So, to become a professional landlord you need bundles of cash – false! A portfolio can be amassed from nothing or as little as £500, as I did five years ago. We have access to cash reserves that we do not even know about because we are not fully aware of certain financial products on the market.
The term ‘initial investment’ implies that starting capital is required. However, even though it is advisable to have an initial investment, it is not mandatory to set up a multi-million pound investment portfolio – no matter what business experts say. I’m sure you’ve heard many testimonies of multi-millionaires who started with a couple of pounds in their pocket. What made these people succeed was their attitude to risk. To become a millionaire in business you have to take a certain degree of risk. Otherwise, we would all be rich! However, I expect that many readers do not have the same attitudes to risk as the millionaires I have just mentioned. The beauty of property is that you can invest in property according to your own personal attitudes to risk.
Lets look at the risks in investing in property. There are three core elements making up the income & expenditure account - income being rent, expenditure being the mortgage payment and maintenance. All these three elements can be fixed if need be, and as long as income exceeds expenditure, you’re in the money! That’s right -guaranteed profit. There are financial products out there that can guarantee rental income, fix mortgage payments and fix maintenance expenditure.
Consider which risk class you fit in based on the table below:
|If only! This is the investor who has enough cash to buy a property outright, guarantee his income, never worry about maintaining the property and still earns treble what a bank or building society will offer him.
|This is the investor who does not have bundles of cash but is willing to borrow. However, he also wants to ensure that he will meet his mortgage payment and any maintenance costs. This is someone who is risk-averse and is not typically a handyman when it comes to household repairs.
|This is a risk-averse investor, but he can do his own household repairs or is willing to take the risk on household repairs.
|This is an investor who accepts a fair degree of risk to interest rate fluctuations and household repairs.
|This is an investor who probably works and earns more than he spends in order to cover the mortgage and maintenance payments. Receipt of rental income is crucial, but not as crucial enough to meet the fixed mortgage and maintenance payments on time. Cashflow is not an issue for this investor in the short term.
|Again this is an investor who works and earns more than he spends. However, he is also willing to take the risk of maintaining the property because he is a handyman or is just simply willing to take the risk.
|The risk taker. Here we have our future millionaire. His income is maximised because he obtains his rent in the open market, his mortgage payment is minimised because he sources the best-discounted mortgage product and he has taken full risk on maintenance hoping that nothing major will go wrong. This strategy is probably suited to investors who comfortably earn an income in excess of their spending. Cashflow is crucial.
There are other permutations of this model but most people fall into one of the seven categories. The higher the risk factor you are, the more money you can make, but the key factor is whichever risk factor you are, you will make money.
The initial investment you require is completely determined by your attitude to risk. The lower your risk factor, the higher the initial investment will be. For example, an investor who falls into risk class 1 has to finance the whole purchase price of the property in order for him not to have to meet a monthly mortgage payment. Hence, he is not dependent on the punctuality of the tenants’ rent payment. This way his investment in the property market is restricted to his savings in the bank. On the other hand, someone with a risk factor 7, with nothing in the bank, can borrow on an unsecured personal loan basis. He can then use this as deposits for a number of properties on a buy-to-let mortgage scheme and acquire a number of properties.
Let’s look at a specific example:
Mandy with risk class 1 and £40,000 to invest
Mandy buys a property for £40,000 in Northampton. She guarantees her rent from a rental guarantee company, borrows nothing and pays for a maintenance insurance contract which covers the cost for all major incidental maintenance expenditure. Her monthly return is:
Arnie with risk class 7 and £3,000 to invest
Arnie borrows £18,000 on an unsecured basis at 8 per cent APR over seven years and uses this to fund three properties for £40,000 each in Northampton on a buy-to-let mortgage basis at 85 per cent ‘loan to value’ at 6 per cent APR. This means that he has to put down £6,000 each on the three properties. This adds up to £18,000 unsecured borrowings. The £3,000 that Arnie has goes towards professional fees on all three properties.
|Mortgage (interest only)
|Unsecured Loan (interest only)
Arnie earns more than Mandy but Arnie has a greater borrowing requirement. Currently this proves the principle that BORROWING IS CHEAP.
