The Complete Guide to Property Investment PDF

The Complete Guide to Property Investment How to survive and thrive in the new world of buy-to-let Rob Dix Published by Team Incredible Publishing Copyright © Team Incredible Ltd. 2016 All rights reserved. This book is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, re-sold, hired out or otherwise circulated in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser. GET THE EXTRAS! I’ve put together some totally free extras to cover important concepts that don’t quite lend themselves to “book” form. All you need to do is register (for free), and you’ll get access to videos showing: My step-by-step process for assessing a potential investment area How to determine the value of a property How to calculate the maximum price you can afford to pay for a property you’re planning to refurbish and sell My method for setting goals, and the spreadsheet I use to do it It’s all totally free with no strings attached – so for instant access, just sign up at propertygeek.net/extra. INTRODUCTION Getting a UK-centric audience excited about property investment is about as challenging as getting YouTube views with a cute cat video. There are over a million private landlords in the UK, and millions more who’ve thought about it. A quick glance at any day’s newspaper headlines, meanwhile, will show that everyone else has a very strong opinion about it. Technically, all that’s needed to call yourself a “property investor” is to buy one house or flat and rent it out – and if you do that well, you’ll have an asset that will bring in money each month and grow in value over time. That’s pretty good, and it will put you ahead of the 80% of the population who just work all their lives and retire without any real assets to show for it. But the game is changing. As political pressure against landlords mounts and the tax regime changes, it’s becoming impossible to be a casual buy-any-old-house- and-watch-it-go-up-in-value investor. Strange as it may seem though, I think the coming years will be better than ever – for educated and committed investors, at least. Amateurs will get squeezed out of the market, leaving opportunities wide open for those of us who are switched-on, strategic, and in it for the long haul. Even if changes weren’t afoot, I still think we can – indeed should – aim higher than just buying the odd property when we can. After all, for most of us the ultimate dream isn’t an extra couple of hundred pounds in our pocket each month or bragging rights at dinner parties. There’s some kind of goal we’re aiming for, like securing a comfortable retirement or being able to support our family without leaving for the office at 7am every day. Property can be the means to that end… but unless we’re clear on what the objective actually is, it can easily just be a source of hassle and disappointment. Over the last few years I’ve spoken to hundreds of aspiring and established investors. Often, they’ll ask for my advice because they’re not sure where to start – or they’ll be disappointed because they’ve got going and bought a property, but still don’t feel much closer to where they want to be. In almost every case, the problem would be solved if they just had a meaningful goal paired with a clear strategy designed to help them reach it. But I’m rarely asked about that – instead the questions are about what mortgage to use, how much to pay for a specific property, whether or not to self-manage, what research to do before buying at auction, and a million other things about the “procedural” aspect of property investment. These are all perfectly good and valid questions… but they’re all secondary concerns until a goal has been set and a strategy sketched out. In this book, I’m going to cover it all: the strategic overview, the nitty-gritty procedural details, and everything you need to know to adapt and thrive over time – whatever the economy and the politicians throw your way. By calling this the “complete guide”, I know I’m leaving myself wide open for people to go through looking for flaws, errors and omissions. If you go in search of things to disagree with, you’ll find plenty: as this is a book written by one person, there will be some parts that you don’t think are explained fully enough and others where you don’t agree with my reasoning. When it comes to the word “complete” itself, I don’t mean that it will cover every situation that you could possibly encounter over a lifetime of investing in property – clearly, that’s not possible. What I mean is that it takes you through the entire process of becoming a successful investor. Most books focus on how to research and buy a single property, but this one starts way before the first purchase and doesn’t stop until you’ve built a long-term portfolio. In Part 1, I get you thinking about your goals by showing you five different investment strategies that you could follow – each suitable for different objectives, financial positions and levels of involvement. The aim is to give you a vision of what you can achieve – even if you’re starting out with no special skills or experience. In Part 2, we’ll go through every step of the property investment process in order. Starting with arranging finance, we’ll advance through deciding what to buy, assessing potential deals, getting an offer accepted, surviving the buying process, and going all the way through to managing the property and taking care of the paperwork. You can read it through to prepare yourself for exactly what’s ahead, then refer back to each chapter as you progress through an actual investment to make sure you’re confident at every step. Then in Part 3, it’s time to look at the topics that separate the “dabblers” who buy a property on a whim from those who are serious about building a long-term financial future: refinancing, surviving downturns, shaping your portfolio over time and thinking about an eventual exit strategy. Overall, everything in this book is geared towards helping you to take action. It’s not telling you “how I did it” and giving you one model to follow, it’s not an inspirational story, and it’s not a boring list of first-do-this-then-do-that. It’s designed to take you from wherever you are now to wherever you want to be, by arming you with both the procedural knowledge and the big-picture thinking you need to make smart decisions. If property isn’t your obsession yet, I hope it will be by the end of this book: not only is it one of the most profitable things you can be obsessed with, it’s also a whole lot of fun. ABOUT ME While this book is intended to serve you rather than my ego, it might be helpful to give you a bit of context so you know who I am and where I’m coming from. Property investment is the geeky hobby that took over my life. As soon as I started researching my first investment in 2006 as a place to stash some spare cash, I was hooked. I’d spend all my spare time reading books and message boards – and yes, watching a fair bit of Homes Under The Hammer – absorbing everything I possibly could. I was fascinated by the number of ways in which it was possible to approach property investment, and I began to see how success involves understanding human psychology (and understanding your own abilities and motivations) in addition to knowing the cold, hard numbers. As a happy side-effect, I loved the fact that – as hobbies go – it can make you seriously wealthy. In 2012 I started my blog, Property Geek, as a place to think out loud and make contact with other investors so I could learn even more. Since then, even though my “day job” is technically being a copywriter, property has almost completely taken over… I’ve written three best-selling property books, which have over 350 five- star reviews on Amazon between them. I co-present The Property Podcast, which is the most popular business podcast in the UK and is listened to over 100,000 times per month. I co-founded The Property Hub – a community for property investors with over 13,000 members, which runs a network of over 35 monthly meetups and publishes a quarterly magazine. I’m a director of a nationwide letting agency (Yellow Lettings), and a bridging finance company (LendSwift). I don’t have the UK’s biggest portfolio or decades of experience, but I’ve supplemented my own knowledge and experience with learning from hundreds of investors who I’ve had the pleasure to meet and quiz. It means that if I haven’t done it myself, I’ve spoken (at length) to multiple people who have. My own strategy? Well, it’s evolved over time – and I’ve certainly had my fair share of getting sidetracked. When I started out, all I cared about was buying as much rental income as I could, as cheaply as possible. That approach led me to good-quality ex-council flats in London, which nobody else wanted to buy – especially after the mid-2000s crash – yet rented spectacularly well to young professionals. Over time I came to think more in terms of total asset growth: parking my savings in quality properties that make me money each month but also have good growth potential. Additionally, I began adding to those savings by flipping the odd property where possible. (I can’t shake my old yield-monkey tendencies completely though, and occasionally I’ll buy properties with limited growth potential if I can get a great return while leaving little cash in the deal.) The ultimate plan? To be in a “work optional” situation, with a big lump sum in the bank and a few moderately leveraged properties generating a nice income, at a young enough age to mean I can pursue whatever seems interesting at the time without money being a factor. Just to be clear: I’m not a tycoon with hundreds of properties, and there are many, many, many investors who are vastly more successful than I am. If there’s one specific strategy or aspect of investment you want to know about, there will be someone more qualified than me to teach you about it (and I might be able to introduce you to them). But what I can do is give you an easy-to-understand, comprehensive and hopefully fun overview of the whole property landscape. So let’s get on and do exactly that. PART 1: STRATEGIES In this first part of the book, I’m going to explore five potential investment strategies – each of which requires a different amount of cash and time input, and pays off over a different timeframe. If you’re just starting out, feel free to flip through them to get a general sense of what the options are – but don’t go any further with planning out your next moves until you’ve clearly defined your goal. You might think you’ve got a goal already, but if you were forced to get it out of your head and onto paper it’d probably look embarrassingly vague. A goal like “own lots of properties” or “eventually reach the point of not having to work for someone else” just isn’t going to cut it – you need more precision in order to select the strategy that’s best suited to getting you there. When it comes to setting a goal, there are three elements that I think are the most important: 1. It needs to be specific enough that you’ll know when you’ve achieved it – which is where “lots of properties” falls down. Pinning a number on it is an easy way to accomplish this: if the goal is “£3,000 in monthly net profit”, you’ve either achieved it or you haven’t. 2. You need to define a timeframe. As you’ll see when we get to the strategies, this is probably the most important factor of all: the approach you’d take to make £3,000 in monthly net profit by next year would be radically different from if you wanted to achieve it in ten years. 