So you’ve got the finance in place, now you need to find the property. This is the most important decision in the whole process. It is the property you choose that dictates your success. There are many properties on the market but less than one per cent are worth buying.
During the whole property investment process there is only one figure you can ever be in control of – the purchase price. If the price is too high, then you can walk away. You only ever become involved in the whole property purchase process when the price is right. But what is the right price?
There is a rule of thumb that I always apply when looking for a property to invest in - I call it the rule of 12. It’s very simple to remember when looking at properties.
Lets assume the purchase price is £45,000. Knock off the two zeros at the end (in effect, divide the purchase price by 100) and you arrive at £450. This then determines the monthly rental figure that needs to be charged to obtain a 12 per cent gross yield. Gross yield is defined as:
Annual rental income x 100 = gross yield
Property purchase price
If you can achieve a 12 per cent yield, then go for it! Speak to letting agents or look in the local press for typical rental values for the area that you are looking at. This yield is also stated as a payback period – the length of time it would take to own the property if you reinvested all the income earned to replenish your savings. You would calculate it as follows:
1 = payback period
So in this example the payback period would be 8.33 years.
12 per cent is a like-for-like comparison to a bank or building society rate. So if your bank is offering four per cent you know that you can earn three times as much from investing in property. But this assumes that you have funded the whole property purchase out of your own funds. Usually this is not the case. When you borrow to finance the purchase the returns are significantly higher as highlighted in the previous chapter.
When you become familiar with an area and its rental values, then you know when a property is a bargain. If typical rental values for a one-bedroom flat are £500 per month, then you instantly know if you walk past an agent’s window and there’s a flat advertised for £46,000, that you are going to get in excess of 12 per cent so it’s worth an enquiry.
If, however, flats in the area are rarely priced under £70,000, then forget that area! You are not going to make any money there. It is the price that will dictate the area. Forget LOCATION, LOCATION, LOCATION, it’s PRICE, PRICE, PRICE! This is because you are looking for a property to invest in rather that to live in.
It’s surprisingly easy to manage a property outside your area once the property is set up right. There are many areas that offer you a return of 12 per cent and greater. Areas like these I call hotspots. In the reference chapter is a list of all the hotspots I have identified with their gross yields of 12 per cent and greater.
What about capital appreciation?
Capital appreciation is the amount the property rises in value over time. I never include the gains by capital appreciation in my calculation of yields because it is an unknown figure at the point you make the investment. If there was any certainty of the capital appreciation of a property then the purchase price of the property would include this gain. As there is a lot of uncertainty over capital appreciation because of the numerous variables involved, it is very difficult to predict when house prices will rise. Remember, the gain is only realised when you sell the property and the difficult thing with any investment is knowing when to get out and sell.
I see capital appreciation as a bonus. I focus on the investment as it stands. If it makes money now it will almost certainly make you money in the future. If the property prices crash, who cares! You are still making money as the rent rises with inflation and the mortgage payment is still the same. If property prices soar, great! You can realise that equity by remortgaging or by selling and buying further properties! This way there is no downside risk and only upside potential.
Admittedly there is a lot of money to be made in capital appreciation speculation but this should be left to the professional property investors. They have the time to research the market and can stomach the loss if there is a property price crash.
How to achieve a higher return of 12 per cent
I have a property in Harlow, Essex that is a five-bedroom, two-bathroom property. I used to let it out to a large family - husband, wife and seven children! I was achieving around 12 per cent return and I was quite happy. I thought they would stay there for a long time, as there is a real shortage of five-bedroomed properties to rent, let alone buy. However, in business nothing is guaranteed and they decided to move out. So I readvertised the property and an accommodation project approached me.
An accommodation project is a non-profit organisation, usually a charity or local government-funded body that assists the homeless in the town or city they are based. They suggested to me that they would like to convert the property into five single units for people on housing benefit and they would handle the management for no charge. The conversion costs were minimal, simply installing independent locks on the door, providing cheap single beds in each room and basic kitchen appliances.