The reason for this is because the returns to be made from property are far greater than the cost of borrowing. Typically the return from property is around 20 per cent and the cost of borrowing is around 6 per cent at current rates. This assumes that you have chosen the right property, which this book shows you how to do in Chapter 4.
Taking this example further let’s say property prices increase by 10 per cent over three years. Then the total profit made by each investor by way of rental profit and capital appreciation profit over the three years is:
(Risk Factor 1)
(Risk Factor 7)
(36 months x Monthly rental profit)
(10 per cent x total cost of properties bought)
Comparing these two investors shows that Arnie who started with £3,000 has earned 66 per cent more than Mandy who started with £40,000! Looking at the actual return from your initial investment being:
Profit x 100
Then the returns for each investor are:
(Risk Factor 1)
(Risk Factor 7)
|Total Profit (from the table above)
|Return on Initial Investment over 3 years
|Return on Initial Investment averaged over 1 year
|Return on Initial Investment if deposited in a high interest building society account (current Bank of England base interest rate)
You can see that both investors have made returns in excess of any high interest building society account. You can also see that Arnie has made phenomenal returns far in excess of most investment funds or even technology stocks at their peak. The best thing is that you are investing in property, which all of us have some degree of understanding in, rather than a stock which you know little about and have to rely heavily on the financial press and tipsters.
But an even more important principle than the one above is that WHATEVER YOUR ATTITUDE TO RISK IS, YOU WILL MAKE MONEY!
The reality is that in the last three years we have seen average property prices grow by 10 per cent every year rather than 10 per cent over three years. This equates to 33 per cent capital appreciation over the three years. Thus the annual return from property over the last three years for both investors was 24 per cent and 662 per cent respectively. This example gives you an indication on how I have amassed great wealth through property as any money invested has grown by over six times each year because I have a risk factor of 7. So every £1,000 I invested was worth £6,620 in year 1, £13,240 in year 2 and £19,860 in year 3.
In the reference chapter you will find all the providers for guaranteed rent, buy-to-let mortgages and maintenance insurers and contractors.
Now once you’ve decided what risk factor you are this will determine how much initial investment is needed. Assuming a property is at a purchase price of £50,000, the following initial investment will be needed:
|INITIAL INVESTMENT (£)
This assumes a 15 per cent deposit for the mortgage and £1,000 fees for solicitors, valuations and the initial void period when waiting to find the right tenant. Risk factor 6 investors borrow the initial deposit and risk factor 7 investors borrow the initial deposit and associated fees by way of secured or unsecured borrowings.
Raising The Initial Investment
So you’ve decided which risk factor you are and this has determined how much initial investment is required. How do you then go about raising the initial investment? The following table ranks in order the ‘cost’ to you starting with the cheapest first, the cost being the effective interest rate being paid on the initial investment as a result of your choice of investing in property. BOE means current Bank Of England base rate in the table below.
|Assets that are no longer being used but have some resale value. This may be jewellery, cars, furniture, pieces of art, electrical equipment etc. The cost is nil as the assets are not being used but they could be used to realise some cash in order to invest. Look in the garage or attic - you may be surprised! Think about it like this – you’re trading in your Ford now for the Ferrari in five years time!
|BOE Base Rate
|You may have savings in a deposit account or cash ISA. If you use this money the cost will be the lost interest that would have been earned if you had left it in the account.
|Endowment Policies or Company Shares
|BOE Base Rate + 3%
|You could surrender an endowment policy or liquidise a current share portfolio to raise the cash. I recommend you talk to your financial adviser and stock broker before taking this action as you could be better off holding out on some of these policies or shares. But it could be time to let go of some poorly performing stocks and enter the property arena as so many of the share market investors are doing now. The cost of this on average is equivalent to the average return the stock market delivers. This, of course, will be different depending on the type of policy or stocks you hold.
|Borrow from Family
|BOE + 4%
|You may have a family member who has cash sitting in the bank and is willing to lend it to you. You can offer them a better rate of return than any deposit account could. If he or she is a close member of the family they may lend it to you for 0%, but if you proposition a family member offering BOE+4% you might get quite a few more positive responses than expected.