3. It’s got to be meaningful, so you’re motivated to keep making progress through thick and thin. If a goal like “own 100 properties” or “have a million-pound portfolio” is meaningful to you, that’s fine – but for many people, what’s truly motivational is having enough monthly income to replace their job or enough equity for a comfortable retirement. I could bang on about goal-setting for another few chapters at least, but I won’t. Instead, I’ll recommend that if you don’t have an appropriate goal in mind already, you should watch the free course we put together on The Property Hub. It makes sure your goal meets the criteria above, and shares a technique that a lot of people find very useful in defining a meaningful outcome (and leads to surprising results). It’s free as part of the extras that come along with this book, so go pick them up at propertygeek.net/extra. About the strategies I’m going to walk through five investment strategies, and of course there are far more than that out there – each of which could be sub-divided into all manner of different varieties. But I’ve chosen these particular examples for two reasons: to give a sense of how property investment can work for you, whatever your goals and constraints; and to explore some of the big themes that will keep appearing throughout this book. Before getting into them though, we need to be very clear about a few things. Firstly, I don’t recommend that you attempt to follow any of these strategies to the letter. Not because they’re unrealistic, but because you can actually do much better! To keep things simple, I’ve left out all kinds of clever tricks and imagined that the person in each example is blindly following a plan without improving as they go, or looking at the world around them and changing course as needed. If you come back to Part 1 after reading the rest of the book, you’ll be able to spot all kinds of tweaks you could make to get far, far better results. The flipside of keeping things simple is that there are a lot of things I just don’t mention. For example, mortgage arrangement fees: they get added to the loan, so they don’t factor in your initial calculations (and interest isn’t charged on them), but you will have to pay them back when you sell or refinance. Also, I don’t mention the need to pay council tax and bills while a property is empty and being refurbished. This isn’t an attempt to gloss over the facts and paint a pretty picture – it’s just that if I included every last detail the overall point would be lost, and I try to be careful enough with my numbers elsewhere that it doesn’t matter too much. Then there’s tax. I mention the possible impact of tax in each scenario, but it’s impossible to make statements like “your tax bill from this transaction will be £X” or “make sure you set aside £Y”. The answer will be different depending on your other sources of earnings, marital status, whether the property is owned by an individual or a company, other property transactions you’ve made that year, and about a million other things. So the results I talk about are always pre-tax – not because I’m trying to make them look better than they really are, but because it’s impossible to do otherwise: the amount of tax you’ll need to pay on the income from any given property will depend on whether you own the property as an individual or a company, your other earnings, your losses or expenditure across the rest of your portfolio, and plenty of other factors. Just because it’s impossible to generalise about the tax implications of any particular purchase, that doesn’t mean it’s not important: it’s very important indeed. If you’re new to property investment, you might be surprised by just how harsh the treatment of property income can be. While it’s much more fun to get excited about the money you can make than to think about the money that could be taken away from you, you should absolutely spend plenty of time getting to grips with the tax implications of property investment before you begin. The time you spend structuring your investments to be as tax-efficient as possible at the beginning could add up to tens of thousands of pounds over your investing lifetime. We’ll cover the major aspects of tax you need to know in Part 2, so feel free to skip ahead and read that first if you want to. In the meantime I’ll attempt to flag up the points at which it’s an important consideration without getting into too much detail. And finally, because my crystal ball’s a bit hazy at the moment, I’ve been forced to lay everything out as if there aren’t going to be any major changes in legislation – and who knows what might happen in terms of inflation, interest rates and everything else that affects an investment. That’s why, again, these aren’t intended to be 100% accurate and they’re certainly not recommendations for what to do – just models to give you an idea of some of the different approaches that are out there. I think that’s enough caveats for now. Just one last thing before getting to the strategies: a quick overview of the calculations you’ll encounter as we discuss the results of different investments. Measuring success To be successful in property investment, you need to know your numbers. I appreciate the beauty of a good spreadsheet as much as the next person (as long as the next person is extremely geeky too), but in truth, maths isn’t my strong point. That’s why I like to stick to three simple calculations, each of which is most useful in a slightly different situation. You should already be familiar with these if you’ve read any other property books (including my one, Property Investment For Beginners). But as they crop up so often throughout this book, it’s worth a quick refresher to make sure we’re clear on exactly what we’re talking about. (As a quick note to avoid confusion, these calculations are always made on pre- tax returns for reasons discussed earlier.) You’ll hear a lot about yield, of which there are two types: gross and net. In general, when someone says “yield” and doesn’t specify which type, they’re talking about gross yield – and that’s a convention I stick to here. Gross yield is the annual rental income generated by an asset, divided by the price of acquiring it – so a property that brings in £10,000 per year in rent and cost you £100,000 to buy gives a gross yield of 10%. (On your calculator, that’s 10,000 divided by 100,000. The result is 0.1, which expressed as a percentage is 10%.) It clearly doesn’t reflect the real results you’ll get from an investment, because it doesn’t take into account the costs you’ll incur. As a result, saying “I got a gross yield of 10%” isn’t enough to know whether that’s a good thing or not – but because it’s so simple to calculate, it’s a handy rough-and-ready way to quickly compare properties that are likely to have similar costs associated with them. (When I calculate gross yield, I like to include any major refurbishment costs in the “price of acquiring” part of the equation. After all, it’s a bit misleading to calculate figures on the basis of buying a property for £70,000 if it’s such a wreck that you immediately need to spend £30,000 doing it up.) Net yield is the annual rental profit (rather than income) generated by an asset, divided by the price of acquiring it. So if the property cost you £100,000, the annual rent is £10,000, and you have costs (including mortgage costs, management fees and maintenance) of £5,000, that’s a net yield of 5%. As this calculation takes costs into account, it’s more useful than gross yield in situations where you can reliably estimate what your expenses will be. When different people talk about “net yield” you can never be totally sure which expenses they’ve accounted for – the big ones are obvious, but you could get down to the cost of shoe leather when walking over to inspect the property if you wanted to. It doesn’t particularly matter: the calculations you make are only for yourself, so it’s important just to be consistent with what you include so you’re always comparing like with like. Gross and net yield have their uses, but neither of them captures the entire investment equation. What we really need is a calculation that takes everything into account – and which we can use not just to compare different properties, but also to compare our return from a property investment to the returns we could get if we invested in a different asset class entirely. That calculation is Return on investment (ROI) – calculated as the annual rental profit divided by the money you put in. If you buy wholly in cash, the money you put in is the same as the cost of acquiring the asset, so your ROI and net yield will be identical. But if you use a mortgage, your ROI will be higher than your net yield. For example, our hypothetical property cost £100,000 and generates a £5,000 annual profit, giving a net yield of 5%. But say that you only put in £20,000 in cash, with the rest of the purchase price being funded by a mortgage. Your ROI is therefore £5,000 profit divided by £20,000 cash invested, which equals 25%. You’d be forgiven for asking,“What’s a good ROI?”. Unfortunately, that’s an almost impossible question to answer. But let me try. It’s easy to say what a bad ROI is: a negative one, meaning you’re losing money. Beyond that, it’s completely personal. For example, an ROI of 2% sounds rubbish to me – I could practically get that in a savings account without going to all the effort of buying a property. But to someone who’s convinced that local property prices are about to rocket and they’ll make a killing on the capital growth, “not making a loss” might be good enough in the meantime. At the other end of the scale, some investors target ROIs of 25% or more – far beyond what I aim for. That’s because they’ve got a strategy that’s geared towards sweating their assets hard, perhaps by buying cheap houses and renting them out by the room. They know from experience that it’s possible to achieve those returns with the model they follow, so they’re not going to settle for less. I’m exceptionally hesitant to even put a range on it: on the one hand I don’t want to hold you back by giving you low expectations, and on the other I don’t want you to avoid buying something that would have matched your goals perfectly because you’re trying to hit the bottom of an arbitrary range. You should also be mistrustful of the numbers that other people quote (especially if they’re trying to sell you something), because it’s often hard to be sure what they’re including. For example, the exact same property might give an ROI of 12% if you’re self- managing, 8% if you’re factoring in an agent’s fees, or 5% if you’ve also put in more of your own cash because you want a smaller mortgage. But I know you won’t let me get away without giving you an actual number, so fine: with my own investment I look for an ROI of at least 10%, although I often get far higher and will be tempted slightly lower if there are other positive reasons to buy. Does that tell you anything? Not really, so I encourage you to completely disregard that single data point and focus on what you can achieve and need to achieve in order to hit your goals. Chapter 1 Save hard, take it easy, retire well Aim: Build a healthy income stream over 20 years without working too hard. In a nutshell: Invest enough to buy one high-yielding property every 18 months, then increase the pace as rental income compounds. Upfront capital required: Moderate Effort involved: Low initially, moderate as portfolio grows Ongoing investment required: High Payoff: Long term For this first strategy, we’ll take the most basic form of property investment possible: saving up hard, and using those savings to buy properties. As time goes on you add each property’s rental income to your savings, allowing you to pick up the pace. You’re not going to get rich off the income from one property, so this isn’t a lot of use if you’re desperate to quit your job right now (don’t worry if that’s you – we’ve got strategies to cover that later). Instead, this would work nicely if you’re in your 30s or 40s, have a job that you enjoy, but don’t fancy the idea of working until you’re in your 60s or beyond. At this stage in life it’s common to have a demanding job and a young family, so you may want a strategy that doesn’t involve