They said I would be able to charge on average £70 per week for each room, which equated to £1,515 per calendar month. I compared this to what I was originally getting of £600 per month and thought I should give it a go. I had to pay all the utility bills and council tax but even after that my net profit was set to increase fivefold. I’ve been running this scheme for over a year now and I have never looked back. I even converted another one of my two-bedroom properties into a three-bedroomed place (converting the living room into another bedroom) to cash in on such a scheme.
It has not been without problems though. The five-bedroom place is let to five guys of all ages and they can be quite boisterous. I have had complaints from the neighbours and environmental health but they haven’t closed me down yet. The property requires more time and effort but that is expected considering the high yield that one is obtaining.
If you consider this type of property, go for a property that can have four lettable rooms. This could be a four-bedroom property, or a three-bedroom two-reception property (converting one reception room into another bedroom) and see if you can get two bathrooms (even if one of the bathrooms is a shower room). I would set the yield required at 33 per cent. This means that you would need £20,000 rental income for a purchase price of £60,000. For example, if the property had five rooms then you would require an average room rate of £77 per room (£20,000/52 weeks/five rooms). Expect to visit this property every fortnight to make sure nothing has been damaged or there are no other people staying round other than the tenants.
A list of accommodation projects can be found in the reference chapter. I would suggest you speak to them before entering into a venture, as they will be able to assess the likely demand and typical room rates.
Should you refurbish a property? If you are new to the property game I would advise you not to. It is time-consuming, easy to be conned by builders, stressful and you lose money while the property is unlet. When viewing a prospective property, if it has had the kitchen or bathroom ripped out, forget it. By the time you have refurbished it you would have spent at least £5,000 in repair costs and interest and you would have built up an affection for the property. It will take you a long time to recoup the money and because you have invested a lot of your time on the property you may be too choosy over the right tenant to move in. I mean, do you really want to be sacrificing your evenings and weekends refurbishing a wreck? No! You want to be on the high street spending all that money you’re earning from making the right property investments.
If you are a bit experienced, have the time and can afford the initial negative cashflow, then a good return can be had if the property is very cheap. As a rule of thumb I’m interested in properties such as these if they can provide a return of 24 per cent or greater. Here you are paying less than £20,000 for a rental value of £400 per month. Always remember to double all initial budgeted refurbishment costs as experience shows that other problems emerge.
What to look for when viewing a property
Do not believe the myth that a property is only worth buying if you could see yourself living there. The fact is that you aren’t going to live there so what is the point of asking yourself if you could live there? You should ask, ‘Would someone live here?’ In a high demand area people will live in a house as long as it has running hot water. I’m sure you’ve heard the horror stories from people living in London. I knew of 16 Australian and New Zealand backpackers sharing one room! I wouldn’t live there, but the landlord found 16 people who would! You have to assess the demand.
The best way to assess the demand is to put a rogue advert in the local press. Place an ad before you own any property in that area for a property at market value rent. See how many calls you get. If you get one or two calls then forget it. However, if you get 40+ calls then you know you’ve hit a hotspot. I have a few properties in Harlow, Essex and I placed an ad for one of my properties at slightly above market value and I had at least 40 calls and the property was let within two hours of the paper coming out.
When viewing a property check for:
|You have a legal duty to provide floor coverings. If there are no carpets then you will have to pay for new ones.|
|Kitchen||Is the kitchen big enough to accommodate a small dining table? This is attractive if there is only one reception room and it turns the kitchen into a kitchen-diner.|
|Smallest bedroom||If the smallest bedroom is smaller than 6ft 6” in any direction then it is not a bedroom! You need to be able to get a bed in a bedroom hence this room can only be considered as a study or a baby’s room. You need to consider this when considering what type of tenant you are looking for. If you are looking for two professional people to share a two-bedroom flat then the second bedroom must be bigger than 6ft 6”.|
|Bathroom||Is there a fitted shower? A bathroom is a lot more desirable if there is a power shower. If there are two bathrooms then the property is very desirable, even if it is only a shower room.|
|Heating||Is the heating system old? This can be costly to replace. If possible get it checked prior to purchase. It is your legal duty to provide heating and to issue a gas safety record.|
|Electrics||Are the electric sockets old? This will tell you that at some point the whole electric system will need rewiring.|
|Service charges||If it is a flat you will have to pay service charges. Ask the agent if he has any details of the service charges. Some places have exorbitant service charges that render the whole investment unprofitable. Avoid listed buildings as they have frequent redecoration policies that can be expensive.|
If the property is in a reasonable condition then buy it. If demand is good there should be no problem letting it out as long as the property is in reasonable condition.