You could access your inheritance early, as many families do, to avoid inheritance tax. As long as the donator lives seven years beyond the date of the gift there is no inheritance tax to pay and is thus beneficial to both parties. A family member may be more willing to give you assets if you are proposing to invest it further rather than to just simply squander it on a new car or holiday.
|To do this you must already own a property. The cheapest way to do this is to remortgage the whole property and release the equity tied up in your home. It pays to shop around. A good mortgage broker could probably beat the current rate that you are paying now and even reduce your monthly payments whilst still raising you some cash on top.
The other way is to get a second charge loan where you keep your existing mortgage and borrow on the remaining equity on the house. You’ve probably seen the TV ads promising you a new car or holiday just from one phone call. Well forget a new car or holiday – we’re going property hunting!
|The cheapest way to do this is by transferring a current credit card balance to a new credit card with introductory rate offers. You draw out as much cash as you can on your current credit card and then apply for a credit card that has a low introductory rate for balance transfers until the balance is cleared. Once your new credit card has been approved you transfer your existing balance on your old credit card to the new credit card at the introductory rate, typically BOE+2%. This rate is fixed until you clear the balance.
You may, however, not get this new credit card. The other way is to draw down the cash on your existing credit card at the credit card rate. This can be expensive but if the property you have found has a high income yield you could use the cash on a short term basis, say one to two years, and use the profits to clear the credit card balance.
You may be able to arrange an overdraft with your bank or a personal loan at around BOE+6%. You need to speak to your bank manager.
You can also go to other unsecured lenders but there are high arrangement fees and the interest rate can even go up to BOE+35%! You need to shop around but I would advise steering clear of anything with an interest rate higher than 25% unless you are really desperate and the property you have found has a very high income yield.
|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.
This is not an exhaustive list. You may have other good ideas for raising finance but if you can’t raise the finance the project can’t go ahead. It’s as simple as that. The only other way is to change your attitude to risk. This means being willing to take a bigger risk and hence increase your risk factor thus reducing the initial investment needed. Greater borrowings will be inevitable.
I raised my initial investment by saving as much of my salary as I could. While my colleagues were spending everything they earned on high rents on apartments, expensive holidays and designer clothes I saved my money by living in one room in a shared house, holidaying in the UK and wearing unbranded clothes. After five years I live in a large detached house with swimming pool, holiday abroad three times a year and wear only designer clothes. You need patience and a medium to long-term vision if you truly desire to have enough wealth to live the lifestyle you want.
If All Else Fails
If you are struggling to find the initial investment there are still two further tricks you could consider:
- Get a 100 per cent loan to value residential mortgage
- Create vendor deposit
Get a 100 per cent loan to value residential mortgage
There is still one way you can acquire a property if you are a first time buyer. There are certain lenders that provide 100 per cent residential mortgages that are free of fees. This means the lender funds the whole purchase of the property and pays for all the valuation and solicitor fees.
This product is for residential purposes only. However, you can make the application with the intent to live in the property but then inform the lender when the purchase completes that you intend to let it out now as you have changed your mind. Some lenders don’t mind and simply charge a letting fee of £50-£100 per year. Some lenders, usually building societies, charge additional interest, typically two per cent, on the loan. You have to look at your figures very carefully to ensure the rent can cover the 100 per cent financing plus the additional interest if need be.
A list of 100 per cent fee-free lenders can be found in the reference chapter.
Create vendor deposit
This is where you basically get the vendor to pay your deposit! This is best explained by following the example below:
Gavin wishes to buy an investment property for £54,000 but he only has £3,000 to invest. The minimum deposit he needs is 15 per cent of £54,000, which equals £8,100. You may think he cannot go ahead. However, if he got the vendor to inflate the purchase price to £60,000, then the deposit required is 15 per cent of £60,000, which equals £9,000. If he got the vendor to contribute £6,000 and Gavin contributed £3,000, with the total contribution being £9,000, then Gavin can purchase the property. Everybody’s a winner.
The vendor gets:
£60,000 - £6,000 = £54,000
The inflated price Vendor contribution Original asking price
Gavin gets an investment property costing £54,000 for £3,000 initial investment.
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 10 per cent gross inflation of the purchase price is not a lot considering you are only talking about an inflation of £6,000. For higher value properties (greater than £200,000) I would suggest a five per cent vendor deposit contribution as a £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 £54,000, 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 one per cent or two per cent inflated he will assume that it will reach the valuation in a few months anyway.
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 £7,000 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.