Get into High Gear with Gearing
Published 09/05/2012 Using Finance to Increase your Returns
After recently attending local property networking events it still amazes me that investors think it’s a good idea to buy properties for cash. Firstly, the financial returns are less when a property is purchased for cash. Secondly, it means a large amount of cash is tied up for six months as no remortgaging can take place until a period of six months has elapsed. This means if a bargain property opportunity comes along within that six month period you will miss out, unless you have more cash to hand. So start as you mean to go on i.e. gear the property on purchase with a mortgage, ideally 75% to 80% loan to value mortgage.
Without Gearing
Mr & Mrs Smith don’t believe in finance. They use their £100,000 accumulated savings to purchase one investment property for cash. They let the property for £600 per month, i.e. £7,200 per annum. Due to inflation, the rent increases and eventually, after 5 years of fluctuations in the property market, the house increases in value by say 40%.
Outcome – MR & MRS Smith property investment now = £140,000
Note: This example of without gearing could be said as the same as if it were a stock market investment.
With Gearing
Mr & Mrs Jones use their £100,000 accumulated savings as deposits to buy £500,000 (five) of properties, just like the one Mr and Mrs Smith purchased. On this basis they also receive five times as much rental income, i.e. £3,000 per month or £36,000 per annum. The other £400,000 is borrowed (80% Loan to Value) and they pay interest on this amount of 5.0%. This works out to be £20,000 per annum. Therefore, net of interest they receive £16,000 per annum.
They are already better off than Mr & Mrs Smith, but what happens in years to come? Well it is probably safe to say that Mr and Mrs Joneses rental income will rise with inflation as per Mr & Mrs Smith. However, Mr & Mrs Joneses mortgage costs remain the same. Therefore, the gap between both couples rental income will continue to widen as time goes by!
We then need to look at the year 5 positions, when the properties have increased in value by say 40%. Mr & Mrs Smith have made a capital gain of £40,000 and have £140,000 worth of investment property. On the other hand, Mr and Mrs Jones have made a capital gain of £200,000, five times as much as Mr & Mrs Smith’s cash property investment (or stock market investment).
Outcome – Mr & Mrs Joneses property investment now = £700,000
The same principle is true whether you buy investment properties of £50,000 or £200,000. The larger the property value, for instance 10 times more, the greater the potential capital gain (£500,000 per property), but the greater the potential loss if property values goes down.
Note: As the property value goes up the rental yield generally comes down, which can lead to negative cash flow, and a definite negative cash flow if interest rates go up significantly.
Portfolio Building
As explained above many investors purchase investment properties for cash to create both an instant income and a property portfolio. Alternatively the funding process known as “Gearing” can be implemented.
As stipulated the mortgage amount is paid by the rental income; the difference represents the investor’s profit. There is no limit to the size of the portfolio that can be produced by implementing this system!
Let’s now look at what happens when Mr & Mrs Jones refinance their five properties after 5 years by the use of further advance/ re-mortgaging. Remember after 5 years their portfolio is now worth £700,000 in this example. At 80% Loan to Value this will raise £160,000 as an ‘Equity Release’ i.e. £560,000 less original borrowings of £400,000.
Mr & Mrs Jones then use the £160,000 as deposits to buy £800,000 (eight) of £100,000 properties. On this basis they now receive thirteen times (5 + 8) as much rental income, i.e. £600 x 13 = £7,800 per month or £93,600 per annum. Their total borrowings now total £640,000 + £400,000 = £1,040,000 (80% Loan to Value) and they pay interest on this amount of 5.0%. This works out to be £52,000 per annum. Therefore, net of interest they receive £41,600 per annum.
Outcome – Mr & Mrs Jones property investment now = £800,000 + £700,000 = £1,500,000
To some investors this all now starts to look very worrying, all those 000’s at first glance can look a daunting prospect. However, you shouldn’t be afraid of debt, just be mindful of it. After all, nations and countries are built on debt; America has over 15 Trillion dollars of debt.
Debt only becomes worrying and a problem if there is no mechanism to service the debt. Fortunately property provides a good and dependable income stream that can adequately service the debt providing the properties are not over geared (over financed), and exhibit a reasonable ‘Gross Yield’ of 7% or above.
