The Ultimate Property Investment Guide1


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In this report I’ve concentrated on the first two reasons. which in the current economic climate, seem to me to be the most relevant. But updated “modules” on the others, particularly the use of property to provide a tax efficient pension fund. will follow in time.

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The Ultimate Property Investment Guide1

  1. 1. http://www.proebayer.comDon’t get ripped off on eBay!Down load your free eBay buyers guide and sellers guide from: up for your free monthly newsletter for more eBay money making tips,tricks, reviews and much more
  2. 2. FORE WARNINGTHIS PUBLICATION DOES NOT CONSTITUTE ADVICE WITHIN THE TERMSOF THE FINANCIAL SERVICES ACT 1996 (OR ANY SUBSEQUENT REVISIONS,ADDITIONS, OR AMMENDMENTS).The contents are a general guide only and are not intended to be in substitution for professional advise.All readers are strongly advised to take advice from their solicitor, accountant and surveyor beforeproceeding with any property purchase. 3
  3. 3. ContentsPage5 Introduction6 We are what we think we are9 Attributes of a successful property investor16 Anyone can do it…19 A laymans guide to valuation33 Why you don’t need to be able to afford a whole property37 Other peoples money and how to get it50 A clever thing to do in a hot market55 Buying at auction61 Safe as houses – residential lettings65 A long term idea – going for growth73 An alternative idea – going for income82 Stuff you have to know if you want to be a landlord89 Patience is a virtue – residential reversions92 Blocks of flats for £1000 ? Freehold ground rents98 Garage mania102 How holiday makers can pay for your dream cottage103 Appendix One How a lodger could pay your mortgage106 Appendix Two How to buy a £60,000 investment property for £22,500125 ACTION STEPS TO GET YOU STARTED 4
  4. 4. IntroductionWhilst every care has been taken in preparing this report the guidance given should not beconsidered exhaustive nor does it attempt to give an authoritative interpretation of the law.With one or two exceptions this report has not commented upon tax on the basis that eachreader will have a unique tax position. Any examples given within the text should beconsidered in the light of your own tax position and due allowance made.Naturally the investment examples given assume that the world as we know it now willcontinue pretty much as it is. I have made no allowance for global or national economicdisaster, war, pestilence, plague, famine, earthquake or any other disaster, which willadversely affect the investment market.In a report of this nature I can only offer general comments which should not be construed orinterpreted as advice. Each reader’s requirements, financial background, and tax status willbe different so I can only give a very general view on the way I see things.Every reader is strongly advised to take his or her own independent professional advicebefore making any property purchase. 5
  5. 5. We are what we think we areProperty has universal appeal. Owning an investment property or renovating a property forprofit is something most people would accept as a worthy and understandable goal. I’veheard it said that more people have become millionaires through property than any other typeof business. This may happen for you, in theory, at least, there’s no reason why not if youhave desire and discipline. But even on a more modest scale there’s a lot to be said forowning property.Four reasons readily spring to mind although as individuals we may be able to think of other,more personal, reasons: it’s ideal for providing an income; it can be used to grow capital; in inflationary times it has traditionally been an excellent hedge to protect savings; and it can provide a powerfully tax efficient way to build a substantial pension.In this report I’ve concentrated on the first two reasons, which in the current economicclimate, seem to me to be the most relevant. But updated “modules” on the others,particularly the use of property to provide a tax efficient pension fund, will follow in time.It seems that more people than ever before are thinking about, or actually, putting moneyinto property. On the face of it there has probably never been a better time; relatively lowinterest rates, close to full employment, increasing capital values, and the success of the Buyto Let scheme have given smaller investors the confidence to have a go.Although the steps to building a profitable portfolio are relatively straightforward in theory,in practice there will inevitably be frustrations and obstacles along the way, even for theseasoned professional..Most, if not all those problems will be surmountable with application. This is the first rule ofsuccess, not just in property, but in any field “Perseverance is more important than talent”I’ll say more about my perceptions on the characteristics of successful property investorsshortly. But when the going gets tough, as the song says, the tough get going. It has beensaid that “ a millionaire is a person who has tried just one more time”.One key to success in property, which I’ll say a little bit more about later, is to seepossibilities where others would only see impossibilities. You’ve probably heard thedefinition of an entrepreneur as being a “problem solver”, someone who finds solutionswhere others see obstacles. Property entrepreneurs are ideally placed to profit from thisapproach. On the larger scale it may be over coming problems with contaminated sites or 6
  6. 6. planning restrictions. At the level at which this report is aimed it might quite simply bethrough raising the finance to get started.Allied to this is attitude. Attitude and perseverance go hand in hand. If you want “it” badlyenough, you’ll get “it”. All problems can be solved eventually with enough effort. You couldrestate the rule above as “Attitude is 80% of success, aptitude is just 20%”For a smaller, private or relatively inexperienced investor, the first hurdle can beoverwhelming. I think that this is partly due to the scale of property. Even “cheap” propertyis relatively expensive, and if you have funded it through a loan, you can feel veryvulnerable and accountable if things don’t run smoothly.This is why early in the report I look at the mindset of a successful property investor so youcan decide whether this is really for you. I hope that it is. I honestly believe that there isnothing magical about success in property, and that with perseverance and common senseanyone can make a go of it.When the whole thing is underpinned by other people’s money, for some the risk can be veryuncomfortable. I would never advocate recklessness. The purpose, as I see it, of involvementin property is investment, not speculation. But often the risk is only a perception and not areality. As we’ll see, the best route to making large returns is usually through borrowing, butonly after due consideration of the implications and the downside.Starting any venture without tuning into the three preconditions for success is almostinevitably going to be fruitless. Before you start, you must ask yourself whether you have: the belief that you can succeed in property; a passionate desire for improvement in your life through your involvement in property, whatever form that improvement may take; and an awareness that your situation will change only if you take the right actions.Our greatest limitations are often created in our own minds, and unfortunately in the mindsof others if we allow them to impose their own doubts on us. If we see ourselves as “unable”,then we “won’t”. The self-improvement brigade will tell you that “what you picture yourselfas, you become” and I can see the truth in that.Couple belief with passion and you are starting to get somewhere, especially passionatedesire for change. If you had enough money to work just for fun, would you still be doingyour current job, or would you get out as soon as you could? If you’d quit as soon as youcould, then you are in the wrong place. Is property the answer? Perhaps, but in the short termyou still have to cover your overheads so don’t do anything hasty. The more importantquestion is whether you can feel that passionate about property, or what property willprovide. If you think it won’t give you that pleasure and fulfilment, then don’t even start.Without passion you will be wasting your time.Then add the third part, the awareness that things will only change if you take action to makethem change. Building a property business, or even maintaining an existing portfolio, is not 7