MAKING AN OFFER
If you suspect that there will be a lot of interest in the property because it is cheap, do not be afraid to simply offer the asking price. This way there is no to-ing and fro-ing, the deal is done on the day and the property is removed from the market. If the agent gets the asking price, there is no need for them to show the property to someone else.
If you’ve arranged your mortgage, give a copy of the acceptance letter from the lender to the estate agent. This will convince him that you can act quickly, you are serious about buying the property and you are not just someone off the street who has just seen this property and thinks they can make some money out of it without giving it much thought. If you can show him your bank statement as well which proves you have the deposit then do so. Anything that will convince the estate agent that you are serious will make him unlikely to show the property to someone else.
If you suspect that demand is not high for the property but is still a sound investment then ask the agent how long it has been on the market. If it’s been a while then go in low. I would say 75-80 per cent of the asking price. Ask the estate agent, ‘Has it ever had an offer? What offers have been refused?’ Then you will be able to gauge your entry offer. This is assuming you believe the agent! If you have built up a relationship with an agent this should not be an issue, but always be aware.
Always remember the rule of 12 when negotiating. Do not get carried away with the negotiations and put in an offer that breaks the rule of 12.
When the offer is accepted they will almost certainly ask you for your solicitor’s details. Have your solicitor arranged prior to placing an offer. Simply inform a solicitor that you will be using them for a future purchase. The agent will then write to your solicitor to confirm the sale and the solicitor will instruct you what to do from then on.
You have to be patient when buying properties. Under normal circumstances the purchase should take no longer than eight weeks from the date your offer was accepted. There are many things that can go wrong with a purchase and sometimes there is nothing you can do about it but sit back and wait. I have listed some of the things that can go wrong and what, if possible, you can do about it:
What can go wrong
|What to do about it|
|Vendor withdraws property from market.||If the vendor has decided to keep the property there is nothing you can do about. If he has decided to sell to someone else then find out the selling price and go in even higher. If the property is worth more then pay it! Remember, don’t forget the rule of 12.|
|Survey fails or surveyor undervalues the property.||Find out what it failed on. Ask the vendor to remedy the problems. Do not, under any circumstances, offer to contribute to the cost of any remedial work. This is because after he has remedied the problems he may not sell to you and you will find it difficult to get your money back.|
If the property has been undervalued it is difficult to persuade the valuer to value it up but it is worth a try. Consider approaching another lender for revaluation or contributing the difference in the purchase price and the valuation.
|The mortgage company require further documentation at the last minute but you do not have the documentation or it will take a long time to get it.||Kick up a fuss! If they’ve approved your mortgage but then want further documentation they should have asked for it earlier. Threaten to complain to the Financial Services Authority (FSA). If all else fails try to get a compromise, i.e. if they want your mortgage statement to prove you have kept up to date on your mortgage payments in the last 12 months, offer them your bank statements for the last 12 months.|
|The flow of documentation between solicitors is slow or nonexistent.||Ring your estate agent and get them to chase for you. The agent’s wages depend on the sale of the property so he will have an interest in the sale occurring sooner rather than later. Ring your solicitor and ask what the hold up is. Ask your solicitor if there is anything you can do. If you really want the property, you have to be prepared to do some of the acquisition work yourself. If it is proving impossible to get certain documentation from the freeholders when buying the leasehold, then consider losing the property. This is because when it comes to selling the property you will probably have the same problems and purchasers will get fed up and pull out.|
If things are progressing normally, however, then let your solicitor do everything, as this is what you are paying him for. Only react when your solicitor has informed you of a problem or you haven’t heard anything for six weeks.
It’s advisable, prior to exchange of contracts, that you view the property to see that it is still in the state you first viewed it as exchanged contracts are legally binding. If kitchen appliances were included in the sale, then check that they still remain there. Check that the carpets and curtains remain and the condition of the property has not deteriorated.
Once the purchase is complete you then have the task of finding the right tenant…