Moving another 5 years ahead; due to inflation, the rent increases and eventually, after 5 years of fluctuations in the property market, the house increases in value by say another 40%. Note: This is fair to assume as since the 1950’s property prices have doubled on average every 7 to 10 years.
Outcome – Mr & Mrs Smith investment now increases from £140,000 by £56,000 to £196,000.
For Mr & Mrs Smith this represents a £96,000 increase on their original investment of £100,000, which is great but as you will now find out it’s not even half as great as the Joneses.
Outcome – Mr & Mrs Joneses investment increases from £1,500,000 by £600,000 to £2,100,000.
For Mr & Mrs Jones this represents a £960,000 (£2,100,000 less borrowings of £1,040,000 and £100,000 investment) or 10 times/ 1,000% gains on the original investment of £100,000. This means the Joneses are now property millionaires. Not only that let’s now look at the rental income situation for both parties now that 10 years has elapsed.
Note: It’s reasonable to assume that with inflation the rental income would increase by 50%, just as a loaf of Bread costing £1 will be £1.50 in 10 years’ time.
Rental Income Outcome – Mr & Mrs Smith £600 + 50% = £900 per month/ £10,800 per annum
Rental Income Outcome – Mr & Mrs Jones £7,800 + 50% = £11,700 per month/ £140,400 per annum less mortgage/ borrowing interest of £52,000 = £88,400 per annum
From this simple illustration you can see the Joneses are now living on easy street and the Smiths will still have to count the pennies in their later years. Furthermore when one property is empty (Rental Void Periods) the Smiths lose 100% their rental income, whereas the Joneses only lose 8% of their rental income; safety in numbers.
Caveat Emptor Statement – “Note for ease of illustration property maintenance and management costs have been excluded; this is just meant to be an illustration of what ‘Gearing’ can do providing you gain further knowledge on property management and investment skills.”
“So do try to Keep Up with the Joneses”
About Property Maverick
The Property Maverick is often found as Kelvin Kingsley. Formerly of the electronics industry, he has developed several developments overseas. In the UK he has built up a substantial buy to let portfolio in between living in South Africa and paragliding from mountain tops.
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Mark Alexander says:
09/05/2012 at 12:19
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Mark Alexander says:
09/05/2012 at 12:20
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Property Maverick says:
09/05/2012 at 18:48
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Property Maverick says:
09/05/2012 at 18:56
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Property Maverick says:
09/05/2012 at 19:35
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Timfawcett2004 says:
09/05/2012 at 22:06
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Property Maverick says:
10/05/2012 at 13:28
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Jonathan Clarke says:
11/05/2012 at 01:37
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Property Maverick says:
11/05/2012 at 08:01
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Mark Alexander says:
11/05/2012 at 08:44
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Property Maverick says:
11/05/2012 at 09:05
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Mark Alexander says:
11/05/2012 at 09:13
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Jonathan Clarke says:
11/05/2012 at 12:12
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Timfawcett2004 says:
12/05/2012 at 00:36
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Mark Alexander says:
12/05/2012 at 09:52
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Jonathan Clarke says:
12/05/2012 at 11:44
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Mark Alexander says:
12/05/2012 at 12:05
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Timfawcett2004 says:
12/05/2012 at 15:45
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Property Maverick says:
13/05/2012 at 09:19
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Mark Alexander says:
14/05/2012 at 16:16
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Property Maverick says:
14/05/2012 at 16:24
Leave a commentHi Kelvin
Well written, however, run those
figures through our Number Crunchers and they don’t look so good.
Reality is that the Jones’ need to
budget for the following:-
Ø
Voids
say 21 days every 18 months, i.e. 14 days per annum = say £300 per annum
Ø
Maintenance
at say £60 pcm = £720 pcm
Ø
Lettings
and management fees at say 12% per annum = £864
Ø
Insurance
at say £150 per annum
Ø
Gas
safety certificate say £60 per annum
Ø
Accountancy,
say £100 per annum
Ø
TOTAL – £2,194 per annum which I believe to be a
realistic annual budget per property based on an average of 5 years ownership.
