Make sure your Buy to Let Investments Stack Up!

One of the main benefits of investing in property is the significant capital gain you can make as your property rises in value over the long term. However, to benefit from the gain you need to make sure you can afford to hold the property in the meantime. Ideally you don’t want to have to support your property portfolio. Quite the opposite in fact! Your portfolio should support you financially. The rent you receive from your tenants should more than cover all the costs of ownership such that each month there is surplus cash profit left over for you to enjoy.

Investors who lose money are often the ones who get it wrong because of cash flow. They can’t afford to hold their property and so have to sell which depending on the market conditions means they themselves may become motivated sellers. The purpose of this chapter is to help you ensure you maximize the cash flow from your investment properties.

So let’s go back to fundamentals for a moment. As a property investor, one of the critical skills you need to develop is the ability to quickly assess a particular opportunity to decide if it is a good investment and suitable for you or not.

What makes a good investment?

Now let’s just remind ourselves of the first 3 of my 5 Golden rules of Investing.

1. Always buy below market value from motivated sellers.
2. Buy in an area with strong rental demand
3. Buy for cash flow

Of course you want to ethically pay as little as possible for the property but the discount alone is not the only factor to consider. There is no point buying a property even with a great discount if you cannot easily rent it out and make a positive cash flow.

To help you focus on only buying good cash flow properties you could buy “as if prices will never go up again” and so the only reason to buy would be for the great cash flow and return on investment.

When researching any potential investment there are two main factors we are concerned with. We want to determine:

A) The true market value of the property

B) The realistic market rent that could be achieved

This is the information that a mortgage company would want a chartered surveyor to collect on their behalf in order to assess whether to grant you a buy to let mortgage on a particular property. You need this information a long time before you even apply for the mortgage, to decide if it is the right kind of investment for you.

With these two pieces of information you can ascertain whether you are going to make a profit each month after covering all of the expenses.

The main expense you will incur on a monthly basis is the interest on your buy to let mortgage. I have a very simple rule of thumb which you can use to asses this monthly expense.

For every £20,000 you borrow, at an interest rate of 6%, you will pay £100 per calendar month (pcm) in interest. For example, if you were to borrow £80,000 it would cost you £400 pcm.

This is based on a 6% annual interest rate for two reasons: First of all it’s the average rate I’ve had over the last 15 years. Secondly, it keeps the numbers easy to calculate because every £20,000 you borrow cost just £100 pcm. I like to keep thing as simple as possible.

If the average cost of a mortgage is only 5% per annum then this rule of thumb is very conservative. This means that in reality £20k will not cost you as much as £100 pcm but by using this in your calculations you are being very cautions which is good because you don’t want to be too optimistic.

When working out the cash flow many investors are too optimistic on what the costs will be and they don’t get it right. It’s better to be pessimistic and have a nice surprise to make more money than expected.

Does the investment stack up?

The mortgage lender will then use a rent multiplier to make sure that the rent is going to be enough to cover the monthly interest and the other cost associated with the property.

This rent multiplier can vary from lender to lender but most will uses something like 125%. This means that the lender wants to check that the monthly rent is 125% of the monthly interest payment. (Rent > Monthly interest x 125%).

With a mortgage of £80,000 and a monthly interest charge of £400 your lender would generally want to see a monthly rental income of at least £500 pcm (£400 x 125%). The extra 25% over and above the interest payments is an approximation of the other monthly costs.

Using this rent multiplier will help you to very quickly asses if a property is going to make monthly cash flow for you. With a monthly interest cost of £400, if the monthly rent was just £500, it may only just about covers the costs. However, if the monthly rent was £550, then it means you would probably make some cash flow from this property each month. If the rent was just £450, you wouldn’t be making positive cash flow, in fact we know it’s going to cost you month each month. In reality the lender may not lend the full amount.

To summarise, you can quickly work out if a property stacks up as follows:

1. Work out how much is the mortgage going to cost you
2. Multiply the monthly interest by 125% to give the required rent
3. Check that the actual rent is more than the required rent

Having used this quick approximation, if the property does not stack up you can move on to the next one without wasting too much time. If however it looks like it does stack up well, it may be worth spending a little more time to properly work out the true cash flow to help decide if you want to purchase it.

This article is taken from the new 2010 edition of “Property Magic: How to buy property using other people’s time, money and experience.” Property Magic is an Amazon No 1 best seller and we highly recommend it. You can buy it here: www.amazon.co.uk

You can also do your Due Diligence in 15 minutes with this new eBook from Yvonne Emery –

http://www.justdoproperty.co.uk/due-diligence-in-15-minutes

If you would like to ask Simon a question click here

In this article I would like to share my 5 Golden Rules which will help you minimise the risks of investing and maximise your profit.

1. Always buy Below Market Value from motivated sellers

Instead of looking for a property you like and then negotiating with the seller, you need to find motivated sellers who will sell you their property well below the market value, and then decide if you want to buy that particular property. The amount of discount will vary depending on the motivation of the seller and the general market conditions. In a rising market you may be happy with a 15% to 20% discount. In a falling market you would want a bigger discount of 25% to 40% to give you more of a safety buffer in case prices come down further. This means that you make a paper profit the day you buy instead of waiting for the long term price rises.

