“Rodney, you plonker!” The often and mostly unfairly derided Rodney Trotter from Only Fools and Horses in the most part at least tried to look into things a little. His brother and lead partner Del Boy on the other hand was a gung-ho! risk-taking and frankly dodgy (if loveable) businessman. Whilst good old Del & Rodders might not be the best example of demonstrating my point today, which is about applying a little more of a business-like approach and researching our property investing - the simple illustration of the blend of characters does help to make my point. Taking on some element of risk is inevitable (and even desirable) in any form of investing and that applies equally so with property investing. Any number of things can and often do go wrong. That is not to say that we should not proceed, as the results can be very rewarding in the long run. That said, to blindly follow our gut or the herd and make a stampede straight towards the pack of lions waiting to pick us off one-by-one may not be the best method of survival. Just a little bit of reading, training, asking around & basic research could help us to avoid some of the dangers ahead. To illustrate the point simply, let us take the figures shown in this article as an example. If the typical property investor has a portfolio worth £650,000 and an average rental yield of 5.6%, how sensitive are their returns to interest rate movements and rental or property prices changes? For the purpose of illustration, I shall assume that the investor uses a buy-to-let mortgage at 70% LTV at an interest rate of 4.2% on an interest-only basis and uses a letting agent charging 10% plus VAT. Their position in summary: Portfolio value £650,000 Equity £195,000 Mortgage debt £455,000 Annual gross rent £36,400 Annual letting fees £4,368 Annual mortgage payments £19,110 Net rent before voids, maintenance & other costs £12,922, so far so good! Digging a little deeper though… An average void period assumed of around 3 weeks per year, so £2,100 Maintenance and repairs might run into 3% to 5% per annum or £1,456 as a mid-point Throw in some incidentals like insurance, gas safety, agent set up fees and an average cost of remortgaging every few years for another £1,000 a year say That takes our net rent down to £8,366 and an ROI (return on our cash funds invested excluding buying fees and capital gains) of 4.29% That is not terrible...but is it terrific...well no, not really. However, what is the effect of a 1% change in interest rates? Answer - £4,550 per year and given we are at the bottom of the interest rate cycle the only way is up...many people estimate a 3% rise over the next few years, so that would hit the net return by £13,650 per year...oh dear! Fixing our rate for five years could help to mitigate this however. How about a 5% change in property prices then? Answer – a £32,500 shift in our equity position for every 5% change in property prices. Prices going up and we are laughing...well on paper at least, as we cannot easily access these funds quickly. However, if we have even a 10% drop in property prices this could leave us unable to remortgage with an LTV at close to 80% with fees applied...mmm we could be trapped in a rising mortgage rate deal here if that happened. Learning how to buy below comparable market value and / or ‘force the appreciation’ could be useful to us then. How about rental movements then for every 0.5% shift in rental yields? Answer - £3,250 for every 0.5% change in rents or put another way an annual rent increase / decrease of 8.9%, which seems unlikely as an increase given current affordability levels but a rapid change in the economy could give rise to at least a temporary dip in rents on the flip side. Targeting higher yielding, stable rental areas would help us here. Consider if we bought a few property investment books, got ourselves genned up a bit on our target location, tenant profile and investment fundamentals such as transport links, schools/unis, jobs and inward investment, plus decent local amenities; then could we not seek to get a better deal than the average investor? A bit of knowledge and application could easily see us secure a modest 10% discount on our selling price and if we choose the right location and undertake a light refurb it could increase our property value further. We should be able to nudge up that average yield figure to a more respectable 6% to 7% at least by carefully selecting our rental area and targeting quality tenants that will stay and pay. These steps when combined could allow us to withstand a few shocks and at the same time improve our short to medium term returns, allowing a cash buffer to build up, which we could even pocket if the sun were to keep shining on us. You see, Rodney wasnt quite the plonker that he was made out to be really (well, sometimes yes he was, I admit) but his intent was to look a bit further before taking a leap and thats all that we need to do really. Only 7% of property investors taking professional advice, speaking to more experienced investors or referring to the odd property book is a shocking figure but not that difficult to put right one would hope. Don’t be a plonker then; just a bit of effort and some basic research is all that is required to help keep us off ‘Hookey Street’. sco.lt/5OL6dF
Posted on: Tue, 05 Aug 2014 20:56:32 +0000
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