  7. 7. static and requires constant action. I’ll talk later about goal setting and planning. If you keepdoing the same old things then the only thing that can happen is that you will get the sameold results. To get new and different and better results, you need to do new and different andbetter things. Being prepared can reduce a lot of the fears that inhibit the right actions andstop us from doing something “new”. Don’t forget that one of the best remedies to fear is totake action. To achieve any level of success in property you will have to regularly go beyondyour comfort zone. Otherwise, you are not going to move ahead any further than you arenow.Finally, before you start, deal with your doubts and the doubts of others square on. What arethe two biggest doubts that probably hold back more potential property entrepreneurs thanany other?Number one, “I have no capital”. OK, it’s not the ideal starting position, but it’s not unusual.Conventional wisdom says that you need money to be successful in property, but it doesn’thave to be your money. If you have a sound enough proposition there is someone,somewhere who will fund it. I’m not saying it will be easy to find them, although it mayprove to be easier than you first thought, but with perseverance if you knock on enoughdoors and ask enough people you, you will find them.Number two, “ I’m waiting for the ideal time”. There’s no such thing, but by being awareand flexible you can adapt to market conditions and plan accordingly. If you’ve got a goodidea, or have uncovered a promising situation, you have to press on with it but just beprepared to fine tune along the way. I believe in the “ready, fire, aim” philosophy in thiscontext.Remember that no one is too old or too young. There are plenty of old and young notablesuccesses in property, and in many other businesses as well. Just look at the number ofinternet millionaires in their twenties. Don’t get into the “if only I had started earlier in life”trap, things can still happen very quickly if you want them to.Whatever you have done, and achieved or failed in, during the past, give yourself a breakand wipe the slate clean. If you dwell on your past mistakes, you’ll scare yourself intoinactivity. Everybody fails, the successes just learn from their mistakes and keep on going.Learn to forget your failures.Finally, remember that any success that is going to come your way is totally down to youand nobody else. You have the responsibility to make sure that you have what you need tosucceed. You are the only one who can make yourself the “best” of the “best”. I hope thatreading this report will be a good starting point but don’t leave it there. Education is the key,in whatever area of property you eventually decide to specialise in. There’s no substitutionfor reading. If you’re serious, at least an hour day. There’s so much to learn: construction,law, planning and economics, to name but a few and these are always changing so you needto be updating constantly. 8
  8. 8. Attributes of a successful property investor“Until and unless you can form a clear and distinct and accurate picture of what yourvision for the business… is, I mean when you get to where it is you’re trying to get to,until you have that clear and defined and not abstract, you can’t possibly build orfulfill or achieve your dream for that business”. So says Jay Abraham, my favouritebusiness and marketing genius.Before we start looking at property investment and how it works I think it would be reallyuseful to take an inventory, if you like, of where we are now in out attitudes and attributeswhich could have a bearing on whether we succeed in property or not.As you have bought this report I can take it as read that you think you want to be a propertyinvestor, but perhaps you’re not sure if it’s really for you or whether you’re really cut out forit. No doubt even the great property investors of our time have felt like that on occasions, butwhat sets them apart from the rest is that they still went out and did it.I can’t prove it but I believe that the successful property investors have certain commonattributes. It is true that they might have been born with these, that they are part of theirnature. However, even if you feel that you may not possess these qualities naturally, I thinkthat they are something which with time and a little application, you can start to develop andthen apply to your own situation. I cannot guarantee that this will bring you success inproperty, but frankly I don’t think it will do any harm.These are what I feel are the most noticeable attributes of a successful property investor thatI have observed. Attribute number one - they are focussedThe great and successful investors know where they are going, why they are going there, andhow they are going to get there.I certainly agree with Jay Abraham that until and unless you know what you want, you aren’tgoing to get there. That’s true for all business not just property. This has been put anotherway, “begin with the end in mind”.I guess that if they were starting again the first question they would ask themselves would be“why do I want to invest in property?” If you were asked that question, do you know whatyou would say ? The answer may be obvious to you, but you still need to ask the question.On the basis of that answer I suspect that the great investors would set their goal, theirpurpose for being in that business. Then they would plan how they are going to achieve it.Then they would do it.Goal setting in a business and personal context is a useful, if not invaluable exercise. If youdon’t know where you are going in an area of your life, how will you be able to plan to getthere, and how will you know when you’ve arrived?There are many books written on goal setting but I think it’s worth saying a few words now.Firstly, here are three basic rules of goal setting. 9
  9. 9. Number one – make sure that the goals are your own, and haven’t been set for you bysomeone else. That would include peer pressure, parental pressure and maybe baggage andprejudices from the past.Number two – make certain that your goals will benefit others, whether in a philanthropicsense, or to the benefit of your family, friends, work colleagues or others close to you. Youmay not believe it at the moment but it’s easier to be successful when your motivation is“self-sacrificing” rather than “self serving”.Number three – Never measure your goals in comparison to others. We are what we are.We are all unique and capable of achieving different things, and different levels of success.If you compare yourself and your achievements with others, you run the risk of eitherbecoming disheartened if you feel that you don’t measure up, or at the other extreme,pompous and complacent.To be successful in any business you need to be successful in all areas of your life. If you arenot, then any success you do achieve whether in property or elsewhere will be transitory.For example, what is the point of developing a property based business only to have to lose itthough ill health. Why struggle all that time to get there when you only have to sell it allwhen you go through a messy divorce. No one on their deathbed ever said they wish they’dspent more time at work. There are eight main areas where I would suggest that you set goals:Spiritual prayer, recognition that we’re not all there is, there’s something more.Family family priorities and activitiesSocial clubs, friendships, pastimes and pursuitsCommunity volunteer work, civic duties, political involvement, neighboursMental reading, education, seminars etcPhysical wellness/fitness, nutrition, exercise, sport etcFinancial income, savings, pensionsProfessional career advancement, professional objectivesNow you can set your goals in each of these categories.• With each of the above headings in mind, write down everything you want to be, or do or have.• Next ask yourself “why” you want these and decide whether they are burning desires or mere whims.• Then start to eliminate the less important.• Look at what is left on the list and ask if reaching each particular goal will make you happier.• Then ask whether your goals are big enough. Are you being self-limiting.Ask these five questions about the goals that are left on your listq Is it really my goal?q Is it morally right? Will it benefit others?q Will it take me closer to, or further from, where I want to be?q Can I commit myself to this goal, whether emotionally or physically, and see it through to the finish?q Do I believe I can achieve this goal? 10
