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13:23 PM, 17th December 2010, About 13 years ago 23
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“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%.
The basics
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.
Rental demand
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’.
Interest only
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:
Mark Alexander - Founder of Property118
12:07 PM, 30th January 2011, About 13 years ago
Kasim
I don't follow your logic on this.
If you agree that cash in the bank is safer, why would you have 45% and 47% equity and consider 30% equity to be not enough? Did you arrive at your decision based on a cashflow stress test formula (and if so what is it?) or am I missing something?
Regards
Mark
13:26 PM, 30th January 2011, About 13 years ago
When I bought the property, it was in a run down state and I spent 13.5K putting it right. This raised the value to 98K and, because the mortgage is only 54K, this represents equity of 45%.
I took a further advance of 19.5K at 75% off 98K minus the 54K existing mortgage. In other words, I followed your advice of liquidating equity whenever there's enough of it.
Now, Gregory Jones said he has 30% equity, assuming each of his properties is worth 100K, his mortgage would be 70K. If he refinances at 75%, he would get 20K - 4 sets of costs. On second thoughts, this may be enough to expand his portfolio especially if the value of his portfolio is >400K.
Mark Alexander - Founder of Property118
16:23 PM, 30th January 2011, About 13 years ago
Hi Kasim
This makes a lot more sense now, especially if your rent is sufficient to cover 75% lending even if rates increase. At this level of gearing you stand to make £4 for every £1 that properties increase in value. The fact that you maintain 'sinking fund' also concurs with my own strategy. I'm sure you also keep an eye on cashflow. As a matter of interest, have you ever calculated what level of interest rates your portfolio could withstand before you have to start subsiding cashflow from your sinking fund? The reason I ask is that we're working on a calculator for this site which will do exactly that.
BTW - I think most lenders have a minimum further advance of £5,000 so as you say Kasim, Gregory may not be in a position to secure a further advance at this stage if his properties are worth less than £100,000.
Regards
Mark
Mark Alexander - Founder of Property118
23:34 PM, 30th January 2011, About 13 years ago
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Mark
15:55 PM, 15th August 2011, About 13 years ago
I wish to start investing in property , but with very limited cash, what would be your advice for a new starter in the wotrld of property investment.
Mark Alexander - Founder of Property118
16:03 PM, 15th August 2011, About 13 years ago
Great question Andrew, although you might not like my answer.
My advice is DO NOT go into the property investment unless you have savings behind you, the income and assets to raise money against or a business parter with cash, a good income and preferably some assets too.
The preferable way is to find the perfect business partner of course, some people manage to do this but I never did. It took me six years of hard work and saving before I could buy property number two.
I wish you well and please don't trust anybody who tells you that you can do it with very little money in return for paying them a fee. From everything I've seen, that's the easiest mistake to make and the quickest way to lose what money you do have.
TJ
22:23 PM, 27th June 2012, About 12 years ago
Money in the Bank is not so safe, it's better to hold spare cash in Silver or Gold as another investment strategy, this increases in value and can be sold any time you need money. (See Robert Kyosaki's website). TJ
20:20 PM, 5th July 2012, About 12 years ago
Hi there,
Interesting reading.
I'm currently looking into long term planning and how to maintain income both pre and post retirement.
I agree with the concept of interest only and the benefit of cash-flow. However, this will only last up to the end of the mortgage term? At this stage the property would be sold, providing (in most cases) a gross lump sum return. That said however - you would then lose the income being derived from the asset with no scope to re-invest? Obviously you would have cash in the bank - but this would need to be invested to provide a return of income during retirement.
Should capital repayment be considered as a method for long term retirement planning this would result in the mortgage being repaid in full at which point no mortgage would be present and the income would continue to be paid for the foreseable future.
I'm not saying one is better than the other and i feel the capital repayment option would stunt further investment/liquidity using the above strategy.
I would welcome any comments on this subject especially the exit strategy in retirement when looking to maintain a steady income.
Kindest regards
Mark Alexander - Founder of Property118
22:18 PM, 5th July 2012, About 12 years ago
Excellent question, I am 44 years old and my mortgage all have around 20 years to run. When I refinanced last (around 5 years ago) I thought through a variety of exit strategies. Fortunately I have time on my side (I hope) so the effects of inflation work well with my strategy of interest only. My mortgages will not change but rents and capital values are likely to increase substantially over that period. My prediction is that capital values and rents will at least double, thus leaving me with very strong cashflow and equity. I recorded a video with my IFA around 18 months ago which you may find interesting - see >>>
http://www.property118.com/index.php/could-this-be-the-ultimate-buy-to-let-investment-property-exit-strategy/
17:36 PM, 22nd December 2012, About 11 years ago
Mark,
I'm currently finding myself building up surplus cash through my employment and am looking to make some longer-term investments. Buy-to-let does seem appealing and i follow your strategy re. releasing the equity to fund further purchases and maintain liquidity.
I had a similar question to Mr Lowe above which you've answered but I'm not sure i fully understand one point in your response.
You say that your mortgages will not change? Are you simply referring to the size of the mortgage and not the cost of servicing it? I would assume that should interest rates rise (which they certainly will from historic lows) then the cost of servicing the mortgage will increase (perhaps dramatically). Is your assumption that you can always increase rents to allow for this?