Property Analysis – Part 2 – How it can save you thousands!Make Text Bigger
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Mortgage Cap Rate (Interest Only) = Net Annual Rental Income + Annual Mortgage Cost / Current Mortgage Outstanding
Expressed as a percentage this indicator will tell you the maximum interest rate you can sustain and still break even. Obviously the higher the number the greater the safety net you have against rate rises. Any property with a figure around 5% or less needs looking at to see where either cost can be cut or the rent increased.
Interest Rate Cushion = Mortgage Cap Rate – Current Mortgage Rate
Expressed as a percentage this indicator will tell you what increase in mortgage rate can be sustained before a property moves into a negative cash flow situation. A property with a figure less than 2.5% needs looking at to see where improvements can be made over the medium term. A property with a figure less than 2% needs looking at to see where improvements can be made over the short term.
Return on Equity = Net Annual Rental Income / Property Equity
Note: Property Equity = Conservative Market Value – Current Mortgage Outstanding
This indicator is basically the same as return on investment (ROI). Expressed as a percentage it will tell you the net return on the equity you have tied up in a property. This financial indicator can be useful, an indication as to when it is time to sell or to refinance a property. Always consult with your accountant and check the capital gains tax due before selling a property.
This indicator is also useful to highlight any property that is performing poorly overall. A property with a figure less than 4% deserves investigation and correction where possible. A low figure will indicate there is either too much equity tied up in the property. Or the rent charged is too low, or the mortgage costs and or property running costs are too high.
From the spreadsheet it can be seen that older terraced properties are very expensive to maintain. Such on-going maintenance costs can easily turn a positive rental cash flow situation into a negative rental cash flow. For that reason alone I do not recommend today the buying of older terraced properties. This is especially true today when new or newer properties can be purchased at bargain prices.
It can also be seen – and goes without saying – that interest rates play a very important role in the profitability of a property portfolio. In short, a property portfolio is a balancing act. What tactics and technical indicators you use depends on whether you are predominantly cultivating equity or income, you decide!
That concludes our look at “Property Analysis”.
The Snowball Effect – Building a bigger property portfolio with less money
When a property increases in value extra equity is created. Getting this equity cash out is known as a “Further Advancing” or “Equity Release”. Alternatively you may re-mortgage with a new lender, but this is not the preferred option as more costs are involved.
Warning: Always check your original mortgage offer for early redemption penalties.
However in today’s property market the only easy way you can create new or extra equity is by buying well. In other words, you must buy with built in equity on day one. If you buy a property with built in equity on day one (Instant Equity), you can release that extra equity later on!
An illustration of “The Snowball Effect”
Brand New – 2 Bedroom house purchase (Actual Example)
Developer List Price = £110,000
Discount Purchase Price Agreed (33%) = £74,000
Rent Secured = £500 per month
Mortgage 75% Loan to Value = £55,500
Monthly Mortgage Cost = £245 per month
- £255 positive rental surplus per month
- £25,000 Instant Equity gained day 1 (Market Value £100,000 – £74,000 Property Cost – £1,000 Costs)
- Gross Rental Yield over 8%
- Re-Mortgage or Further Advance after 6 months =£100,000 @ 75% LTV = £75,000 – £55,500 = +/- £19,500 (Equity Release, which is +/- 100% Return of Original Deposit)
“Further Advancing” is a great way to release equity cash to buy more properties and hopefully ones with substantial built in “Instant Equity” on day one. This strategy repeated again and again is known as the “Snowball Effect”. It really is an effective way to build a larger property portfolio on a reduced budget.
Warning: Be careful not to over finance a property as this could lead to a negative rental cash flow situation. This highlights the need for a higher than average gross rental yield from day one.
Note that lenders typically require you to own a property for 6 months or a year before they will allow an increase in property value to get your cash out. This is known as “Seasoning”.
Why not put your property figures to work; it can literally save and make you thousands over time.
In the next episode of the Property Maverick we will discuss balance. How you can build a balanced property portfolio with little risk!
Quote of the week: “If you’re interested in ‘balancing’ work and pleasure, stop trying to balance them. Instead make your work more pleasurable”. Donald Trump
Until we speak again. “Take what you do seriously, but don’t take life too seriously; have fun, be different, be a “Maverick”.
So enjoy your property ride, and do tune in for the next episode of the “Property Maverick”.
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