2. Buy in an area with strong rental demand

Remember you don’t want to be paying for the mortgage on your property. That is what you have tenants for. You must make sure there is good rental demand in the area such that if your tenants ever leave, you can quickly find replacement tenants at the full market rent. You can easily check the demand in the area by using the internet and speaking to local letting agents and other investors.

3. Buy for cash flow

Your property should create a monthly positive cash flow for you such that it is an asset rather than a liability. Although we expect property prices to rise in the long term, if you buy your investments “as if prices will never go up again” you will be forced to only buy properties which give you great cash flow now.  Extra cash flow will help you to build up a cash safety buffer, and will help you cover potential rise in interest rates in the future.

4. Invest for the long term buy and hold

Some investors buy and sell property to make a profit. The real profit however is in buying and holding for the long term to benefit from significant capital growth. If you plan to hold for the long term and your property is rented out creating a positive cash flow you do not mind short term fluctuations in price. By long term I mean at least five years in the current market.

5. Have a cash buffer

The investors who get into difficulty are often the ones who do not have any spare cash to access in case of an emergency. As an investor you will incur unexpected costs and so you must have some spare cash to cover these instances. The size of this buffer depends on your personal level of risk.

In my next article I am going to explain how you can work out the return on investment on your investment properties so that you can work out which is the best property to buy.

Simon Zutshi, who is a financially independent property millionaire, is the author of the Amazon No 1 Best Seller “Property Magic” and founder of the property investors network who hold monthly evening seminars for investors in 12 cities around the country. Find out more details at www.pinmeeting.co.uk

Since the end of the 1990’s, property investing has become far more mainstream thanks to the introduction of “Buy To Let” mortgages which has made it much easier for the average person to purchase an investment property.

The UK general public who have a fascination with home ownership, took to property investing like a ducks to water, spurred on by the proliferation of property TV programme such as Property Ladder which showed us all how we could make a fortune in property.

One of the attractions of property investing is that the long term trend for property prices is up. This is due to simple supply and demand. The fact that we have a shortage of accommodation in the UK and an increasing demand due to a growing population. However property prices are cyclical. Just like every other market, prices go down as well as up!

From the early 2000’s the UK property market experienced a boom until prices reached a peak in October 2007. At this point, the two main groups of buyers who stimulate the market (first time buyers and buy to let investors) stopped buying because the property prices were just too high.

As a result, property process fell by an average of 20% by the end of 2009. The UK media was full of doom and gloom about the property market and indeed it was not a good time to be selling a property. But property investors don’t sell property, they buy. So now is actually a great time to invest as long as you know what you are doing and always do your research to make sure you buy the right property.

The fundamental idea is that you buy a property, using some of your own money (the deposit) and borrowed money (the mortgage). You then rent the property out to some tenants who pay you rent to live in the property. The idea being that the tenants cover all of your costs of ownership and also give you some positive cash flow which is the return on the deposit you invest. In addition to this cash flow, you get the benefit of significant capital growth as the property increases in value overtime.

Currently for a typical buy to let investment you need a 25% deposit and can obtain a 75% mortgage. This mortgage is not dependant on your income but rather on the amount of rental income generated from the property. However your personal credit score will be important as lenders have tightened their lending criteria since the Credit Crunch.

The key to successful buy to let investing is to purchase a property in a location where there is strong rental demand and the rent “Stacks up”. This means that the rent is enough to cover all of the costs and still leave a profit for you at the end of each month. Each year you will have to pay income tax on your rental profit.

The main costs you have to cover will include:

• Interest on your mortgage (always get an interest only mortgage)
• Landlord insurance
• Management fees (if you use a letting agent to look after your property for you)
• Service charges (if you have a leasehold property)

In addition to these monthly costs you will need to allow some money for repairs and maintenance and if you have any void periods (where you have no tenants) remember you will have to cover all of the costs yourself so it is highly recommended to have a cash buffer to use in case of emergencies.

With all these costs and the hassle of finding and managing a property, you may be thinking “why do people do it for just a small profit each month?” The answer is they don’t! Most people invest for the long term capital growth. Historically over the last 60 years property has doubled in value on average every 7 to 9 years. It may take a while to recover from the last crash so let’s say it takes 10 to 12 years for prices to double again from now.

If you had a £100k property it could be worth £200k by the year 2020. If you had put a 25% deposit into the property your investment would have been £25k and the capital gain would be £100k. That is a fantastic 400% return on investment. You would not get that kind of return in a bank, in the stock market or in fact any other form of investment which is why property investing is one of the best investments you can possible make.

In future articles I will go into much more detail about how you can make Buy to let investing work for you.

Simon Zutshi, who is a financially independent property millionaire, is the author of the Amazon No 1 Best Seller “Property Magic” and founder of the property investors network who hold monthly evening seminars for investors in 12 cities around the country. Find out more details at www.pinmeeting.co.uk (opens new window)