putting in a lot of time or acquiring all sorts of specialist knowledge. This first strategy fits the bill nicely, but to compensate for the lack of time and skill needed, you will need to put in a fair bit of cash. How much cash? Well, in the example I’m going to run you through below, you’ll need to invest £25,000 to buy each property. If that sounds like a lot to save up… well, it is – if you wanted to buy one every 18 months, it’s £1,388 per month. If you have a post-tax salary of £66,000, that’s a quarter of your income. If saving that much is impossible, you can tweak the variables by buying cheaper properties or waiting longer between purchases – but however you crack it, it’s still a relatively capital-intensive strategy. In its favour though, it’s incredibly safe and simple. Let’s get on to an example then – and assume that we’ve already saved up £25,000 to start off with. Example For the purposes of this example, we’re going to use a three-bedroom terraced house in Eccles, Greater Manchester – just west of Salford. Here’s a link: propgk.uk/eccles-buy As you can see, it sold at an asking price £80,000 and it looks like it doesn’t need any work doing other than a bit of a clear-out. To keep things simple, I’m going to assume that the asking price of £80,000 is a fair reflection of its true market value. (In reality you’d never make this assumption, and we’ll see later in the book how to calculate what a property’s true market value is.) In terms of the purchase then, the figures look like this: Deposit: £20,000 (25% of £80,000 purchase price) Purchase fees (solicitor, survey, etc.): £1,500 Stamp duty: £2,400 (for all examples, I’m using the new “investor” rates of 3% higher than the normal thresholds – which came into effect in April 2016) Refurbishment (just safety certificates and any odds and ends): £1,000 That’s the £25,000 of savings neatly spent (with £100 left over for a celebratory dinner when it goes through). Now, what about income? In that area, someone claiming housing benefit who was entitled to a three- bedroom house would be given £577 per month. There are some areas (often those where property prices are cheapest) where you’ll struggle to find tenants who aren’t claiming housing benefit – but I’ve picked an area where you’d be able to find private tenants, possibly at a higher rent. Here’s one nearby being marketed to private tenants at £595: propgk.uk/eccles-rent. Nevertheless, £577 puts a handy “floor” under the rent, and to play it safe that’s the number we’ll use in calculating our returns. Out of that £577, we need to account for the following monthly expenses: Mortgage (£60,000 borrowed on an interest-only basis at 5% interest): £250 Buildings insurance: £20 Management fee at 10%: £57.70 Allowance for repairs at 10%: £57.70 That leaves us with a monthly profit of £191.75. (Everyone has their own opinions about how much to allow for repairs, and of course you might self-manage and not have that cost to account for. You won’t necessarily agree with my numbers, but the main thing is that I’m going to keep them consistent throughout the book so we’re always comparing like with like.) Before calculating the annual profit, I’m going to allow for the property being empty for two weeks per year. For a house like this, which is likely to let to a family reasonably long term, I think that’s fair enough: it could be a month-long changeover every two years on average, for example. After building that into the figures, we end up with an annual profit of £2,212.47. Based on the £25,000 we put in, that represents an ROI of 8.8%. That’s the first purchase out of the way, and there’s nothing left to do: all we’ve done is pop onto Rightmove, bought a property at the asking price, done the bare minimum of refurbishment and handed it straight to a letting agent. Job done, and in rolls the rental income! At its simplest, we can just repeat this exercise every 18 months. Do it for 15 years in a row, and we’ve got a rental income (ignoring tax) of £22,000. After 30 years, we’ve got £44,000. In fact, we can actually buy more properties as time goes on – because in addition to our investment, we’ve got the rent stacking up in our bank account. And while £2,200 in annual profit doesn’t sound like much, it adds up quickly. If we ignore tax again for a minute, we’d be saving up an additional £2,200 in Year 1, £3,300 in Year 2, £4,400 in Year 3, and so on. By Year 6, we’re able to buy two properties: one with the regular investment, and one with the accumulated years of rental income. By Year 15, we’re able to buy two properties every year. (It’s worth noting that I’ve been talking in “today’s money”, but in reality there would be inflation to contend with. House prices, wages and rents will increase significantly over a decade or more, and this could be good or bad for your plans depending on by how much, and when, each of them grows. There are just too many variables to talk about it sensibly, so we’ll stick to today’s figures – while recognising the need to re-evaluate our strategy as time goes on and things change.) In reality, tax will slow this pace down – although as we’ll see when we come to the “Tax and accounting” section, your tax liability during the acquisition phase could well be lower than you think. Tax or no tax, once the snowball reaches a certain size, the momentum is hugely powerful: while at first it looks like it’s going to take 30 years to accumulate 20 properties, by re-investing the profits it should be possible to get there in closer to 20 years. Lessons This example shows us the power of using leverage in the form of a mortgage – which we can see by comparing this strategy to a couple of alternatives. By the time we’d bought ten properties, we’d invested £250,000 and generated an income of £22,000 per year. If we’d saved up until we could buy properties in cash instead of using mortgages, we’d have only been able to buy two properties – which would give an income of £10,200. On the face of it, using leverage has doubled the returns – but it’s actually better than that. Firstly, buying instantly instead of saving up for extra years has brought in thousands of pounds of extra rental income. Also, if property prices go up by 10%, we’ve got ten properties to gain in value (for a total gain of £80,000) instead of two (a total gain of £16,000). (Using leverage has its risks too, and those mortgages will need to be paid off at some point, but those concerns are less significant than you might think. We’ll talk about this a lot more in Part 2.) Alternatively, if we’d invested that £250,000 in the stock market and later withdrawn it at a rate of 4% per year (a figure that many people claim is a “safe” withdrawal rate in retirement), we’d only end up with £10,000 per year. This nicely demonstrates how powerful property investment can be, even if you do nothing special. Remember: We’ve barely mentioned the potential for the properties to increase in value. The property I chose for the example is in a popular owner-occupier area, so should deliver at least some degree of capital growth over the long term. This gives you interesting options in terms of building your portfolio faster or planning your exit strategy… of which, much more later in the book. The gross yield on the example property is relatively high at 8.6%, but it didn’t require any special knowledge or hours of hunting to find. You’re paying the asking price rather than negotiating any kind of discount. You’re not doing any kind of refurbishment that would add value. There are no effort-intensive but higher cashflowing investments, like multi-lets. There’s nothing clever at all, in fact. You just have to make one very standard purchase every 18 months, and nothing else. There is, of course, one big assumption here: that you can afford to take large chunks of your earnings every year to finance the growth of your portfolio. For many people this isn’t realistic, which is why the next strategy won’t have this requirement. But the current strategy is a great “worst case” place to start, because it involves virtually no time or skill – so as your confidence increases, you can progress to other strategies that are less capital-intensive. In the meantime though, many people find it totally possible to live on 75% of their income with enough discipline and commitment. In fact, when I first drafted this chapter, I based it off saving 50% of your income and had an even more aggressive timescale – because while it may sound impossible, some people manage to do it while still having most of the middle-class trappings (for an introduction to this idea, see propgk.uk/mr-money-mustache). Alternatively, you could start a business in your spare time to generate an extra £1,400 per month. Whether you do it by cutting your spending or increasing your earnings (or a combination), it’s not exactly easy, but nor should it feel impossible – and the rewards are huge. Even if you hadn’t invested in property at all you’d still be doing better than almost everyone else by saving up that much cash – leveraged property investment just pours petrol on the fire. In this model then, property isn’t a get-rich-quick scheme or a method of generating huge returns in itself – which would be impossible with just one, pretty average, acquisition every 18 months. The magic is in the stealthy approach of combining property investment with living a restrained financial life. It’s an approach that might leave you short on skiing holidays and Gucci handbags, but will have your colleagues scratching their heads when you triumphantly hand in your notice 20 years before they could hope to do so… Chapter 2 "Recycle" your cash Aim: Build an income stream while limiting the amount of capital you need to invest. In a nutshell: Find properties that need refurbishing, do the work that will increase their value, and refinance so you need less of your own cash to put into the next purchase. Upfront capital required: Moderate Effort involved: Moderate Ongoing investment required: Low Payoff: Medium term After reading Strategy 1, you might be about to hurl this book down in disgust. “So you’re telling me that if I just invest a shedload of money every year for the next 20 years, I’ll be rich? I don’t need a book to tell me that!” Well, it’s called property investment for a reason: you can’t expect to make money without putting at least some resources in. But never fear: there are ways to get results even with a smaller cash input. In return though, you’ll need to work a bit harder. The strategy we’ll look at next is sometimes known as “recycling your cash”, because you reduce the amount of cash you need by taking one deposit and re- using it for multiple purchases. How? By refurbishing and refinancing. Example To keep things simple, let’s take the same type of house in the same area of Manchester where we bought for £80,000 as part of the previous strategy. But instead of paying £80,000, we find a house that’s near-identical other than being in pretty poor condition. We manage to negotiate buying that tired and unloved house for £55,000, then spend £10,000 bringing it back up to standard – thereby reinstating its “true” value of £80,000. Effectively we’re creating £15,000 of equity out of thin air, which is our reward for improving its condition. You might think that if a property needs £10,000 spending on it in order to raise its value to £80,000, you’ll need to pay £70,000 for it. In fact, any investor would want some kind of “margin” as their reward for doing the work – otherwise they could just buy one that’s already in good condition and save a lot of effort. The question is how far below £70,000 you can secure the property for, because that determines the size of the margin you build in. Margin is hardest to find when the market is buoyant or supply is constrained, because an increase in competition or a lack of other options will mean that investors are willing