  10. 10. Finally, take the most important goal to you from each category and start to look atthe actions you will need to undertake to achieve it and devise a plan. Make this as detailedas possible and resolve to follow it through. Then work through each of your lists indescending order and make plans for achieving each of those goals as well. Set a time-tablefor each goal and then, well, just do it !Make it a discipline to review your goals and plans regularly so that you can keep focussed.It is very easy to become distracted and to do things which seem urgent and even important,but which are actually interfering with your moving forward, and which may even be takingyou further away.I realise that this is a brief canter through the subject which is worthy of a book in its ownright. A worthy ‘Mental’ goal would be to do a lot more reading on this whole subject.In the context of this report your goals may be related to:capital growthincomeor a combination of the twoand may be expressed in terms of :the capital value of a property or properties i.e a portfolioa specific income requirement in the form of rent or expressed as a net profitand may require considering:the types of property you want to invest intheir locationand the vehicle through which you want to own them i.e privately, through a limitedcompany etc. Attribute number two – they get their timing rightSuccessful property investing depends upon timing. Firstly, there is the timing of individualdeals and when to do them. Then there is timing in context of the economic cycle.By nature I think I am a contra-cyclist. I have been privileged enough to work with theManaging Director of a small property company and watch him become a millionairethrough his contra-cyclacism. What does that mean? It really means that he didn’t follow thecrowd, in fact he did the opposite.This is the principal that he taught me. If you buy at the top of the market, what then? Whereis your profit going to come from ? Isn’t it better to buy at the bottom and give your assetroom to really grow? At the bottom of the market you can pick and choose yourself abargain as prices are pushed down because no one else is buying. At the top of the marketevery one else piles in and buys, and prices are pushed up. That’s the time to be selling, notbuying, and taking your profit.I am assuming in this that the boom bust cycle of the British economy is here to stay. Itwould be nice if it weren’t, and in fairness the peaks and troughs may be a little shallower in 11
  11. 11. the future, but I don’t believe we will never have another recession. When the next recessioncomes, as it surely will, it would be sensible to be in a strong enough financial position to beable pick and choose some decent properties cheaply and collect the income until theeconomy picks up. Then they can be sold at a profit.This is what my old M.D did. He bought sound properties with sound tenants cheaply in thelast recession. As a function of the purchase price, they were nicely high yielding and thecompany was very profitable. Then he sold the whole lot about six months ago and pocketeda cool million in profit.The problem most people wrestle with is when to buy. There is always the fear that they maynot be buying at the very bottom of the market. I don’t think this matters. I very much doubtthat any one can actually know when we are the very bottom of a cycle and so you almosthave to expect that prices might continue to slip after you have bought. This is unless you arevery lucky in which case you should treat that as a bonus. If the property is incomeproducing, or capable of being income producing, and is either giving you a surplus on yourinterest payments or at the very least covering your holding costs in full, then it will comegood in the end.Then, of course, they wrestle with when to sell. Again, I don’t think that one can count onperfect timing to get out at the very top, but I don’t think that can be helped. ‘Always leavesomething for the next man’ is a principal worth living by, it helps you sleep at night.Not every one is a contra-cyclicalist and I am not by any means suggesting that one shoulddo nothing during a boom period. Specific opportunities will always arise and should alwaysbe considered. Boom periods definitely allow the chance of quick speculations and gains asagainst longer term holds. The aim then will be to make the maximum amount of capitalgain in the shortest possible period.I would probably be looking to do a series of short sharp deals, moving quickly in and thenmoving out quickly. Property renovation and refurbishment fits the bill well, and to someextent outright redevelopment although I wouldn’t advise a beginner to get involved withthat.Refurbishment works are good because you can create a new product and with careful costcontrol and by choosing a property which needs the right sort of work the increase in valuewill more than cover the cost. In a moving market this sort of tinkering combined withrapidly rising prices means that you can justify coming back to the market within a relativelyshort time at a substantially enhanced asking price.A final thought on timing. If you do feel safer following the crowd just remember that it’sbetter to follow in at the beginning of a trend and ride it for what it’s worth, than to tag on atthe end of a trend that has just about run it’s course. Attribute number three – they take actionRobert G Allen got it right when he said “There’s only one good time to buy real estate; andthat’s now”.So often in life it’s the things we don’t do which we regret, not the things we do. 12
  12. 12. Sometimes an investor will see something in an opportunity that most others won’t. It can bea bit scary being out in front. It’s easy to spot a good deal when there are so many peoplequeuing up in front of you you’ve got no chance of getting it. It’s a bit more uncomfortableto be at the head of the queue. Good deals do come along more often than you’d think butyou won’t always recognise them, sometimes not even when someone else has exploitedthem before your eyes. Individual investors have different objectives.Successful property investor investors take action, at the right time, and when that action isin alignment with their goals. Don’t forget, they have planned for this moment and when itarrives, they act.Try and do the same. Go back and write your goals, think about the timing. Make a plan.And then act. I don’t mean in a reckless way. Of course you must be aware of what can gowrong and be sure that you have plans in place in the unlikely event that something totallyunexpected moves against you.Some things you can’t guard against and can’t plan for, but don’t let that be your excuse forinactivity. If you are going to win at property it is always better to do something rather