13:23 PM, 17th December 2010, About 12 years ago 22
“I measure my business related success by how much I improve my cashflow and my bank balance every year.”
The beginning of my career was spent working in financial rescue and the underwriting of risk. It was the late 1980’s, property values had plummeted and interest rates had soared to 15%.
Property investors who faced financial ruin all had one thing in common and it wasn’t what you might think. It wasn’t high gearing; it was a shortage of cash. Investors with high gearing and high liquidity (cash in the bank) fared well. This taught me that “Cash is King” and that equity left in property is subject to high risk.
Cash is King: Why I build a rainy day fund
Whether I’m in the market to buy or whether I’m dealing with the unexpected I believe it is always better to have cash in the bank. If I don’t there is always the risk that I will not be able to borrow, and where might that leave me?
A strategy of high gearing is all well and good but only when combined with a risk reduction strategy of high liquidity, i.e. money in the bank. I’ve seen far too many investors get greedy and over accelerate the growth of their portfolio by investing all monies raised as a result of high gearing into further purchases. My personal strategy is to retain a substantial level of monies raised from remortgaging.
I use part of my rainy day fund to buy properties that I could add substantial value to. The aim is to get the figures to stack up so that when I’ve optimised the value of a property I can refinance all of my investment back out of it. I measure my success by how much I improve my cashflow and my bank balance.
Why I believe property investment makes so much sense
Vast quantities of people choose not to own their own home for a variety of reasons and prefer to pay rent for the privilege of occupying property. In fact, in the early 1900’s over 90% of people in the UK lived in rented accommodation. This fell to a low point in 1973 to just 7% of the population but has grown steadily since then to around 12%.
I use rental income to service mortgages and the management, maintenance and insurance expenses associated with property ownership. Over time, inflation and other factors increase the value of my properties and the rent. However, my mortgage balances remain constant, assuming of course that only interest is paid. Therefore, as the years roll on the gap widens between the rents received and the total outgoings thus creating an improved cash flow position. Rising property values also increase my net worth. A strategy of borrowing ‘cheap money’ to purchase property is, therefore, an effective method of accelerating my wealth by using other peoples’ money.
Long Term Strategy
My Property Investment Strategy is a long term strategy, i.e. at least one property market cycle. I consider shorter term strategies are not property investment at all, that’s property speculation.
Why I release equity whenever a realistic opportunity to do so presents itself
This has always been a fundamental component of my property investment strategy. It’s all about transfer of risk. If equity is left in the property and the property reduces in value the equity may no longer be accessible and I am taking all the risk. However, once the property is refinanced, I control the liquidity and the risk is transferred to my lenders for which they earn premium interest returns.
The following simple example might explain this better.
Let’s assume I own an investment property worth £100,000 with no mortgage.
One morning I wake up, turn on the TV and watch the news which announces that property values have fallen by 50%.
My property is now worth £50,000.
Prior to this happening I could have raised a mortgage of £75,000 and kept the money in the bank. I would then have a property worth £50,000 and a mortgage of £75,000. Therefore I would have £25,000 of negative equity!
Would I be at risk though? Remember, I would still have £75,000 in the bank.
So what are my choices?
I could feel sorry for the bank. After all, the bank are now carrying the risk. If this is the case I could repay the mortgage, or,
I could simply keep the money in the bank, or
I could use part of the money to buy more cheap properties and keep some on one side for a rainy day.
If I had not refinanced I would find it difficult to raise money as the banks would be nervous about lending at this point. If I then decided to get funding I would probably pay more for it. Additionally, if I could then borrow 75% of the value of my property, I would only manage to raise £37,500.
If the market goes the other way and property values increase then another window of opportunity may well open to release even more equity.
Whilst the general trend over the long term is for rental values to track inflation, I accept rental demand will fall from time to time, usually depending upon the availability of property to rent. This is another reason I build a ‘rainy day fund’.
Like many investors, I have become a cashflow beneficiary of the ‘Credit Crunch’ due to the lowest interest rates in history. A question I am often asked is, “Should I use the extra cashflow to reduce my mortgage balances?” I appreciate that one day interest rates will go back up again and the base logic for the incorrect decision to repay debt now is to reduce payments in the future. However, as property values fall it gets harder to borrow. When dealing with a crisis position, e.g. a desperate need for cash or unaffordable mortgage payments, my preference is to have extra cash in the bank then a slightly smaller mortgage.
Accordingly, as my Property Investment Strategy involves taking money out of properties by refinancing whenever an opportunity to do so exists, I believe there is no sensible argument for making capital repayments on the mortgage, especially if it’s cheap money in comparison to the returns I can make on it elsewhere.
What about negative equity?
My strategy is never to sell, therefore, the only damage that negative equity can cause me is that it prevents me refinancing and may make it difficult for me to sell a property if I need to. Therefore, my liquidity reserve strategy is also beneficial to reduce negative equity if an unexpected need to sell a property occurs.
Why I believe there is never a bad time to buy
When the property market is booming this is usually coupled with widespread availability of competitive mortgage products. This market is, however, ‘counter-cyclical’, which means that when property values are stagnant or in decline, the availability of mortgages is also much tighter. The impact of such ‘supply and demand’ makes borrowing more expensive in recessions and less expensive in boom times. Therefore, I use buoyant property markets to accelerate the growth of my portfolio using a high gearing and high liquidity strategy in conjunction with easily accessible and highly competitively priced funding. I also know that when funding is more expensive and credit controls are tougher I am in a position to acquire property at ‘bargain basement’ prices. When the markets become stronger again I will refinance yet again.
If I had known then what I know now ………..
With hindsight would I have purchased properties in 2006 to 2008? Many of these are now worth less than what I paid for them. Although some of the properties I purchased were overpriced, compared to today’s values, the mortgages were under priced and far more competitive in every way. If it wasn’t for properties being over valued I wouldn’t have been able to refinance to replenish my liquidity reserves and to fund the deposits to expand my portfolio in the first place.
To learn more about my property investment strategy please read the following posts in this order: