership brings:
- Loss of full freedom of sole ownership. When you have to sell you will need to get the partner to agree on whether you want to sell and the price.
- The gain on the property will have to be shared with the partner involved.
- You will be liable for the mortgage payments if the other partner defaults.
I am involved in a TV programme which will exactly about this concept. It will be following first-time buyers put together so that they can purchase their first home together and sell within 2 years, make a gain, split the gain and then use this gain to buy their own property individually. You could use a partner in this way where you both mutually benefit. It is worth planning the exit route and only enter in to this type of agreement with people you trust.
My Real Life Experiences
I do or have done all these 4 ways of raising a deposit. Let me give you a history of what I have done:
|Vendor Gift||I bought a house for £30,000 + £1,500 vendor deposit. This had two effects. I had to put down less as I was getting a £1,500 vendor deposit and it took the purchase price to the £30,000 bracket where you can get higher loan to values.|
|Cashback||I bought a house for £40,000 + £2,500 cashback. Again I had to put down less as I was getting a cash gift of £2,500. I had to put the £2,500 down initially but got it straight back after completion.|
|Cashback Mortgage||My first house was bought on a cashback mortgage. I had to put 5% down as a deposit to get 5% cashback. So I simply borrowed the 5% using my overdraft facility, approximately £2,500, and got the £2,500 back when I completed.|
|92% Residential Mortgage||The second property I bought was on a residential mortgage. I had to put 10% down as a deposit to get 2% cashback. When it completed I got a 2% cashback, around £1,000, and then told the lender that I wished to rent it out. They charged me a £75 annual letting fee and gave me permission to let it out.|
|Remortgage personal home||I’m always doing this! I recently remortgaged my house to 90% LTV, the maximum my lender would go to, to access another £35,000. With this money I bought another 5 houses!|
|Remortgage investment properties||I’m always doing this also! I’m aim to keep my portfolio at 85% LTV of its current market value. Recently I instructed my broker to carry out 31 remortgages in one hit – it certainly kept her busy!|
|Credit Cards||As mentioned earlier in the book I accessed £13,000, the maximum credit limit I have over 3 cards, to fund deposits for new purchases. When the remortgages came through on some other properties I paid back off the credit card balances. The cost of borrowing was no more than £500. The amount I made on the deal was £15,000. Who said credit cards are bad?|
|Overdrafts||As mentioned earlier I used my overdraft for short term funding purposes. Remember that overdraft facilities have a maximum term, usually 1 year, and have to be renewed. Don’t get caught out and be forced to pay back the overdraft as you never checked when the facility expired.|
|Unsecured Loans||I have over £100,000 in personal loans. I got these at the time I was starting. The properties that I’ve bought with this money have netted me around £500,000 in equity. Now that’s not bad by anyone’s standards!|
|Borrow off girlfriend||I sail very close to the wind sometimes and I got in to a situation. I was forced to make the choice of going to a bridging finance company who were going to charge me 22% APR, and £1,000 in arrangement fees to borrow £10,000. I decided to ask my girlfriend and I offered her 16% APR. She generously agreed and I paid her back in 3 months plus interest PLUS a set of diamond earrings!|
|Get a partner||I’m currently doing a deal with someone who has money but not the expertise. They will be fronting all the money and I will be investing it. We’ll be going 50:50 on ownership and profits generated. I’m doing this because it’s a sizeable amount of money. This will give me a greater market share than I already have – this is why it works for me.|
Cost of holding money
I hate having money! Now when I say this I mean I hate having money that’s un-invested. Anything in excess of float is not only making you no money but is costing you money. If I go out and raise £10,000 on an unsecured loan repayable over 5 years then I have to start making payments of around £200 pcm one month after the bank has advanced me the money. Lets say I don’t find an investment. I will have to pay back 60 months x £200 = £12,000. That’s not good business.
If I find an investment property the day I get the money (requiring a £10,000 deposit) and complete on the purchase 3 months later and find a tenant 1 month after that which provides me a positive cashflow of £100 pcm then the figures look like this:
Positive cashflow from investment 56 months x £100 = £5,600
Cost of holding 4 months x £200 (£800)
Profit arising from £10,000 loan £4,800
Two important things to notice about this example:
- £4,800 profit is generated from taking out the £10,000 over 5 years. Even more profit will be generated after the 5 years due to the loan being redeemed thus increasing the cashflow assuming all other factors remaining the same.
- Profit is reduced by £800 due to it taking four months to complete on the property and to find a tenant.
As a result of these findings two principles will hold:
- Its good to borrow – as established above and,
- The quicker you make the investment the more money you make.
Now I’m not saying go out and buy the next property that comes on to the market. But what would make sense is to try and find suitable property investments before you get the loan and as far as possible try and line up a tenant in advance.
Opportunity cost of money
I specialise in low value properties. I typically buy a property for around £30,000. This requires a £5,000 initial investment from me which includes the deposit, legal fees etc. Every time I get hold of £5,000 I’m itching to buy a property.
Now consider this. I’m walking past a car showroom and I see my favourite car, a Mercedes 300SL for £20,000. it’s a bargain, I’ve got £20,000 in the bank and its in my favourite colour – BLACK! Should I buy it? If I did buy it for cash it wont cost me £20,000. it will cost me what I will lose in the future as a result of the purchase. Let me show you what I would lose:
Purchase Price of Car £20,000
Initial Investment for a house £5,000
Number of houses that can be bought £20,000/£5,000 4
Expected profit generated from each property £150 pcm
Total profit expected from 4 properties £600 pcm
So if I buy it for cash I lose £600 pcm. This is £7,200 per year and this excludes capital growth. If the houses have risen by 10% in the year then the capital growth is 4 x £30,000 x 10% = £12,000. So total loss including capital growth is £12,000 + £7,200 = £19,200 – almost the cost of the car! And what would the car be worth in a year? Well it wont be worth more than £20,000 that’s for sure! Lets say £15,000.
So looking at the true loss of buying a car relative to buying 4 investment properties after 1 year:
Net Worth After Buying Car – Market Value of Car £15,000
Net Worth After Buying 4 Properties
4 Deposits x £4500 £18,000
Rental Profit £7,200
Capital Growth £12,000
So after 1 year the difference in net worth of buying a car and investing in 4 properties is:
£37,200 - £15,000 = £22,200
That’s an annual salary for someone! If the £20,000 that I had in the bank was as a result of a remortgage then the figures are even worse. £20,000 borrowed at 5% makes you a further £1,000 worse off. And if you don’t redeem the debt after 1 year then it will cost you £1,000 year after year after year. If you let it run till the end of your mortgage term you may end up paying more interest than the price of the car! Very bad for your wealth.
I’ll be honest with you however. I do own a Mercedes 300SL worth £20,000! But you’ll be damn sure I didn’t pay for it for cash. I bought the car on HP at 17.3% APR. It costs me £462 per month which is paid for out of my £600 pcm profits generated from the property purchases made.
The principle is – preserve your cash! Wherever you can get sensible credit (less than 20% APR) then take it. As long as you are willing to invest the money you have you can always service the credit you get with the profits you generate.