thannothing. And much better than doing just anything, is doing the thing you have planned for. Attribute four – they don’t assume anythingVery little in property is straight forward. Certainly not everything is what it seems to be.Success in property depends upon not taking anything for granted and being prepared to digaround to get to the bottom of the facts. The great property professionals are able to do this,the greatest almost seem to know the facts instinctively. Through a combination ofdeveloping your creative thinking, and experience gained over time, you will be able learnthe right questions you should be asking to get the whole picture.Digging around is what unearths the opportunities not seen by others, and the pitfalls whichwould otherwise have wiped you out.People assume too much, almost always to their own detriment. The worst false assumptionis that they cannot afford a particular deal or a particular type of property. Anything ispossible if you really want it, if you are willing to put in the time and effort to make ithappen. But have you checked that you’re not assuming the wrong thing.When we look we all see different things. That is one of the most exciting things aboutproperty. It is entirely possible that you will see things others have overlooked. You may puttogether two apparently unrelated facts to make a profitable situation, which others have justignored.Never assume a property isn’t for sale. Never assume that the most obvious purchaser hasbeen approached already. Never assume that there are no problems, either physical or legalof which you have not been informed. Never assume that a vendor won’t sell for less, howcan you know what pressure he is under ? Never assume that a deal is beyond your meansuntil you have tried every possible avenue to get it through.This is why local knowledge and specialising on a single geographical area can be sohelpful. When you know your patch inside out you will know when something may work orwhen something may not. You may understand when a change of use may be appropriateand when it would not. You may see demand for something long before the market has 13
  13. 13. spotted it and know when to sit tight. You will know who is looking for what and why. Youwill know the right time to move. All this comes through digging and learning and assumingnothing, being open to every possibility and playing with the permutations. You must neverstop being creative when thinking about property. Attribute number five – they are patient at all timesI think it is true that with property things either happen extremely quickly, or they happenslowly. One of the attributes of the world’s great property investors is that when things aregoing slowly they are able to keep their heads and their focus and if necessary just stop andwait. In other words when they have to be they are supremely patient.If you want to be successful in property you will have to accept that this is a long termcommitment. If things happen quicker than you’d planned, that’s great. If not look to thefuture and content yourself that your assets are growing like a great strong tree. You can’talways see it but it’s happening.Property is illiquid. This paradoxically is one of it’s greatest strengths and one of it’s greatestweaknesses. Buying takes time and selling takes time. Putting deals together takes time.There are always many details to check and attend to. It can take time to make all the piecesfit.All property is in the control of people and people are unpredictable and irrational. Theydon’t always fall in with our plans. Deals and situations need to be patiently cajoled andnurtured.The property market is also a function of fashion. What’s in today will be derelict in adecade. Some things come, others go out. Irish theme pubs and out of town shopping werethe flavour of the month. Then it was call centres. Now it is e-commerce distribution centres.If you spot the next trend coming you may well have to wait to make your move. The greatinvestors do wait.But the great investors don’t use waiting as an excuse for doing nothing. They are preparingand making plans, attending to every detail in advance so, when the waiting is over, they areready to act and they act immediately.There are always things to do. There are always other deals to be done. Each one will gothrough in time. The great investors just seem to know when that time is. If you are patientand learn, with experience so will you. Attribute number six – they invest enough to make it countIn my opinion one of the great myths of investment is that you should spread your risk anddiversify. This is explained as being your insurance policy against something going wrong.The more you spread your investment into different things the less chance there is of all ofthem going wrong together.I see two things wrong with this approach. If you are reducing the chances of it all goingwrong, conversely there is also less chance of anything going right.Second, if you try to do a bit of everything then you will almost certainly become a jack ofall trades and master of none. 14
  14. 14. The great property investors stick to what they know, love and feel comfortable with andthey get very, very good at it indeed. This is really another example of the great investorsbeing totally focussed.Another aspect of this is that they have self-belief. If they really feel that their judgement iscorrect they back it with everything they have got, whether in material sense with theircapital, or in an emotional or intellectual sense. If they believe something will work, theydon’t pussy-foot around, they go out and do it. As I’ve already said, they take action.And finally….Attribute number seven - they love what they doYou can tell by what they say and do that they love their jobs. I am sure that with a fewexceptions most really successful property investors did not go into it for the money. Youknow what they say, that most millionaires are so absorbed with the jobs they love theydon’t even realise that they are millionaires until their accountants tell themOK, I think that’s set the scene. Now let’s have a go and see if we can do it, after all…. 15
  15. 15. Anyone can do it, you just need to try“It’s the law of supply and demand. Real estate, especially residential property, is acommodity which is in critical shortage and for which there is enormous demand. It is anecessity, not a luxury. People can’t print up 100,000 new homes as they might print up astock offering. That’s why I continue to say ‘Don’t wait to buy real estate, buy real estateand wait’” (Robert Allen, American self made millionaire property entrepreneur) Have you noticed that the British public are almost totally obsessed with their homes,or at least the value of their homes? Perhaps it’s because we remember the excitementexperienced in the late 1970s and 1980s when house prices were moving so fast that paperfortunes were being made almost overnight. Every one was a jackpot winner and you didn’tneed a lottery ticket to win; if you lived in your own house or flat you were guaranteed abumper pay-out. Now the market’s hotting up again and the same thing is happening.Friends of mine who bought a four bed house in Surrey last year for £200,000 tell me it’snow worth £300,000. I’m sure we’ve all heard stories like that.Everyone seems to know how much their house is worth, almost to the last penny. Whatmakes this so surprising is that the professional valuers, who tell the Building Societies howmuch your house is worth when you ask for a mortgage, spend at least five years training,including three years at university, and yet most home owners seem to be able to get to theright figure instinctively.When they retire most people’s largest asset is the equity in their home; in a survey in theUSA a few years ago it was found that the average home owner’s assets were worth thirtytimes the value of a home renter’s assets. Just look at how much the capital value of homeshas increased in this country