The Jones’ profits are therefore
£10,970 per annum less than you have suggested over the five year period. Even
the slightest mishap such as a bad payer or a 1% interest rate rise and they
are going to run into cashflow problems very quickly unless they have big surpluses on
their incomes or an additional “war chest”. They could, of course
purchase RGI (Rent Guarantee Insurance) and fix their interest rates but that
would wipe out the entire balance of their £1,030 per annum of profits. In
short, I wouldn’t consider a 7% yield is enough to comfortably service 80%
gearing at todays rates of circa 4% over base. In the days where lifetime base
rate trackers were available at less than 1% over bank base rate that was a
different matter.
I would suggest a minimum yield
requirement to support new 80% lending in todays market needs to be 12% plus.
Either that or reduce the LTV considerably, unless of course the borrower has
access to a cash war chest of say 20% of the value of all borrowings. Based on
my 20% liquidity rule of thumb, Mr & Mrs Jones would need to start off with
£180,000 and not £100,000 to be safe with your proposed strategy.
Hi Kelvin
Well written, however, run those
figures through our Number Crunchers and they don’t look so good.
Reality is that the Jones’ need to
budget for the following:-
Voids say 21 days every 18
months, i.e. 14 days per annum = say £300 per annum
Maintenance at say £60 pcm =
£720 pcm
Lettings and management fees at
say 12% per annum = £864
Insurance at say £150 per annum
Gas safety certificate say £60
per annum
Accountancy, say £100 per annum
TOTAL – £2,194 per annum which
I believe to be a realistic annual budget per property based on an
average of 5 years ownership.
The Jones’ profits are therefore
£10,970 per annum less than you have suggested over the five year period. Even
the slightest mishap such as a bad payer or a 1% interest rate rise and they
are going to run into cashflow problems very quickly unless they have big surpluses on
their incomes or an additional “war chest”. They could, of course
purchase RGI (Rent Guarantee Insurance) and fix their interest rates but that
would wipe out the entire balance of their £1,030 per annum of profits. In
short, I wouldn’t consider a 7% yield is enough to comfortably service 80%
gearing at todays rates of circa 4% over base. In the days where lifetime base
rate trackers were available at less than 1% over bank base rate that was a
different matter.
I would suggest a minimum yield
requirement to support new 80% lending in todays market needs to be 12% plus.
Either that or reduce the LTV considerably, unless of course the borrower has
access to a cash war chest of say 20% of the value of all borrowings. Based on
my 20% liquidity rule of thumb, Mr & Mrs Jones would need to start off with
£180,000 and not £100,000 to be safe with your proposed strategy.
Having to keep it down to +/-1,000 words per blog means this article can not include property management and or
maintenance costs. There’s just not enough room to go into property costs as well as management costs and various funding
arrangements as that would take another 500 words.
There are too many
variables from person to person, place to place and property to property. So the premise for this article had to be an average rental yield of 7% and no costs other than mortgage
interest.
This article must not be read as a be all and end all. One must consider the gaining of extra skills to manage the whole financial process. Basically what surrounds this article is the whole process of property investing itself. Gearing is the process to greatly improve portfolio growth and performance.
For me property maintenance costs are extremely low as I buy new
or almost new property. I no longer advocate the buying of old properties, maintenance costs are generally too high. I also self-manage city centre apartments
and get six months free management costs on houses (8% thereafter), and there’s
also the 2 or 3 year mortgage teaser rates to consider.
So “There’s just too many variables that would
overly complicate this article, which is to purely and simply as possible
to illustrate the power and benefits of using finance (gearing) instead of just
cash.” This article is supposed to be; a glimpse of what could
be, providing other knowledge and disciplines are gained.
I personally did exactly what it states in this article and more, and that’s exactly how it
all turned out; instead of planting a few trees I planted a forest. Sure there were some ups and
down’s and property income shortfall some years, but that was easily paid for from
property re-sale profits as explained in other articles/ blogs. Beyond the simple process explained everything
else falls outside the scope of this article and makes up what is a complete
property investment startegy.
I also neglected to mention no rental increases were spoke of until year 10. In reality every 3 years rents can be tweaked upwards.