to accept a smaller reward for doing the work. Later in the book we’ll look at where to go looking for this kind of opportunity, but for now just believe that it is possible. For example, take this property, which clearly needed a fair bit of work and sold for £55,000: (propgk.uk/liverpool-refurb). Around the same time, nearby properties in good condition were selling for £85,000 or more: (propgk.uk/liverpool-prices). “Equity out of thin air” is the key to putting less cash into subsequent deals. Let’s see how… We’ll start off by buying the property for £55,000, but we won’t use a mortgage to do so. A mortgage wouldn’t be appropriate here, because: As you’ll see, we only want this original loan for a matter of months, at which point we’ll refinance. Mortgages are intended to be held for multiple years – so even if you use a mortgage product that doesn’t have a specific penalty for paying it back early, lenders don’t like it and might not lend to you again. A mortgage company might not lend anyway if they don’t consider the property to be “habitable” – such as there being no functioning kitchen or bathroom, or the property just generally needing so much work that they don’t think anyone could live there right now. So a mortgage won’t work, but we don’t want to put in that much cash either. Instead, we’ll use bridging finance – a form of short-term funding (usually up to a year), which is specifically intended for this kind of situation. Whereas mortgages are typically for up to 75% of the property’s value, bridging normally goes up no further than 70%. It’s more expensive than a mortgage – the interest rate is usually in the range of 0.75%–1.5% per month, plus fees of around 2% of the total loan amount – but it’s quick and easy to arrange. (The terms of bridging loans – the rates payable, and when and how fees are paid – vary extensively between different lenders. To provide a “worst case” for this example, I’m assuming that you need to pay all the interest and fees out of your own pocket at the outset. In reality, the terms will be more favourable to you than that.) Let’s look at the purchase: Deposit: £16,500 (30% of £55,000 purchase price, with a £38,500 bridging loan for the rest) Stamp duty: £1,650 Finance costs: £3,850 (based on a borrowing rate of 1% per month for eight months, plus a 2% fee) Refurb cost: £10,000 Purchase costs (solicitor, survey, broker fees etc.): £1,500 That leaves us putting in £33,500. It’s more than the straightforward buy-to-let purchase from Strategy 1 involved, but don’t worry – we’ll be getting a lot of it back soon. (And as I’ve said, in reality the finance can be structured to put in less cash upfront.) Now, with the work done, we want to get off our expensive bridging loan and onto a traditional mortgage product. And importantly, when we do so, we want to borrow 75% of the new value of the property – the £80,000 we believe it’s now worth, rather than the £55,000 we paid for it. Under most circumstances you can’t apply to re-finance until you’ve owned the property for six months (which is why I reckoned for eight months of bridging payments), so we put a tenant in the property while we wait for that day to arrive. When it does, we borrow 75% of £80,000 – which leaves our cash position like this: New borrowing (75% of £80,000 valuation): £60,000 Repay bridging loan: £38,500 Left in the bank: £21,500 We originally invested £33,500 and got £21,500 back after refinancing – meaning that we now have just £12,000 tied up in that property. If we want to move on to another identical purchase, we already have £21,500 in the bank – so we just need to save up that extra £12,000 in order to do the exact same thing again. Before moving on to discuss the implications of this, let’s see what our month- to-month finances look like now we’re refinanced. Again, the rental income is £577. Mortgage payment (interest-only loan of £60,000 at 5% interest rate): £250 Buildings insurance: £20 Management fee at 10%: £57.70 Repairs allowance at 10%: £57.70 Like last time, I’m going to build in an allowance for the property being empty for two weeks out of every year. After doing so, that leaves us with a monthly pre-tax profit of £184.37 – equal to an annual profit of £2,212.47. In profit terms, that’s identical to Strategy 1 – where we just bought the property for its market value. When you look at our ROI though, things are very different. On the straight purchase for its market value, it was 8.8%. After buying cheap, refurbishing and refinancing, it’s a little under 18.5%. That makes sense: we’re making the same return on a smaller investment left in after refinancing. Lessons So, where does this leave us? Well, it leaves us needing to find another £12,000 to invest again. That means that if we manage to save “just” £1,000 per month, we can buy one property every year. (And just like before, by saving up the rental income it will soon accumulate and allow us to buy at a faster rate.) As a result, by putting in more effort in terms of finding the opportunity and doing the refurbishment, we’re able to put ourselves in exactly the same position as in Strategy 1 while halving the cash requirement. (Noting, of course, that the initial cash requirement is higher because we can’t borrow quite as much and need to find the funds to pay for the refurbishment.) If we’d managed to secure a bigger discount, it would have been possible to do even better – it’s theoretically possible to get all your cash back out of a deal upon refinancing, but it’s not easy. Here, we see what’s going to be a common theme in this book: when you’ve got less cash to invest, you’ll have to put in more effort and accept more risk to get the same result – and vice versa. We haven’t addressed the risk in this strategy yet, so let’s do that now. Whereas with a straight “purchase and wait” strategy you can’t go far wrong, successfully executing a “buy-refurbish-refinance” strategy involves: Finding the opportunity in the first place Accurately judging the refurbishment cost, so you know how much you can afford to pay for the property and still get the margin you need Successfully negotiating the purchase at that price Conducting the refurbishment on time and on budget Convincing the mortgage lender’s valuer that the property is, mere months later, worth significantly more than you paid for it Later in the book we’ll see how to do all of these things. But at every one of these points there’s not only more effort to be made, but also an element of risk to accept – because even the most experienced investor gets things wrong occasionally. There’s also risk associated with short-term market changes: for example, if the market drops 20% while you’re in the process of adding 20% in value, you’re not going to be able to get the revaluation you were hoping for. Over the course of a long-term investment these dips can be ridden out (if you structure your portfolio to survive a recession, which we’ll discuss in Part 3), but it’ll affect your plans more drastically if it happens at the wrong time while you’re trying to lock in a gain. Before wrapping up, let’s just cover a couple of points to help generalise this strategy to situations other than the one I’ve presented here. Firstly, if you’re able to fund the initial purchase and refurbishment with your own cash instead of using a bridging loan, all the better – because you save on some hefty fees. (Although there’s an “opportunity cost” to consider if you could have been doing something else useful with that money.) Another advantage of cash is that you’re not forced to refinance as quickly as possible to get yourself off the expensive bridging finance rates. If the market did take a temporary tumble at the wrong time – or for some other reason it turned out to take longer before you could refinance – you could just wait it out without worrying about your interest rate. Secondly, don’t be put off by the fact that I’ve used a relatively cheap property as an example in this strategy. It works every bit as well on more expensive properties – and can work anywhere in the country, not just the north. I’ve only stuck to the example of a cheap property because it allows you to buy one per year with an amount of savings that won’t seem outrageous to most people. If you’re able to invest more, or you’re willing to wait a couple of years or more between purchases, everything I’ve said applies to pricier properties too. Chapter 3 Lock away a lump sum and watch it grow Aim: Invest a lump sum of cash, and turn it into a much larger amount of cash (or a mortgage-free income) in 10–20 years. In a nutshell: Buy properties with an eye on capital growth, then sit back and wait. Upfront capital required: High Effort involved: Low Ongoing investment required: Low Payoff: Long term So far, we’ve looked at two strategies that only take into account one source of property profits – rental income – without really mentioning the possibility of capital growth. Let’s put that right. Firstly, back to basics. With any property you buy, you have two potential sources of “return” on that investment: Profit left over after receiving the rent and paying out your expenses Growth in the property’s value over time When some people calculate their “ROI”, they combine their rental profits with a projected percentage uplift in capital growth every year. Personally, I don’t see the sense in this: for a start it doesn’t reflect reality (there’s no way property will go up by exactly the same steady percentage every year), and also that increase in value doesn’t do you any good until you either sell or refinance to access the extra equity. I don’t want to give you the idea that capital growth isn’t important: in many cases, the returns you get from capital growth will dwarf the rental income you receive. But capital growth isn’t certain, whereas rental profits are. As an investor, you’ll therefore be looking at properties that target some mixture of the two – and you can be strategic in your acquisitions to target properties that are more heavily weighted towards one or the other. In the first two strategies we focused 100% on income, and treated any capital growth as a bonus. In this strategy, we’ll go completely the other way. Example In this example we’ll pretend that we’ve got £250,000 burning a hole in our bank account, ready to be invested in property. This strategy is just as applicable when you’re investing smaller amounts of money, with the caveat that low-value properties (to pluck a very rough number out of the air, I’d say under £70,000) tend not to offer the greatest growth potential. This is an idea we’ll return to later. £250,000 might sound like a lot of money to have saved up – and it is – but you’d be surprised by how many people I hear from who have that kind of sum to invest. Alternatively, some of that cool quarter mil’ might be in the form of equity that you can take out of your own home. That’s fine (as long as you have the income to support the extra borrowing), but bear in mind that you’ll have higher personal mortgage payments to meet each month and/or be extending the amount of time until your home is paid off. By definition, a strategy that prioritises capital growth is going to be a medium- to-long-term strategy – so for the purposes of this example we’re interested in where a £250,000 investment can get us in 20 years’ time. As we’ve seen, mortgages are typically available for up to 75% of the property’s value. With our £250,000, we could theoretically then buy £1 million of property – although because there will be transaction fees to account for (like legal fees, stamp duty and so on), it will actually end up being slightly less than this. While that money could buy one mansion with its own home cinema and climate-controlled wine room, it would turn out to be a terrible (if fun) investment. Instead, it would be more wise to split that investment between six properties worth around £150,000 each. Let’s look at this flat in Southampton, which recently sold for £142,000: propgk.uk/southampton-buy. With a purchase price of £142,000, we can buy six based on the following figures: Deposit: £35,500 (25% of £142,000 purchase price) Stamp duty: £4,600 Purchase fees (solicitor, broker, survey, etc.): £1,500 For a total investment of £41,600 per flat – £249,600 for six. Each should rent for approximately £850 per month. (Here’s one that rented for £850: propgk.uk/southampton-rent.) Now let’s see how the monthly figures break down. From the £850 monthly rent, we’ll deduct the following: Mortgage payment (£106,500 borrowed interest only at 5% ): £443.75 Service charge and ground rent: £100 (estimated) Buildings insurance: £0 (usually covered within the service charge) Management at 10%: £85 Repairs allowance at 5%: £42.50 (a lower allowance for flats, as the service charge covers some elements that we would be paying for with a house) After allowing for the flat being empty for one month per year (still cautious, but longer than we’ve used before because tenancies in flats like this tend to change over more frequently), we end up making a monthly profit of £165. With six of these, that gives us a grand total of £990 per month before tax. Life- changing? Absolutely not, but that’s not what we’re interested in for the purposes of this strategy. Instead, join me in my time machine as we travel 20 years into the future – where we’re all presumably riding around in driverless cars, you can download the contents of this book directly on to a chip in your brain, and U2 is still putting out disappointing albums. We’ve handed all our properties over to a letting agent, and barely given them a second thought. When we finally remember to check up on them, where have we ended up? At this point I’ll make a statement that might sound like a huge assumption, but I think is actually a very safe bet: property prices will have at least doubled after 20 years. Historically, property prices in the UK have doubled on average every nine years (the longest doubling period has been 14 years). Now, we need to be very careful about two things: extrapolating forward from historical data, and applying a UK average to a specific situation. We’ll come back to both these points – but for now we can be somewhat confident that by extending the timeframe to 20 years, doubling will have occurred. So, in 20 years our six properties – worth a combined £850,000 when we bought them – will be worth £1.7 million. Yet, brilliantly, the total borrowing will be exactly the same as it was before: £639,000. This is the magic of leverage once again: while property prices and rents go up over the long term (even if only in line with inflation), the amount borrowed stays the same. (The interest rate on that borrowing can change of course, which is why you need to have room in your figures to incur higher borrowing costs without being in a loss-making situation. Expect to see lots more about this in Part 3.) At this point, we have at least three options. The first option is to sell them all. After paying off the mortgages, we’ll have just over £1m in the bank. We don’t know what the capital gains tax (CGT) regime of the future will be, but if we assume it’s the same as it is now and we don’t take even the most basic measures to mitigate it, we’ll be left with £700,000 after tax. So we originally put in £250,000, and got out £700,000. That money, invested in a stock market portfolio where it grows by 4% per year, will generate an income of around £28,000 per year for life. However, £28,000 in 2036 won’t have anything like the same buying power as it does now – which is why I favour another option. The second option is to sell two properties to raise a total of £568,000, which is used to pay off the majority of the mortgages on the other four – leaving an outstanding mortgage balance of £71,000. On top of the remaining mortgage balance, the worst-case CGT bill (assuming the same tax regime as today) would be £80,000. Remember those rents we’d forgotten about but which have been accumulating for 20 years? Those will pay off those liabilities instantly. After selling we’re left with four properties, each of which is making a monthly profit of £575 now we no longer have mortgage interest to pay. That gives us a monthly income of £2,300 – or £27,600 per year. And there’s still the potential for further capital appreciation in the future. The big advantage to this second option is that rents will have gone up with inflation over 20 years too. That means your monthly income won’t actually be £2,300 – it will be the 2036 equivalent of £2,300 in today’s money. You’ve taken your initial £250,000, put in absolutely no effort, and given yourself an inflation- proof income of £27,600 per year. The third option is to do something that at first seems a bit bonkers when you first hear it: not only not pay off the mortgages, but actually increase your mortgage balance each year and use the extra borrowing to pay yourself a (tax- free) income. My business partner Rob Bence has been known to refer to this as “the ultimate property strategy” – and while it’s certainly not right for everyone (and isn’t something I follow myself), it’s worth knowing about in case it’s the right option for you. Because it takes a bit of getting your head around, it’s best explained visually – so I roped him in to record a video course that gives you the lowdown. It’s yours for free as part of the extras for this book, so go get it at propertygeek.net/extra. Lessons Other than demonstrating the power of time on leveraged property investment (and giving capital growth some attention after we’d ignored it in previous strategies), the purpose of this example was to get you thinking about where and what you buy. Let’s start with “where”. I said that historically, prices in the UK have doubled on average every nine years. But you’re not going to approximate the “average” unless you own hundreds of properties in every part of the UK – so if you’re interested in capital growth, location matters. I don’t necessarily mean that you should search for the elusive “hotspot” where prices will outperform everywhere else in the UK. Instead, you just need to look out for parts of the UK where you can take a reasonable punt on growth being stronger overall than other areas. For example, cities will as a rule experience more growth than more sparsely populated areas because they’re the economic hubs where jobs are created as the economy expands. And in terms of industry and investment, you’d bet that parts of the country like the North East are going to struggle more than the South East or North West. (A decade or two is a long time to turn things around, of course, but all we can really work from is what we know today.) I chose Southampton pretty much at random when I was trying to think of an economically strong city that’s likely to continue doing well – but there are any number of other cities I could have chosen. In fact, I’d prefer to choose more of them and (in the previous example) own one flat in six different cities: it reduces the odds of finding a massive winner, but I’m also less likely to have put all my eggs in a basket that underperforms. “Where to buy” goes down to the location within cities too, and intersects with “what to buy”. As a rule, growth happens first and fastest in prime and central areas. That’s why I chose in my example to use a modern, relatively new flat in a popular area. The monthly return would have been a lot higher if I’d chosen a house on the fringes (there wouldn’t have been a service charge, and the purchase price would have been lower relative to the rent), but the intention was to maximise capital growth potential. When the economy is in full swing and growth is in the air, demand is always going to be highest (and therefore push up the price more) for the best properties in the best locations. This is the yield/growth trade-off that we often see: as a general rule, properties that yield highly (relative to the area in general) will experience capital growth later and less strongly. This is somewhat simplified, because if a property’s yield is temporarily higher than one would expect for that kind of property, buyers will be attracted and prices will rise to remove the discrepancy. We’ll come back to this when we discuss the property cycle in Part 3, but for now just be aware that you’ll generally need to choose a property with some kind of yield/growth compromise in mind. Finally, I’ve not mentioned “when to buy”. When property prices double, they don’t just drift upwards in a nice predictable way. The majority of that growth happens in just a few years, and is immediately followed by some of the gains being rapidly lost. This is the phenomenon of the property cycle, which we’ll cover in a lot of detail in Part 3 – because if capital growth is your objective, it’s a big part of the picture. You should never truly put the blinkers on for 20 years (as in our example) because then you’re just leaving to chance whether you end up selling at a good time or a bad time. I’d love to get into the property cycle in more detail now, but I’ll restrain myself. Trust me, it’s exciting stuff – think of it as your reward for trudging through some of the drearier bits about accounting that we need to get into later. Chapter 4 Replace your wage with rental income – fast Aim: Turn cash in the bank into an income stream that allows you to quit your job as quickly as possible. In a nutshell: Buy a small number of properties that generate a lot of cash immediately. Upfront capital required: High Effort involved: High, if self-managing Ongoing investment required: Low Payoff: Short term All of the strategies we’ve looked at so far have had a relatively long-term payoff. That’s all well and good (and time is where a lot of the magic of property happens), but what if you’re thoroughly sick of your job and want to quit RIGHT NOW? Well, with this strategy (and the next one) we’ll look at ways to create that instant income you need. Both work best when you have a decent amount of capital to start with. This makes sense: if you have the luxury of time, you can put in more cash over the years or allow equity to build up. That’s not an option if you need to generate a return on your money from day one. This particular strategy is all about accumulating rental income fast – which puts us squarely in the territory of multi-lets rather than single lets. When a property is rented out room by room, the total income generated by that property is generally higher – and of course, the more lettable rooms you can squeeze in (by converting reception rooms into bedrooms or sub-dividing large rooms), the more income you generate. (A multi-let is also known as a House in Multiple Occupation (HMO), and we’ll use the term HMO from here onwards. “HMO” is actually defined in several different ways for different purposes, and it’s possible to have a multi-let that isn’t an HMO… but that isn’t important right now.) The downside is that HMOs involve more management (in terms of keeping all the rooms occupied and making sure everyone is happy), and there will generally be higher maintenance costs as the house is being used more intensively. Let’s look at a couple of examples that demonstrate all of these points. Just like in the previous strategy, we’ll imagine that we’ve got £250,000 to invest. Example 1 We’ll start with an example of an investment I know pretty well, because I own one: a mini-HMO in Liverpool, aimed at students. It’s in the student-y L7 postcode, and has two bedrooms and two reception rooms. By converting one of the reception rooms into a bedroom, it can be let to three students. I bought mine a while a ago now, but looking at Rightmove it seems like you’d need to spend somewhere in the region of £60,000–£65,000 to cover the cost of buying and refurbishing a property like this. In