over the last 30 years. In 1969 the average price of a Britishhome was around £ 4,500. In 1999 alone house prices went up an average 14% and today theaverage house price stands at £ 83,100 (December 1999).And despite recent proposals to radically overhaul the Capital Gains Tax system, owningyour own home and “trading up” is still the most tax efficient way to make money inproperty; if your home is your main residence for tax purposes, when you sell at a profit youpay no tax at all.So if you are serious about making money in property the first step is to own your ownhome. It’s probably the most important investment you’ll ever make. It isn’t just for livingin. As the capital value accumulates it’s also a cash machine, a savings account and a sourceof equity for your future deals. I’ll talk more about that later.But that is by no means the end of the story, it’s only the beginning. As the British public areso naturally good at property I am always surprised that their interest stops at their own frontdoor. Most people don’t seem to realise that there are all sorts of opportunities in theproperty world for every one to explore and exploit, which with a little bit of creativethinking every one can afford.I have been lucky enough to have spent most of the last 18 years working in commercial andresidential property and have been able to follow the careers and fortunes of individuals inthe property world who never seem to put a foot wrong and who have been tremendouslysuccessful in making money from property. 16
  16. 16. It’s probably true to say that property has created more millionaires than any other type ofbusiness. And it seems that business people who are successful in an another area are moreoften than not tempted into trying their hand at property, even if it is only as a side line.You would probably think all property entrepreneurs must have had at least a small fortuneto start with and could afford to play with property. For some of them that may have beentrue, but certainly not for all. Many successful property investors have started almost literallywith nothing but by knowing just a little more than the average lay person have built up largeproperty fortunes.There are several powerful secrets all successful property people use which give them abetter than even chance of being successful . In this report I will teach you what they are andhow to use them so that you can start to build a property empire. At the moment this mayseem like an impossible dream but if you have the time and the desire, and if you put thesesecrets into practice, you too can be a successful property investor.Let me start by telling you something that may surprise you. Any one can afford to be aproperty investor. It really is true that you can start your own private property empiretomorrow by buying properties for as little as £500, perhaps even less if you shop around.And if you are really clever you can start by getting someone else to pay for them for you,perfectly legally. I know this sounds almost incredible but I’ll tell you how to do it later inthis report.Without giving away too much now, how successful you will be depends upon how youperceive property, so now is as good a time as any to start you thinking the right way. Youneed to understand that most people don’t think of property as something they can beinvolved with. Perhaps it’s psychological and they are overwhelmed by the physical size andscale of property. Perhaps it’s because they assume that all property is too expensive and outof their price range and they don’t realise that they don’t have to pay the whole purchaseprice themselves.But the key to building your property empire is to start thinking more laterally, and to start tosee the opportunity and not the building. So this is the first point to remember, the value of aproperty depends on the interest being sold and not on the physical accommodation itprovides.Flats are a good example. Many people in this country own flats and most flats are sold onlong leases. It is quite usual for the lease to be for 99 years or 125 years and for the “flatowner”, who is technically a long leaseholder, to pay a ground rent of say £50 a year to afreeholder.A two bed flat in my town costs on average about £70,000 if you want to buy it to live in. Sofor the purposes of this example we will assume that this is the value of the flat to the flatowner.Now think of the value to the freeholder. Is the value of the flat also £70,000 to thefreeholder? Try thinking of it this way, how much would you pay to get an income of £50 ayear in ground rent from the flat owner. You certainly wouldn’t pay £70,000. In fact atcurrent prices property investors are paying between ten and fifteen times the amount of rentreceived for freehold interests of blocks of flats. So in this example, assuming a ground rent 17
  17. 17. of £50 a year, you will probably only have to pay between £500 and £750 to own thefreehold.Why would anybody want to buy the freehold of a flat? Well, if they paid £ 500 for anincome of £50 per annum they would be earning 10 % on their money; I will show you someof the basic maths you will need to work out how well your properties are performing, andmore importantly how much you should be paying for them, in a future article. Even if theinvestor paid £750 they would still get a 6.7 % return on their money which is still betterthan they will get in a building society savings account. And there are other ways to increasethe return which I will tell you more about later in this report.So you can see that it is possible to own a £70,000 flat for a few hundred pounds, althoughof course you won’t be able to live in it, yet. We’ll look at the attractions of freehold groundrents in more detail another time. I hope you are beginning to get the point. It’s true that tobe successful in property you need to engage in some creative thinking but don’t worry, Ibelieve that is a skill most people can learn with practice.I have written this report especially for private investors who may have limited resources andwant to do something more interesting than leave it in a building society. Even with interestrates creeping up they pay such a small amount of interest at the moment that waiting foryour investment to grow really is as exciting as watching paint dry.In this report, amongst many other things, I am going to tell you why it’s better to buyproperty using other peoples money, and how to get them to lend it to you, a rough rule ofthumb which will show you how to value investment properties and work out whether youare getting the best return on your money, and about the different types of property that areavailable and why they should be of interest to you. 18
  18. 18. Yes, but not at any price A layman’s guide to valuation Oscar Wilde famously said "a cynic is someone who knows the price of everythingbut the value of nothing". If this is true we can assume that cynics dont get very far in theproperty business, because, quite simply, if you dont know the value you cant make a profit.There are two things that are disastrous for a property investor; either paying too much orselling too cheaply. If you want to be successful you must learn not to do either. This meansthat you must have at least a working knowledge of property valuation.I mentioned earlier that most home owners have almost an instinctive feel when it comes tovaluing their own homes. That’s because, whether they know it or not, they are using the“direct comparison” method of valuation, also known as the “comparative method” or“market value approach”. The “direct comparison method of valuation”Simply, this is a method of valuation by which the value of a property is assessed by lookingat prices recently agreed on other similar properties. The more similar the other propertiesare, the easier and more accurate the valuation will be. Ideally, you will be looking for theprice agreed for properties of a similar age and size, in the same or a similar location, and