Future Proofing Gearing Proposal
One could take a fixed interest rate mortgage for 5 years at 5.5% to 6%. Then at the end of the 5 years rents would be +/- 25% higher. Maybe even opt for Loan to value reduction; a less agressive stance of 75% or 70% mortgage could be taken. You could even speak to your financial advisor about interest rate hedging products.
Also the adding of apartments with higher yields could balance out lower yield houses.
One could buy newer property to keep maintenance costs right down and even do repairs one self. One could also self manage the properties instead of using a letting agent, but this is not always advised as your time is valueable.
Finally, selling one property now and again for profit balances the books nicely; selling properties now and again is what balanced my rental books back in 2004 to 2007.
This is out of date thinking – it only works in a rising market with ample low mortage rates in a competitive banking environment.
Non of that is true today.
10 properties may well produce more rent than 1 but how many portfolio landlords can honestly say that they prefer today’s economic environment to the one in 1997? In those days you could release equity and buy 2 or 3 properties a year without blinking. Increases in net rental income due to the crisis won’t enable us to do that.
Realistically the costs largely cancel out any net rental income so buy to let is best thought of as a long term growth in capital.
Right now I feel investors should be sitting on their hands until direction returns to the market.
Sorry and with all due respect, but that is where you are missing the current opportunity and the big long term picture. Great investing and the same is true about stock market investing is all about buying when, for want of better words; “There is blood on the streets. During the Great US Depression of 1920/ 30′s there were more Millionaires made then, than before.
The use of Gearing is how I went safely and correctly from 40 to 80 properties since the Credit Crunch. How? By buying extremly well at discounts a normal investor does not have access to or they are too busy looking for bargains in area’s where there are non to be found.
Gearing as explained is only part of the great property investment puzzle. To make it work properly and safely I have explained many more investment skills and knowledge are needed. Buying well below market value with built in equity (Value Investing) means you not only create the upside on day one, but you also look after the potential downside if things got worse after purchase. I practice safe investing “Value Investing”.
As they say “Fortune Favours The Brave”.
I haven`t looked in depth at these particular figures but I agree with Maverick and the principal of gearing is sound and it is true today as was in 1997. It may take you maybe a bit longer now than in 1997 to get to where you want to be but 80% gearing high yield high cash reserves and stress tested to say 8% rates works for me.
I agree a rising market and 85% LTV as it used to be helped me to grow quicker back then but by borrowing as much as you can at around 5% and making at least 20% ROI each time is the way forward. Gearing your investment and making around £300 + per property means each property is a successful business in its own right. The more you have the more you will make. After a while it becomes self perpetuating because you can soon save up for your next deposit with your high cash flow each month. When you get to that stage you dont have to rely on rising prices but simply use cashflow to fund the next one.
Far from out of date thinking its very current. I dont agree with Tim when he says sit on your hands. I am purchasing a 4 bed at 100K at the moment. It will positive cash flow £600 gross at 75% LTV . Thats £7,200 pa. Its about 10% BMV maybe. Its on a 5.49% fix for 5 years. So thats 36K passive income in 5 years. I dont really care whether house prices dip 10% its the cashflow that counts. With a 20yr mortgage I will worry about that when it comes in 2032. By then I`m thinking it will be at least double the price i bought it at so maybe 200K. The rents will rise of course but even it they dont I will have gained a tidy 144K in cashflow by then.
Buy property and wait – dont wait to buy property
Bravo Jonathan way to go and keep it up. As you say its all about what you buy, and now is a great time to buy. Don’t forget to buy with built in equity as well as good income. It’s still OK to have some low income returning properties with high built in equity balanced with high income returning properties and low built in equity. That can lead to portfolio cashflow safety while still boosting your equity bottom line.
Remember prices going up in the future are not guaranteed, properties in Germany and Japan have been stagnant for 15 years, so make your money on the purchase to be safe, lock in the equity on day 1; you make your money on the purchase not on the sale.
If you are going to walk the gearing on gearing line make sure you acquire all the other skills needed to go with it. From Jonathans writings I can see that he has.
As they say “Education will make you a living, self education will make you a fortune.”