fact, here’s one for £60,000 that has apparently just been fully refurbished – so nothing needs to be done: propgk.uk/liverpool-buy (the area isn’t ideal for students, but it’s passable). To be pessimistic, I’m going to assume you need to buy for £60,000 and spend £10,000 on refurbishment. So the cash investment needed is: 25% deposit on £60,000 purchase price: £15,000 Stamp duty: £1,800 Refurbishment: £10,000 Purchase fees (solicitor, broker, survey, etc.): £1,500 For a total investment of £28,300. The house will have three lettable rooms, each of which will command a rent of £82 per week, for a monthly total rent roll of £1,065. That’s a gross yield (dividing the annual rent by the total purchase price and refurbishment cost) of 18.2% – more than double the typical yield of a single family home. But before you get too excited, it’s worth remembering that HMOs come with more than their fair share of expenses too – which is why gross yield is only a meaningful calculation for comparing investments that have similar cost profiles. One big extra expense is bills, which are usually included as part of the rent: £20 per room per week is a fairly standard estimate for rooms let to professionals, although it may be lower for students because they’re exempt from council tax and might not expect Sky TV with all the trimmings. Management fees (if you don’t plan to self-manage) are also generally higher, as more work is involved than a single let. So from our gross monthly rent of £1,065 I’m going to deduct: Mortgage (£45,000 borrowed interest only at 5%): £187.50 Insurance: £20 Bills (£20 per room per week): £259.80 Repairs allowance of 10%: £106.52 Management at 12.5% (typically higher than for single lets): £133.15 That gets us to a monthly profit of £358.49, or an ROI of 15.2%. In fact though, student lets tend to run for a period of 11 months – so by the time you allow for a month without income and average that out over the year, the monthly profit reduces to £328.64 and the ROI to 13.94%. (And to show just how cautious my assumptions are, the one I own actually has a real-life ROI of around 30% because my mortgage interest rate is lower and I’ve been lucky with repairs over the last few years.) With our £250,000, we could buy nine of these (OK, we’d need to negotiate a discount of £5,000 across all nine properties to hit our budget), for a total monthly pre-tax income of fractionally under £3,000. Enough to quit your job? It might be a pay cut, but even after factoring in time for admin and phone calls from your letting agent, you’d still have plenty of time on your hands to pursue other sources of income. If your thumbs started to hurt from all the twiddling and you wanted to self-manage, you’d save £1,200 per month and take your monthly income to over £4,000. Clearly this is a strategy I quite like because I’ve done it. I don’t have my entire portfolio in these investments, however, because there are downsides that are worth exploring. Firstly, terraced houses in student areas tend not to be the most desirable, so (in accordance with what we’ve seen in previous examples) they’re unlikely to give much in the way of capital growth. If you consider “total profit” (rental profit plus equity gain) over the entire time that you own the property, it could end up lower than a single let even though the month-to-month income is higher. This becomes even more marked when you divide your total profit by the number of hours you put in over the duration of the investment. Capital growth is never any kind of certainty, but you could end up making less money for more work, even though the ROI appears to be higher. Another downside, when it comes to student HMOs at least, is concentration of risk. What you’ve basically got here are cheap, not-that-great houses that students happen to be willing to pay a good chunk of cash to live in right now. If trends shift (as they’re doing in many student areas towards purpose-built accommodation), you could suddenly be the proud owner of nine unexciting houses where your yield has just been cut in half and your tenants have recurring cameos on Crimewatch. Example 2 The “trend-shift risk” we saw in the previous example is specific to a particular type of student property, though. The HMO sector in general is thriving and should continue to do so, because young people aren’t going to find it any easier to afford their own flats – even to rent. So in the professional market you’ve got people living in rented accommodation well into their 30s, and in the housing benefit market you’ve got people who are only given enough to cover a room rather than a flat until they’re 35 (unless they have dependents). Let’s take another example then, because owning nine houses seems like a lot of work and there are risks involved. Could you quit your job by just owning a handful of more upmarket professional house shares that are less at risk of a drop in rental demand? Here’s a real-life example from a friend in Milton Keynes: Purchase price: £190,000 Stamp duty: £7,000 Refurb and set-up: £10,000 Number of rooms: 6 Rent per room per month: £370 Total income: £2,220 Total bills: £500 (including insurance – just under the £20 per room per week figure that I estimated earlier) Mortgage: £593 (£142,500 borrowed interest only at 5%) Repairs allowance of 10%: £220 This gives an ROI of 16.84% and a monthly profit after costs of £905. £250,000 would just about buy four of these (with a fractional discount or saving on a refurb), giving an income of £3,620 per month. You can’t tell from the example, but it wasn’t easy to pack six bedrooms into that house. The chap who gave me the case study is a dab hand at reconfiguring houses to squeeze in as many rooms as possible without making it overly pokey or breaching any regulations. This is where expertise comes in: if you thought it was only possible to get five bedrooms out of that house, your returns would have been cut dramatically. The takeaway lesson from this scenario? That you can buy four houses, generate £3,620 per month and quit your job. However, you’ve just given yourself multiple new jobs: you’re now a letting agent, general dogsbody, referee in fights over who got crumbs in the butter, and so on. While HMOs seem more profitable than single lets, some of that profit has a time cost attached to it – and while being a full-time landlord might sound more glamorous than the job you’ve got now, you could be pining for a nice easy office job after a few months of running around after multiple tenants. The alternative is, of course, to use a managing agent – but doing so reduces the ROI to not far off what you’d expect from a single let. In the example above, adding in management at 12.5% would add £277.50 in costs for each house, or £1,110 in total. This reduces the monthly income to £2,518, and the ROI to 11.67%. Actually, your costs of using an agent will be even higher because most agents will charge a letting fee every time they rent a room on top of the management fee. If six rooms are turning over once per year and the agent charges £150 each time, that’s another £75 monthly cost on average. This example, therefore, brings out another truth of property investment: outsized returns are generally earned, through hard work and hard-won expertise. In the scenario above, if you do the management yourself (hard work) and know how to maximise the amount of rent you can generate from any given house (hard-won expertise), you’ll do very well. Otherwise you’ll have to settle for lower returns. Not that there’s anything wrong with either approach. You might be happy with making a lower return if you want to spend your time on other things and would rather outsource the management. Alternatively, you might prefer the job of being a part-time HMO manager to the job you’ve got right now – and you might even be able to systemise it, take on other people’s properties and eventually employ someone to do the job for you. Chapter 5 Flip your way out of the day job Aim: Embark on a new career as a property trader – bringing in enough money to replace your wage. In a nutshell: Buy, fix up, and sell on for a profit Upfront capital required: High for best results, but moderate can work too Effort involved: High Ongoing investment required: Low Payoff: Short term In the last strategy we looked at how to use a lump sum to create an income right now, so that you can get out of your job pronto. What if you still want to tell your boss where to stick it, but don’t have that much cash to put to work? To demonstrate this strategy, we’ll use £50,000 as the amount of starting capital. This £50,000 won’t be enough to buy a decent chunk of rental income, even with HMOs. Realistically then, the only way to get an immediate income is to look at trading in property (rather than investing in property): buying, refurbishing, and selling on at a higher price. “Trading”, “buy-to-sell” and “flipping” are all used pretty much synonymously to refer to this process. As you don’t have enough to buy a property purely with cash, you can use bridging finance – which, as we saw earlier, is a handy but costly form of short- term lending. Alternatively, you could approach a friend or a family member who has cash in the bank and offer them a fixed percentage return on their money for the duration of the project. (You could instead offer to go in 50/50 with them and split the profits, but that’s a worse deal for you unless they bring skills to the table too.) Example For this example we’ll look at a property that we can buy for £90,000, and needs £18,000 spending on it in order to bring it into tip-top condition. Once it’s gone from tired and unappealing to shiny and desirable, we reckon we can sell it for £140,000. With bridging you can typically borrow 70% of the property’s value, so we’ll borrow £63,000 and put in £27,000 as a deposit. That means the upfront costs are: Deposit: £27,000 (30% of £90,000 purchase price) Stamp duty: £2,700 Refurbishment budget: £18,000 Purchase fees (solicitor, valuation, etc.): £1,500 So that’s £49,200 of the £50,000 cash pot spent. There will also be costs associated with the bridging loan of £63,000. It’s usually possible to structure the loan so that these fees (or at least the majority of them) are paid at the end of the project, but in case of any upfront fees there’s £800 left in the budget to cover them. I’m going to assume that we borrow the money for eight months, at an interest rate of 1% per month and with fees totalling 2% of the amount borrowed. That leaves total borrowing costs of £6,300 to pay back. Because we’re professionals, we run the project like a military operation and finish on time and on budget, finally achieving the anticipated sale price of £140,000. With the property sold, it’s time to calculate the profit. The difference between the purchase price (£90,000) and sale price (£140,000) is £50,000 – from which we need to deduct: Refurbishment: £18,000 Stamp duty: £2,700 Bridging interest and fees: £6,300 Legal fees and other transaction costs (for both purchase and sale): £3,000 That leaves a profit of £20,000. I said I was going to leave tax aside for these models, but it’s more straightforward to calculate with property trading: if the property was bought within a limited company (generally a good idea for buy-to-sell projects, as we’ll see later), we’ll pay corporation tax (currently 20%) on the profits. That would leave a post-tax profit from this project of £16,000. In theory, if everything goes perfectly, six-month projects like this could be run back-to-back – allowing two to be completed per year. That would give the company £32,000 in post-tax profit, although, like with any company, there may be additional tax to pay when taking money out as a wage or as dividends. So, ready to quit your job right now and start trading? I wouldn’t recommend it – because even for people who are highly experienced, it’s never the case that