ofa similar quality and with similar amenities.There is also a presumption that it will be used mainly for vacant properties, although if youwere valuing a property that had been let, and you were able to find identical properties leton identical terms to similar types of tenants, I guess you could apply it if you are careful.However, those circumstances are rare so I mention them only in passing.So, for example, if you are valuing a three bedroom terraced house in a row of otherwiseidentical three bedroom houses, and two have both sold recently, one for say £30,000 andanother for £30,500, then it is fair to say that the value of the property you are valuing willbe around £30,000.I should say here that because valuation is an art and not a science precision does not comeinto it. This is why valuers use terms like “in the region of” and “fairly represented by” andoccasionally “in the range of”.Where there are obvious differences between the properties, you will need to makeadjustments to get to the valuation figure.If the two properties which have just sold both have a modern full gas fired central heatingsystem but the property you are valuing does not, in an ideal world you would start again bylooking for sales prices of properties without central heating. But let’s assume that there arenone, or that in all other respects these properties are so similar that you feel that you canaccurately account for this one significant difference. The way you may deal with this is thatyou estimate it would cost around £2500 to install a similar system so you knock this off thefigure to give a valuation of “around” £27,500.Then suppose that in addition to the central heating both of these other properties have beenmodernised and have new kitchens and bathrooms, and the property to be valued is in an 19
  19. 19. unmodernised condition. You may allow another £5,000 for a new bathroom and kitchen togive a value of £22,500.Time for a word of warning. Unfortunately, even this is something of an over simplification.Any property professional will tell you “cost does not equal value”. The valuation figureyou are trying to arrive at is a reflection of what a purchaser would pay in the open market.So a prospective purchaser may know that it would actually cost £6000 to install a newkitchen and bathroom, but in order to secure a purchase they may offer a price reflecting areduction of only £5,000.Similarly, you also need to take account of the overall quality and value of the property. Forexample, an allowance of £5000 may be appropriate for a new kitchen and bathroom in asmall three bedroom terraced house, but would be totally inappropriate in a large, fivebedroom, luxury, executive detached house.The more unique a property is, the less likely it is that you will be able to find directlyrelevant evidence, and the more adjustments you will need to make. In other words, the more“judgement” you will need to use and often this will stray into the realm of “gut-feel” wherethere is no substitute for experience. It’s no accident that valuers spend years training andthen years out in the market learning their trade. But that doesn’t mean that you can’t have ago and be close, or at the extreme, get a feel for whether a proposition is worth takingforward before you start incurring fees and costs. If your initial appraisal suggests that it is arunner then you can get additional professional help.An interesting aspect of the property market over here is that we tend to consider property infairly general terms. For example, we compare a three bed house with a three bed house, butunless one is significantly larger, we usually make no real adjustment for differences in size.However, on the continent, our European cousins have for many years used the floor area asa direct unit of comparison and will analyse the sale price down to francs per square metre,for example, and then apply the resultant figure to the property they are valuing.So if a 100 square metre appartment sells for £50,000, i.e £500 per square metre the propertyappartment next door which measures 110 square meters, all other things being equal, willbe valued at £55,000.This methodology is catching on more and more over here, in particular in high value areassuch as the City fringe in London, and more particularly since the loft style of appartmentcaught on where in effect one buys a “shell” which is then fitted out to your ownrequirements. A Quick Guide to Investment ValuationsIf you are serious about buying an investment property you will also need to know how tovalue a property which isn’t vacant.Ive tried to keep the theory and maths to a minimum but unfortunately there has to be some,but nothing you can’t handle without a pocket calculator.It may sound obvious but the key to understanding the valuation of investment property is tofirstly understand what an investment property is and why investors buy them. My definitionof an investment property is a property that produces income, usually in the form of rent – 20
  20. 20. (although not always)- and mostly investors buy them to have the income, although they canbe equally concerned with capital growth.By this definition any type of property can be an investment, whether it is a house or a flat,an office, a factory, or a shop, or something more unusual like a petrol filling station, a sea-front amusement arcade, a river bank with fishing rights, an advertising hoarding or a radiomast, just so long as it produces an income for its owner.When an investor values a property he is not really concerned with the physical bricks andmortar, what he is really valuing is the current income or rent, or if he thinks this couldincrease, his estimate of the future rent. If you remember this you shouldn’t go too farwrong.When you understand this the next thing to do is to take a deep breath and think of valuing aproperty as like looking at your building society account, only backwards. Let me explain.Suppose you have a building society account which pays you 10% per annum interest andyou want to know how much you need to invest to get £1000 a year in interest. This is easyto work out. If it pays 10% you need to invest £10,000. What would the answer be if theaccount only paid 5%? The interest paid is only half so you will need to invest twice theamount, £20,000. To make it easy you could use the formula:Capital sum x interest rate/100 = income receivedor in this example£20,000 x 5/100 = £1,000.Now to relate this to property we need to add one more element to the equation, the "targetrate of return". This is also known as “the yield” and to all intents is the same as the interestrate in the Building Society example.Usually when buying a property an investor will not be trying to buy a specific amount ofrent but will be trying to achieve a specific return on the money he is investing.Serious property investors will know what rate of return they want to achieve from thedifferent types and qualities of the properties available. Other than in exceptionalcircumstances these “rates of return” will be market led. In other words an investor will notusually want to pay more for a property than the “going rate” and through keeping an eye onwhat others are paying, perhaps through regularly attending auctions, he will be able toanalyse the sales prices and see what “return” or “yield” is appropriate for particular types ofproperties.He knows that the “going rate” is really a reflection of the cumulative views of all theindividual investors in the market, and in particular reflects their views on the “risks” and“expectations” for that type of property. An individual investor is at liberty to agree with thatview, or if he thinks he knows something the others don’t, he can bid either more or less.Remember, investors mainly buy property for the income they produce. So the three mostimportant things the yield will reflect are the current income, whether this will increase in 21
  21. 21. the future, and how secure the income is, that is whether the tenant can afford to pay the rent.This is where the risk and expectation comes in.Probably the most important of these considerations is the security of the income. If theinvestor finds a property producing a cracking rent, it wont amount to much if the tenantgoes bust. That will leave the investor with an empty building and no rent, the cost of findinga new tenant and, in a poor market, the possibility of having to accept a lower rent to findany tenant at all.The rule of thumb is that the riskier the income, the higher the target rate of return that willbe required by the investor to tempt him to buy the property. He will weigh up all of theadvantages and disadvantages of a particular property and decide which target rate of returnhe requires to compensate him for the risk he is taking with his money.So how does this relate to looking at a building society account backwards and how does thishelp us to value a property? Using a hypothetical example, let’s assume I’m interested inbuying a residential investment. Other investments of the quality of the one I’m looking athave been selling at auction recently at prices reflecting a gross yield on the rent of around13%. If my target property produces a rent of say £5000 a year, the most I should pay is£38,500. I can calculate this using the formula I showed you earlier but backwards.income (rent)/interest rate (yield) x 100 = Capital sum (value) £5,000/13 x 100 = £38,461, say £38,500No one should pay more than a property is worth and so you will need to get a good idea ofwhat yield is appropriate for particular types of property. In practice this is easy just bykeeping an ear to the ground and seeing what different properties are selling for. Irecommend going to as many property auctions as you can.You may be asking how did I know the other properties were selling at prices reflecting areturn of 13%? Well, you can analyse the sales prices by slightly changing the formula againto:Yield = rent/purchase price x 100Once you understand the maths you can see that the higher the yield the less valuable theproperty is. This seems a bit strange at first. After all it would be natural to assume that aproperty producing a high yield will have a high value. But if you think about it a high yieldmeans that in effect you get a lot of income by spending not much money. In other wordsyou want to agree a low purchase price relative to the rent.Lets look at a practical example to give you a better idea. This is illustrated by going toextremes and by and comparing the attractiveness as investments of a batch of lock-upgarages, and a modern town centre office building that has recently been let to a multi-national company.If you were to do some digging around on recent investment deals to get a feel of whatother investors think about these types of property I would expect today to see sales pricesfor similar properties showing yields of around 15% for the lock-up garages and, depending 22
  22. 22. on who the tenant is, 6%-7% for the office building. Because these yields have beenestablished in the open market through bids at auctions, and negotiations betweenindividual buyers and sellers, they directly reflect the current view in the market place ofthe relative desirability of lock-up garages and offices as property investments.The 15% yield achieved on lock-up garages is very high compared to the yields achieved forother types of investment property and there are good reasons for this. These are all relatedto the rent.The first thing an investor will consider before buying a property is how safe the rent is.Lock-up garages don’t provide a guaranteed and constant income, usually one or more of thegarages will be vacant. Some investors need certainty, particularly the certainty of receivingtheir money, and the less certain the income, the higher the yield they will require.Then there is the cost of owning the garages. They are often located on the edges of estatesand at risk of being vandalised. Of course some areas are better than others and an investormay think that these particular garages wont be under too much threat and so he shouldnthave to pay out a lot on maintenance and repairs. But he will have to decide whether he isgoing to manage them himself or appoint agents to act for him. He may wish to appointagents if he lives a long way from the garages which would make it impractical for him tovisit them regularly, or if he knows that the current tenants have a history of being slowpayers and collecting the rent could be time consuming.Lastly an investor will consider the probability of future rental growth and may concludethat although demand for garages in this area is steady there is unlikely to be anyspectacular increase in the rent. It may just about keep up with inflation if he is lucky.Weighing all this up an investor may conclude that these garages are only worth buying if hecan get a yield or return on his money much higher than he could get if he bought anothertype of property investment. If he thinks the rent wont increase any faster than inflation,and so the income is effectively fixed, he will only get a high yield by paying a relativelysmall amount of money relative to the rent. Looked at another way, the income will have tobe high relative to the purchase price to achieve a high yield.Because of his research into the market and sales prices acheived he knows that lock-upgarages are currently selling at prices reflecting yields of around 15%. If he thinks that afterallowing for some of the garages being periodically vacant he will get a rent of £4,000 everyyear, he calculates their value to be £26,666, say £26,500, and this is the most that he will beprepared to pay.The maths looks like this:Income x100/ Target yield =£4,000 x 100/15 = £26,666 say £26,500He may think that lock-up garages are so risky that he may not be prepared to pay even themarket value and may need a guaranteed yield of at least 20% before he will even considerbuying. This means that the most he will pay is £20,000 which he will calculate like this:Income x 100/ Target yield =£4,000 x 100/ 20 =£20,000 23
  23. 23. If the market is valuing garages of this quality at 15% he will have to search around to get abargain at 20%, but more often than not is likely to be outbid by another purchaser and willeventually have to put his money into a more secure category of investment.The offices let to the Plc dont have the same risks or problems for an investor. Let’s assumethat the tenant is an extremely profitable multi-national corporation, and in real life we cancheck this by ringing up their head office and asking them for a copy of their latest publishedcompany accounts. Most large companies (that are listed on the Stock Exchange) will sendthese free of charge. If the accounts look alright they can be assumed to be a save bet when itcomes to paying the rent. Using property talk they are a "good covenant" and the rent shouldbe safe for the whole length of the lease which could be as long as 25 years if it were grantedsome years ago.So, unlike the garages, the rent should not only be paid, but should be paid for theforeseeable future and beyond. Investors, as opposed to speculators, often need this certaintyand will be willing to pay for it.An investment will be even more attractive if, in addition, there is good reason to assumethat the rental value of the property will increase. These offices are located in a primetown-centre location and an investor may conclude that the rental value will grow faster thaninflation. Almost without exception modern commercial leases allow landlords to increaserents periodically and so in time he will get a real increase in his income.It’s modern practice for leases to make tenants responsible for all repairs and maintenance.This means that the investor will be able to retain the majority, if not all, of the rentalincome, which again will be reflected in a higher price.In all respects the offices are a much more