Hi Jonathan
Regarding the “4 bed at 100K at the moment. It will positive cash flow £600 gross at 75% LTV” how did you arrive at those figures? The mortgage will be £345 a month and then you have additional costs of insurance, maintenance etc on top of that. On that basis the gross rent needs to be £1,000 pcm. That being the case, you are looking at 12% plus gross yield. If that’s what you are achieving then I agree with your strategy.
My point to Kelvin was that he was advocating 80% gearing on properties yielding 7% gross. What I was pointing out was that such a strategy is very high risk without a substantial liquidity reserve (cash in bank of say 20% of debt value) and/or significant disposable income from other businesses, employment or investments.
I wasn’t advocating 80% Loan to Value at all; I have never used above 75% LTV for over 5 years now.
The article is purely and simply to illustrate the differences between buying for cash and buying with mortgage (gearing) and nothing more.
It was never intended to be a strategy proposal by itself, its merely a principle for people to adopt with other skills if their desire is to build a larger portfolio over the long term with any given starting fund.
The reason I choose 80% LTV instead of the norm 75% for the calculations is because they are rounded up nicely and simply. Cash flow also depends on what type of property you buy whether new or old.
Yes I understood that, we discussed it offline, others will not have had the benefit of that discussion though so that’s why I lead the thread into a direction where further “safety strategies” could be debated and considered. This is an excellent piece, it has good SEO and will no doubt appear in searches. Therefore, newbie investors will find it in search and that may well be their first experience of Property118 and the Property Maverick. It makes a lot of sense, therefore, to expand the debate into a discussion about liquidity and yields.
Hi Mark
Yes spot on – £1000 in rent which is £950 LHA directly payable to me + £50 top up pcm. The tenant is moving in day 1 and has 6 kids so gets lots of child benefits to afford the £50 top up. We have discussed liquidity in the past and I`ve always thought your 20% is on the high side and i used to feel comfortable on about 2% in an era of prices rising and i was building my portfolio. I understand they are or were risks attached to such a low level for me but nothing ventured nothing gained.
.
. I now run at about 5% and by end of 2012 will be at about 7% to prepare for interest rate rises. But with other investments due to mature and unencumbered property which i could sell 25% BMV if needs be my safety net could within a short time frame increase to around 10% which is well within my comfort zone. It is about getting the balance right of course as you say and some are more risk adverse than others. I would not personally buy at 7% yield but there are those I know who are happy with that. They are maybe mid 30`s have two good steady incomes for the next 20 years and view property as a long term pension type investment for mainly capital growth and maybe only £100 positive cashflow pcm. Nothing wrong with that strategy either.
.
The main thing for me as Maverick says and you endorse is have no fear whatsoever of good debt. Respect debt yes but control it to your advantage and gear your investments accordingly. The biggest hurdle I find with new investors I advise is that many cling on to the mind set that you should pay off mortgage debt when I advise you should do the opposite and acquire mortgage debt. Parents and the traditionlist educators are of course well meaning when they say pay off your mortgage as they naturally think and believe that they have your best interests at heart. BUT they have a lot to answer for sometimes as many unfortunately dont really understand mortgage debt. They hold others back with their own fears and negative approaches to good debt. You can be sensible controlled skilled and maverick all at the same time. ( I`m a Top Gun fan). Aim to be the best of the best
Be a rebel with a cause :-)
Hi Mark,
Is there a blog from you anywhere which gives your analysis of how you arrived at the 20% of debt held as cash? I’m sure we’d all be interested to see your thinking. Thanks Tim Fawcett
There is indeed Tim, I documented the roots of my property investment strategy a long time ago, it’s a 16 part series. This is a link specifically to the section about the 20% liquidity rules but please feel free to read the entire series or simply pick out what you want. At the foot of each blog is a link to other parts of the series. See >>>
http://www.property118.com/index.php/btl-strategy/896/
Hi Mark
Does your 20% liquidity strategy take into account individuals lifestyle aspirations. I was just thinking if for example 2 investors came to you with identical portfolios but one had a 200K pa already expensive lifestyle as per your example in part 6 of your series and one investor was quite happy with their existing modest say 24K pa lifestyle would your advice be the same as to them both aiming to have 20% liquidity? Is that 20% rule fairly fixed in your eyes? Personally I would be thinking that as lifestyle expenses can be quite a major variable in individuals a lesser % of liquidity say 10% is required or advisable perhaps for the more modest spender.
