11:37 AM, 8th March 2011, About 11 years ago
The following is an extract from my 1,000th discussion on Property Tribes (my favourite property forum).
I asked the members 5 questions about their property investment strategies and then went on to answer the same questions myself, after reading what others do.
The thread is still running and is linked here. Later into the thread I have also revealed a lot more about evolution of Property118.com
I’ve brought it to your attention here as I know that the most visited pages on this site are my ever evolving eBook, featured to the right of this page beneath my picture. The thought processes behind many of my strategies are explained in more detail in this article but you may also wish to take a look at what others say they do on Property Tribes in order to develop your own strategy based on a wider perspective.
The questions were as follows:
1. What’s best, interest only or capital repayment and why do you think this way?
For me it’s interest only till the day I die (or sell up if I need to). My primary reason being cashflow. I appreciate that some people want to repay their loans even though it goes against my strategy and isn’t particularly efficient for IHT, CGT or income tax purposes. However, for the life of me I can’t understand why people make a repayment commitment contractually with their lenders unless the lender gives them no choice and that’s the best lender for them (e.g. Paragon). Why not retain flexibility of interest only and then over-pay? The outcome is the same but the commitment isn’t. With interest only it’s easy to overpay in the good times but in hard times, how difficult might it be to persuade a lender to allow you to switch from repayment to interest only?
2. What ratio of cash in the bank do you think investors ought to hold in relation to the balances outstanding on their mortgages? How did you arrive at this figure?
This depends on many factors. I like 20% because my properties only break-even at a 6% interest rate after costs. I also like to have a trading fund so that I don’t need to pay high bridging costs and arrangement fees when I find a good deal. For investors getting 10% to 20% gross yields on value, perhaps because they are in the LHA, HMO or holiday lets business I can understand why they are happy with much smaller reserves, especially if they are not buying.
3. What percentage of rental income do you think expenses such as management, maintenance, insurance etc. should run at?
20% on freeholds, 25% to 30% on leaseholds.
4. What level of interest rates do you think investors should stress test their portfolio’s at, after deducting expenses from rental income as above? It might be better to use bank rates net of margin for these calculations as some people are paying less than 1% over base, the norm for pre-credit crunch borrowing seems to be circa 1.75% over base and new debt is costing 3% to 5% over base. Therefore, a pay rate of say 6% means very different things to different people; to some people it relates to a base rate of 5% whereas to other it relates to a 1% base rate.
I’ve taken an educated guess that rates will not exceed 4.25% for at least 5 years unless we experience high inflation, hence my 6% strategy as I typically pay BBR plus 1.75%. I have a number of trackers at BBR + 1% but deals these days are costing me BBR + 3% so 1.75% is my average margin. I’ve been considering adding some HMO’s to my portfolio to increase my yields now that I’ve found out that 16% is achievable in East Anglia (link here for info). I’d be paying around 4% over base for them but the yield would still improve my cashflow even if BBR were to hit 4.25%. My friend who owns 9,000 properties is now selling holiday park properties (brick built 3 bed houses) with 20 years fixed rate mortgages (developer financed) at 6% with no fees and no ERC’s – that got me thinking as he’s no fool.
5. Over the next 20 years, what do you think inflation will run at and at what level do think house growth will average? There’s a mathematical formula to calculate this called the rule of 72. If you divide the number 72 by the number of years you think it will take for properties to double in value it will give you the average compound growth rate over the term. For example, if you think property will double in value over 20 years the average compound growth rate would be 3.6%, i.e. 72 divided by 20 = 3.6.
I’m quite optimistic so I’m guessing 4.8% average compound growth per annum which equates to 15 years doubling of property values. At 80% gearing this would transform my equity on cash invested return to 24% per annum. However, my returns are far better than this, in fact they are infinite, as I refinance all of my cash out of my properties at the earliest possible opportunity, subject of course to the criteria above.
Finally, here’s one to think about. Would I care if I were in negative equity? The answer is not a bit. I have no covenants in my mortgages to ensure that I stay within a certain gearing ratio so why should I care? If property were to halve in value tomorrow I would be at 160% LTV but I would have maximum cash in the bank and my cashflow position would be the same. I suspect the rental market would be even stronger than it is today too as nobody would be lending at all but people would still need somewhere to live. If nobody could afford to borrow or to rent and interest rates were to rocket (the “doomsday scenario”) at least I would have cash in the bank to hire and equip a small army to defend myself against the rioters and looters! LOL
To learn more about my property investment strategy please read the following posts in this order:
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