everything goes perfectly. If you end up with a property where everything goes wrong and you only break even, or which you can’t sell at all and are stuck with, you’re stuffed: your cash is tied up and you don’t have enough money to pay the bills. A more sensible approach would be to keep your job temporarily, and do some flips on the side to start with. If you can execute three successful flips like the one we’ve just been through, you’ve pretty much doubled your money – leaving the company with £48,000 post-tax to add to your original £50,000. At that point (which could be less than two years away), you’ll then have nearly £100,000 with which to kick off your career as a full-time flipper – meaning you can either run two projects at once, or (with a greater concentration of risk) trade in properties that are twice as expensive so you make twice as much profit for the same amount of effort. Of course, if you have more cash to start with – or the contacts who are willing to lend you more money – you can be full-time from the start. But the point is that once you start living off your profits instead of re-investing them, you’re more personally vulnerable to things going wrong: a house that takes twice as long as expected to sell isn’t just annoyingly slowing down your plans – it’s potentially affecting your ability to meet your personal financial obligations. Lessons The trading model is pretty simple, but that doesn’t necessarily make it easy. Executing this successfully involves: Identifying the opportunities Arranging finance Acquiring the properties Correctly estimating the costs Running an on-time and on-budget refurbishment project (either by doing the work yourself or managing a team of contractors) Presenting the property correctly so that it sells at the price you need within the desired timeframe … All while simultaneously looking out for the next one, so you can get started as soon as the cash comes back into your bank account. This only emphasises the point I made in the previous model: that rapid profits need to be earned through hard work or hard-won knowledge. So it requires a fair bit of effort and successful execution, but as a means of escaping your job and getting full-time into property in a couple of years with only a modest amount of capital? It’s not for everyone, but for the right kind of person it’s likely to be a much more enjoyable way of making a living. Conclusion Excited? You should be – because although we’ve only looked at a few of the many possible strategies out there, you should be seeing how there’s an approach to suit every goal, timescale, budget and skill set. It’s nearly time to move on to Part 2 and put the theory into action, so let’s just quickly recap some of the general themes that we’ve encountered while looking at these strategies. The tighter the timescale to reach your goal or the smaller the amount of money you can put in at the start, the more hands-on you’ll need to be, and the less certain you can be of getting your result. For example, if you’re trying to generate immediate cash through trading property (Strategy 5) you’ll have to work hard and there’s a lot more that can go wrong than if you’re just buying and collecting the rent over the years (Strategy 1). Appreciating this and understanding your constraints in these areas is the key to setting realistic goals. Each example I gave started with an investment of at least £25,000 – so what do you do if you have less than that? The obvious answer would be to save up, but you could also team up with a friend or family member who has the money. Later in the book we’ll look at how to correctly structure a joint venture like this. What you buy and where you buy has a large impact on the relative contributions that rental income and capital growth make to your total returns. You can target investments that produce a strong rental return if that’s your preference, or instead target those that are most likely to benefit from strong capital growth – and there will always be some degree of compromise. You’ll continue to notice this as you start researching your own options in more detail. All the strategies described in this chapter involve very different skills, preferences and attitudes to risk. Coming up with your own plan is a matter of finding a strategy that matches not only your goals, but your personality too: there’s no point working out a brilliant plan that involves flipping a house every six months if you work 18 hours per day in the City and have absolutely no interest in construction projects. Finding the sweet spot that matches up all these different factors isn’t easy, but it’s worth the effort of getting it right. At the heart of choosing the right strategy, as we’ve seen, is setting an appropriate goal. As part of the free “extras” for this book, I share the spreadsheet I use to set my own goals – and talk you through my annual goal-setting exercise. It’s totally free – all you need to do is sign up at propertygeek.net/extra. So, there you go – we’ve given a lot of thought to the final destination, which was vital to do before setting off. Between here and there, there’s much to be done – starting with lining up the finance and finding a property to buy, and progressing all the way through the acquisition process to management and beyond. It’s a lot of work, but it’s (mostly) all good fun too – and Part 2 will cover all of it in detail. PART 2: THE INVESTMENT PROCESS With your strategy in place, we can turn to the mechanics of property investment: getting financing, deciding where to buy, analysing potential opportunities, then following the process all the way through to either management or sale. As a special treat, we can even talk about tax for a bit. I wouldn’t describe the process as “easy”, because there’s a lot to it and there are plenty of potential setbacks, but there’s no one particular aspect where you need to be a genius. You’ll find different parts of the process challenging depending on your strengths and weaknesses: some people really struggle to find good opportunities, others get bogged down in the research, and many find the management and record keeping to be a real chore. Whatever your particular abilities though, this whole process becomes easier once you’ve got a strategy in place. For a start, it answers a lot of questions about the type of property you should be looking for – and therefore removes a good deal of uncertainty. It will also keep you motivated, because you’ll know how worthwhile it will be once you’ve achieved your goals. So, let’s dive in – starting with the all-important financing of your investment… Chapter 6 Finance When I was in my teens and early twenties, I’d always read the “Money” section of the newspaper at the weekends. I couldn’t get enough of anything to do with dividends, savings and interest rates… but I was never able to muster up any excitement for the (seemingly endless) articles about mortgages. In truth, I don’t think I fully understood what they were – I just knew they were scary, and that adults seemed to spend disproportionate amounts of time stressing out about them. I remember repeatedly thinking, “I’m never going to have one of those… I’ll just wait until I have enough money of my own to buy a house outright.” Fast-forward a decade and, much like my “This Twitter lark seems like a silly fad” prediction of 2007, I turned out to be spectacularly wrong. I now have a number of mortgages – far more than the average “normal” person. Even more strangely, I actually find the whole business of finance totally fascinating. Your view of debt is probably less warped than mine used to be, but you’re still likely to have all sorts of hang-ups and uncertainties around mortgage lending (and its alternatives). This chapter is here to help. By making this the first chapter of Part 2, I seem to be suggesting that you should consider how to fund a purchase before you even go out looking for something you might want to buy – why is that? It’s a common newbie mistake to rush out and look at properties, only to have to back out of a deal later because you can’t borrow as much as you thought you could. It’s a waste of your time, and it destroys your credibility with the estate agent you were dealing with. That’s why I recommend understanding the basic factors that influence lending and looking into your options before you begin. Focusing on finance first will give you (justified) confidence that you’ll be able to go ahead when you find something suitable. It will also give you as much time as possible to address any factors that might restrict your ability to take on borrowing. We’ll start with the most basic question of all: if you have a decent amount of cash saved up, should you take out a mortgage at all? Should you get a mortgage? Say you have £50,000 sitting in your bank account. Should you buy one small terraced house in the cheapest part of town with that cash, or take out a mortgage to buy two bigger and more desirable houses for £100,000 each? Answer: the latter. Almost always. To explain why, let’s say property prices go up by 10%. In the first scenario your portfolio has increased in value by £5,000, and in the second the value has increased by £20,000 – even though your own cash investment is the same. After a 10% increase in prices, you could theoretically sell both houses immediately and bank a 40% return on your investment (the £20,000 gain divided by your £50,000 cash input) – ignoring transaction fees and so forth. That’s leverage. As this simple example shows, it’s exceptionally powerful – and it should be treated with the caution it deserves. There are two dangers to be mindful of. First of all, leverage works against you when prices fall: if property values had dropped by 10% in our example, you would have lost 40% of your investment. This is only an issue, however, if you’re forced to sell at that point. If you can ride out the dip and wait for prices to pick up again, you’re all good. How do you make sure you can ride out the dips? By protecting your cashflow at all costs. If a property is making a profit, you should be able to hold on to it forever, through good times and bad. However, the second danger is that having a mortgage decreases your cashflow (compared to if you bought with cash), because you have an extra cost to contend with: the cost of repaying the mortgage. This is why it’s dangerous to be over-leveraged: if you have huge borrowings and interest rates go up (thus increasing your monthly payments), you could be stuck in a situation where the property is costing you money every month. If you run out of ability to subsidise the property at the same time as prices have just collapsed and you can’t sell it for a high enough price to repay the mortgage… bad news. Like, “bankruptcy” bad. (In Part 3 we’ll look at property crashes and how to ensure you have a sufficient safety margin to survive in almost any circumstances.) Despite the dangers, using leverage responsibly will still do wonderful things for your long-term returns. Unless your personal situation is such that you wouldn’t be comfortable with any kind of debt, it’s something you should strongly consider. Deciding on interest only vs capital repayment When taking out a mortgage on a buy-to-let property, you’ll be able to choose between repaying a small amount of the loan each month until you owe nothing at the end of the mortgage term (a “capital repayment” loan), or just paying off the interest each month so that at the end of the term you still owe exactly as much as you borrowed in the first place (an “interest only” loan). If you’re not overly comfortable with debt, capital repayment will seem like the “safe” choice. But I’m going to try to convince you that “interest only” is actually safer. Why? Because if you’re repaying a chunk of the capital each month, it means your monthly payments will be higher and your cashflow will therefore be lower. And, as we’ve already seen, the real danger is that you’re stuck in a position where prices have crashed and the property is making a loss (because your rental income doesn’t cover your expenses). Paying off just the interest gives you more income each month. Yes, you need to find the money to repay the mortgage in the distant future when you’re unable to extend the loan term any further – but you’ll get a major helping hand from inflation. Inflation is an extremely powerful force, but it’s easy to miss because, year to year, it’s barely noticeable. Over a 25-year mortgage term though, its effect is huge. Let’s say you borrow £75,000 today (to buy a house worth £100,000) and pay off nothing but the interest. Assuming annual inflation of just 2%, its “real value” by the time you pay it back in 25 years will be only £45,000. At the same time, let’s assume house prices increase by 2% per year too – so the house you bought for £100,000 will be worth £164,000 in 25 years. As a result, even though you haven’t paid off a penny of the amount you borrowed, your loan-to-value proportion has dropped from 75% to 27%. Looked at like that, paying off your mortgage in the future seems a much less scary prospect. Still uncomfortable with the idea? Here’s the point that most people miss: having an interest-only loan doesn’t mean you can’t repay chunks of the capital if you want to. Yes, fixed-rate deals (to be explained shortly) will have an initial period when you’re penalised for overpaying, but after a while (when the fixed-rate period ends or you remortgage) you’ll be free to pay off capital at will. That’s truly the best of both worlds. Benefit from the extra monthly cashflow with an interest-only deal, let the cash build up in the bank, then you can decide to use those savings to pay off capital or not – depending on what seems like the best idea at the time. All you’re doing is giving yourself more flexibility, because you’re not locked into a set repayment schedule. Making use of equity in your home Many people get started in property investment by extending their residential mortgage and releasing equity that’s built up in their own home. They then use the money to put down a deposit on a property, or even buy it outright. It’s common, but not for everyone: if you’ve dreamed for years of finally paying off your mortgage completely, you might not appreciate the idea of ramping it up again to buy more property. Whether you want to bring your own home into play is a completely personal decision for you (and your partner). But if you do, there are a few things to keep in mind. Firstly, yes, it’s possible. Lenders vary, but most won’t be fazed if you say you want the money to buy another property. The amount you can borrow will be determined by two things: 1. The value of your home. With residential mortgages, you’ll often be able to borrow around 90% of the property’s value – which is more relaxed than buy-to-let where (as we’ll see in a minute) the maximum “loan-to-value” is usually around 80%. 2. Your income – because residential mortgages are offered as a multiple of your salary. Again, this is different from buy-to-let mortgages where (as we’ll see) your income is only a small factor, and the amount they’ll lend is based on the rental income the property can generate. So let’s say you have a home worth £500,000, of which you have £100,000 still outstanding on the mortgage. Based on its value, a lender might allow you to borrow up to £450,000 (90% of its value). But they might also cap the amount they’ll lend at 5x your income. If you earn a salary of £50,000, that would cap your borrowing at £250,000. So in this case, as your loan is already £100,000, you’d be allowed to borrow an extra £150,000. The obvious upside of extending the borrowing on your own home is that you can use the cash you release as a deposit on a new property, allowing you to buy even if you don’t have any savings to put in. You’ll also find that the interest rate you’ll pay on a residential mortgage is generally lower than on a buy-to-let loan. The disadvantage is that pretty much all new residential loans are going to be on a capital repayment basis. This means that £100,000 borrowed against your own home might have a lower interest rate than the same amount borrowed against a buy-to-let property, but your monthly repayments might end up being higher because you have no choice but to pay off the capital as well as the interest. Something else to bear in mind: if you release equity from your home to serve as a deposit, and then use a buy-to-let mortgage to fund the rest of the purchase, the property you’re buying is effectively 100% mortgaged. That’s fine, but it means you’ll need to consider both sets of payments when calculating whether the deal stacks up – and it’ll therefore be more challenging to find purchases that will make you a monthly profit. How much can you borrow? The amount you can borrow on a buy-to-let property is determined by both its value and the rental income it brings in. Your own circumstances aren’t irrelevant, but the lender is far more interested in the property than they are in you: They want to be sure of its value because if they need to repossess, they’ll sell it to get their money back. They want to know its income-generating potential to be sure that the investment will be self-financing (so you can meet your repayments regardless of what else is going on in your financial life). The maximum loan-to-value (the proportion of a property’s value that you can borrow) on a buy-to-let loan at the moment is 85%, and the most typical level is 75%. So if you want to buy a property for £100,000, you’ll need to put down a £25,000 deposit from your own funds and they’ll lend you the rest. Of course, you can always borrow lower amounts – and as you get down to 60% loan-to- value and below, the interest rates often decrease. Lenders use something they call “rental cover” to assess whether the investment is self-financing. Most buy-to-let lenders are regulated by the Bank of England’s Prudential Regulation Authority (PRA), who (as of January 2017) insist that the rent must cover at least 125% of the mortgage payment – assuming that the interest rate is at least 5.5%. (This doesn’t apply to certain “specialist” lending such as bridging, commercial or semi-commercial property and holiday lets, nor to any lending with a fixed term of five years or longer. You also don’t have to worry about any of this if you’re re-mortgaging an existing property without increasing the debt, because that also escapes these rules.) Example time! Let’s say you buy a £100,000 property with a mortgage of £75,000. Working from the notional interest rate of 5.5% (it doesn’t matter if your actual interest rate is lower: they’ll be making their calculations on the basis that it’s 5.5%), your monthly mortgage payment would be £343.75 (£75,000 multiplied by 0.055, divided by 12 to get the monthly amount). The lender would therefore want the monthly rental income to be at least £429.68 (£343.75 multiplied by 1.25) in order to give you the loan you asked for. Different lenders vary in their criteria. While the regulations dictate that they need at least 125% rental cover, some lenders will go further and require 135% or 145%. Others will test more stringently in certain circumstances based on your tax position and other liabilities. I generally don’t pay too much attention to it. In my view, if you’re anywhere near having to worry about whether you have enough rental cover, the property will probably lose you money each month. After all, the mortgage is just one cost. In the example above, a rental income of £429 would satisfy the lender, but let’s imagine your actual rental income was £500: after paying the mortgage, you’d only have £71 to cover all other costs (maintenance, management fee, service charges, etc.) and leave you a profit. OK, in reality your interest rate might be lower than the notional 5.5%, but in any case it’s far too tight for me. The PRA is insisting that another round of changes is brought in by September 2017. These changes will (among other things) establish tougher criteria for “portfolio landlords” – which they define as someone with four or more mortgaged properties. Generally speaking, the new criteria means that lenders must take into account income and liabilities across the investor’s entire portfolio rather than just look at the proposed new investment in isolation. It remains to be seen what effect this will have, but it certainly seems that portfolio landlords will have to jump through more hoops in order to secure a mortgage – and presumably the process will take longer (and perhaps even be more expensive) as a result. What lenders want to know about you That was the property. Now let’s talk about the other thing that lenders will be looking at: you. As I’ve said, for buy-to-let mortgages, lenders won’t scrutinise every last KFC receipt like they tend to do for lending on your own home. The property is their main concern, but the number of mortgage options open to you will certainly depend on your personal circumstances. There are hundreds of buy-to-let products available, and a good broker (a subject we’ll come to later) should be able to place you with something almost irrespective of your circumstances. However, you’ll have a wider selection of the market available to you – which will mean more choice, better rates, higher loan-to-value ratios, and so on – if your broker is able to tick certain boxes for you. The first box to tick is having a non-property income of at least £25,000 – which can be a joint income if, for example, you and your spouse are buying the property together. While the amount they’ll lend is based on rent rather than a multiple of your income, most lenders want to see that you have some income so you’ll be able to service the debt if the property is empty for a period of time. Different lenders have different “minimum income” requirements, but £25,000 is fairly typical. They specify “non-property income” because, again, if your whole income comes from rents then there’s always the possibility that you’ll have multiple empty properties and be unable to pay. This requirement can cause issues for freelancers or contractors, who find it harder to demonstrate their income than an employee who can just show payslips. Lenders typically want to see at least two years of accounts, but again, a good broker can look for exceptions to the rule. The next box to tick is owning your own residential home. This is less to do with financial security (although it helps) than avoiding fraud: because buy-to-let lending criteria are more relaxed than residential, it’s not uncommon for people to get a buy-to-let mortgage on a property they actually want to live in themselves. Having your own home already reduces that risk in the eyes of the lender. (And let’s be clear for a moment: using a buy-to-let loan on a property you want to live in, or getting a residential mortgage on a property you intend to let out, are both mortgage fraud and are seriously not a good idea – however many people tell you they’ve been doing it for years and “the lender doesn’t care as long as they get paid every month”.) Another factor lenders will look at is whether you have property experience already – which, of course, doesn’t help when you’re brand new to property investment. So if you’re starting out with no provable income, no home of your own and no investment properties… it’s going to be tough, but not impossible. If you do manage to find a lender who’ll accept you, the interest rate they offer you will be less competitive than normal because they need to price in the extra risk, and they might also offer you a lower loan-to-value ratio. As time goes on and you become an “experienced landlord”, it does get easier… until it starts getting harder again, because many

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