Jonathan, a question that makes another person think is an excellent question, yours has made me think deeply, thank you.
I devised that strategy based upon a the reality that most people spend what they earn. The investors I observed back in the early 1990′s to formulate the strategy considered their property investments to be long term. They had reinvested all profits into the continued growth of their portfolio’s, they were not living off the proceeds as they had alternative income sources, some from employment, others from other businesses.
The property investors that failed did so due to lack of liquidity when interest rates doubled to 15%. Very few could support the negative cashflow from surplus earnings elsewhere, particularly those who grew large portfolios. It is very natural for us to match our incomes to our lifestyles. It concerns me that people are doing that now we are in such a low interest rate environment, I’m guilty of it myself.
The investors with 20% liquidity reserves scraped through the early to mid 90′s high interest rate period, however, if interest rates hadn’t fallen back when they did, they too would have failed. The negative cashflow reduced their liquidity reserves to virtually zero.
My conclusion is that gearing is a calculated risk. However, the lack of gearing also puts the chances of improving returns at risk.
We all make our choices and whatever anybody decide is right for them must accept the consequences and risks, whether that is mediocrity, optimal success based on available resources or complete failure.
I like Mark’s response. One of the problems that has caused the recent crisis is that people extended their mortgages and spent the money on non-investment goods like holidays, new cars that depreciate and luxury goods. It’s tempting to do the same with high net rental incomes received on buy to let portfolios too. From a business point of view the 20% rule combined with a discipline of not spending the net rental income but instead investing it could be best. Of course there might be some landlords out there that live off their properties entirely and don’t hold down other jobs – in their situation it is a matter of adjusting the amount of income that is drawn out of the property business according to economic circumstances – not an easy balancing act I would imagine. Particularly when we are all not too sure when and by how much interest rates and buy to let mortgage rates are going to rise. This takes us back to the original question. An interesting dilemma!
I agree 20% cash reserves on debt value is a good idea as a general rule of thumb especially if an investor is a low income earner and has a small portfolio’s of 1 to 10 properties. Note the cash flow risks are higher if you have say two properties and lets say one isn’t paying and you have to evict that tenant and the other property became empty; you would have 0% rental income to service the mortgage debt. Whereas if you had 20 properties and 2 properties are not producing income the rental void/ loss is just 10%.
In my instance 20% cash reserves on debt would mean £1 Million sitting in the bank earning 1% interest/ doing nothing. Personally I have always sort to make equity make more equity, money makes money so today I like to box clever and box clean today. Also positive property income/ cash flow is great and important because it must be there for the good and bad times. Today I reinvest much of the income back into some of the properties otherwise “Income is easily spent” so I focus on the equity gain and equity protection. I like to make sure going forward there is at least a 3% interest rate cushion (see my property analysis blog), if further cushion is needed in times of hardship then self management, self property repair, selling some properties, increasing rents, using cash in the bank, cutting back on lifestyle can be exercised and selling the fancy car etc can be exercised (forward diaster management considerations).
Today I only buy if my deposit money/ cash in (25%) is doubled on day one of purchase without lifting a paint brush. If I am putting £25,000 in I want the actual equity in the property to be £50,000 at real market value; this is achieved on 8 out of 10 purchases. So in today’s market £1 Million could make me £1 Million within a year, without lifting a paint brush and without leaving my house. However builders are now getting wise to having to sell off stagnant stock at cost and are now moving more towrads building to order only. I have done my years of renovating old houses and no longer want such hassles.
Yes new builds only offer 7% to 8% yields on houses and 9% to 10% on apartments, but with zero maintenance for at least 3 years its an effective better net yield than 80 year old terraced properties on 12% gross yields that are bigger blood suckers than Count Dracula. Compare these to the new build yields in 2005 to 2007 that were 5% and 6% resepctively one can see the value.
In terms of liquidity for rainy days I prefer is to have a minimum of 6 months cash to cover all mortgage payments as if there was zero rental income coming in; so that’s a cash reserve of £100,000 give or take £25,000 at all times. This flucutates up and down with property purchases, property sales and remortgages over the year. However this lower rainy day liquidty is gained from a diversification of property types, property areas and tenant types, but I don’t get involved in higher yield HMO’s because don’t I wouldn’t want one situated next to me so I can’t evoke the same to another.
Over the years I have never flown close to the wind, I stopped buying in 2006/ 7 and sold some properties as rental yields just didn’t make sense at the then 5% yield, and I have never once used the no money down deal process. My process and methodolgy has always been about buying well (value investing). As far as I am concerned markets going up are just a bonus and shouldn’t be solely banked upon; buy profit for today and if the cherry on the cake comes (further capital appreciation), well then that’s even better and happy days!
Hi Kelvin
Please help me to understand the mathematics.
If you buy a property valued at say £120,000 at a 25% discount then that suggests you are paying £90,000. My question is whether your 7% gross yield is based on the £120,000 value or the £90,000 purchase price. If the 7% yield is based on the full value of £120,000 then the actual yield based on purchase price is in fact 9.33%. That’s great for a new build deal.
However, if the 7% yield is based on the £90,000 purchase price that means the yield based on the full value of £120,000 is only 5.25% (pre-credit crunch yields) which would make it impossible to remortgage to 75% of value whilst retaining positive cashflow unless rental values increase significantly. In this latter scenario I can’t see how this stacks up as a long term hold investment. If you are renting these properties short term and then flipping them on to first time buyers at full market value I can see that it could work, providing of course that first time buyers will pay full market value for a property which doesn’t have the fresh feel of a brand new home.
Please explain.
Regards
Mark
Yes the Gross Yield is based on the purchase price paid (discounted price paid). Its not easy to explain in words, easier to see in spread sheets as yields vary from location to location and property type to property type.
But I will give it a go. The yields on city centre apartments like Manchester purchased in 2009 were 9% to 10% on purchase and they have inceased slightly since then. So its been straight forward with those to pull out the 30% instant equity gained on purchase via further advance or remortgaging after 6 months/ 1 year to roll into new purchases. And yes I see these properties as more longer term keep investments. However the city centre developer bargain apartments in Manchester have all but finished now, no more are being built as yet and that’s been great for rental demand.
Whereas the new build discounted house bargains (2, 3 and 4 beds) that I pick up from time to time in areas like Lincolnshire and South Yorkshire are different in terms of gross yields. These are areas where rents right now have not increased due to economic conditions; soft rents. However the yields have still averaged out 7.5% without pushing the rental envelope, i.e. minimize the initial void after purchase. Going forward any properties achieving less than 7.5% gross yield like the new 3 bedroom and 4 bedroom Townhouses are earmarked for resale as soon as the Early Redemption Period ends. Whereas the 2 bedroom town houses are fine to further advance or remortgage and ideal for longer term keeping. I find once the price goes above 90,000 or above 100,000 the Yield becomes marginal in terms of making remortgaging or further advance a worthwhile or possible exercise; Its better to access the equity gain and pay the appropriate CGT and then buy some more when and if you can.
An Actual Example allowing FA or remortging to access equity gain
Brand New – 2 Bedroom House
Developer List Price = £110,000
Real Market Value = £99,000/ £100,000
Purchased Price = £74,000
Deposit Used = £18,500
+/- Equity Gain on purchase = £25,000
Rental Achieved = £500/ month
Gross Yield = 8.1%
Mortgage 75% LTV = £55,500
Mortgage Cost = £245/ month
The gross yields in most parts of Lincolnshire and South Yorkshire (The North) have always been on the low side, in 2005/ 2006 the new build rental yield was more like 4% than 5%. The Great North South Divide continues. Rents above £500 seem to rise dispropotionately slower as the property value goes up; even 4 beds in some areas only reach £550 to £600. So yes many of these such properties are just short term holds to cash in on the equity gain on day 1 of purchase and not the rental income. As stated previously I prefer to look for equity gain first and rental income gain second; you can’t spend equity gains as easily as easily as you can spend income gains. : )