attractive and less risky investment than thegarages. Investors wont need to achieve such a high yield to compensate them for riskingtheir money, in fact there are likely to be so many potential buyers in the market for this typeof investment, that between them they will push the price higher and the yield lower.This raises the interesting question of why should a property investor want to buy a propertywith a 1ow yield. Why doesn’t he put his money into an investment which will give him ahigh return such as a high yielding property. The reason is that a low yield implies that theinvestor is confident that the rent is not only secure for the whole length of the lease butthat he is confident that the rent will increase.It will be apparent by now that one of the most important considerations for an investor isfuture rental growth but you may be wondering how and why rents rise and how investorsget the benefit.Quite simply rents rise when demand for certain types of property increases in aparticular location. For example I have already mentioned the property boom of the l980swhen shop rents in particular went through the roof as retailers scrambled to open up moreand more shops to take advantage of free-spending consumers.Commercial properties like shops, offices and factories are usually let on leases foranywhere between five and twenty-five years. Historically the rent would be fixed for theentire length of the lease but because of rent inflation during the l960s and 1970s landlordsrealised that they were missing out as rents achieved on new lettings soared above the rentsthat had been fixed on their other properties. To overcome this problem it became common 24
  24. 24. practice for leases to allow for periodic rent reviews, usually every five or seven years forcommercial property. Normal practice today is every three or five years. Under the terms ofthe lease the tenant will have to accept the increase in rent if the landlord can prove it isjustified by comparison with rents agreed on other similar properties in the locality, or insimilar locations.It is not so clear whether an investor can expect rental growth on residential investments asthis will depend very much on when the lease was granted. In the past residentialtenancies have been heavily legislated and if a lease was granted before 1987 it is probably aRegulated Tenancy.If it is, the law only allows the rent to be reviewed every two years and then to a level thatwill almost certainly be below an open market rent. Things have improved since thepassing of the Housing Act 1988 and I shall explain why later in this report. Needless to say,receiving rising rents will have a profound effect. Let’s have a look at an example.During the boom years of the late 1980s it wasn’t unknown for investors to buy prime shopunits for prices reflecting yields as low as 2.5% - 3%. They were confident that becausethere was strong consumer spending, and demand for shops from retailers was high, shoprents would grow rapidly. They were happy to buy shop properties and wait knowing that atthe next rent review they would benefit from a substantial increase in rent. As a result theyield on the money they had spent buying the investment would also increase dramatically.For example, our investor may have bought a prime shop in a major commercial locationsuch as London s Oxford Street, considered by many to be the very best retail pitch in thecountry. Let’s assume the rent is £100,000 per annum and the investor is prepared to makean offer reflecting a yield as low as 3%. This means that he will pay £3.335m which he cancalculate by:Income x 100/Target yield = £100,000 x l00/ 3= £3,335,000For a yield this low you may think its hardly worth the effort to buy the investment and hecould probably obtain a higher rate of interest from a simple building society account.However, our investor, who has been keeping a careful eye on the retail market , knows thatshop rents in Oxford Street have grown so quickly over the last couple of years that at thenext rent review, which we will assume is in three years time, the rent will at least doubleand could even treble. If it does then the yield will double or treble respectively as wecan work out by slightly adjusting our valuation formula:Income/ purchase price x 100 = yield£200.000 /£3,335,000 x 100 = 6%Or if the rent trebles:Income /Purchase price x 100 = yield£300.000/ £3,335,000 x 100 = 9%With the promise of rental growth like this the property will soon be producing anattractive yield and if the market continues to value prime Oxford Street shops at prices 25
  25. 25. reflecting yields of 3% then he will also make a considerable capital gain as thevalue rises in line with the rent.He paid £3.335m but if the rent received is £300,000 per annum the value is nowIncome x 100 /target yield = £300,000 x 100/3 = £10,000,000So he now has a property producing a 9% yield on his original outlay of capital, three timesthe rental income as when he first bought the property, and an increase in capital value of£6.7m.In practice, after each increase in rent, the market would push the yield out to reflect thatthere is no imminent prospect of rental growth. However, as retail rents continue to rise theyield will move back in again until the next opportunity to increase the rent arises. So thecapital value will increase, but immediately after each increase in rent, part of the increasedvalue attributable to that increase will be off-set by the increase in yield. The underlyingtrend will be for an increase in capital value but the yield pattern will be stepped.In real life the calculations will be a more complicated depending how detailed an analysisthe investor requires of a transaction. The purchase price isnt the only money paid out onpurchase.There will be stamp duty which is currently charged at 1% of the purchase price (orthe value of a property, whichever is the higher) on all transactions over £60, 000, 2.5% over£250,000 and 3.5% over £500,000 (April 1999).Then there will be solicitors fees for conveyancing and legal advice on leases although forinvestments of the value with which this report is concerned with I wouldnt have thoughtthat this would be more than a few hundred pounds each time. And lastly there will besurveyors fees for valuation advice and undertaking surveys. Again for smallinvestment properties worth less than £100,000 you are likely to pay around £500 for avaluation and survey if you shop around.Obviously fees and costs will vary from one property to another and it is largelycommon sense to estimate what they will be in each individual instance. A rough rule ofthumb used by large investors who deal in properties worth hundreds of thousands or evenmillions of pounds is to allow a percentage of the purchase price for fees, which iscalculated as stamp duty at the appropriate rate, plus 1% surveyor’s fees plus VAT, and0.5% solicitors fees plus VAT. This provides a rough guide and will not always be helpfulfor small properties or cheaper investments where there is unlikely to be such an easilydefined relationship between purchase costs and purchase price. It will require adjustmentfor abnormal circumstances such as title problems or a defective lease. These will result inmore legal work and so a purchaser’s solicitors fees will be higher as will the banks legalfees, which will normally be the responsibility of the purchaser.Once you have purchased a property there will also be ongoing costs of ownership. In theearlier example of the lock-up garages I referred to the appointment of managing agents tolook after the day to day running of the investment, for example organising repairs and rentcollection. Managing agents generally charge 10% of the rent collected for their fee, plusVAT. For a full management service the standard charge is 15% plus VAT. Depending uponthe lease terms and the type of property owned an investor may also have to budget part ofthe rent each year to cover the costs of repairs and maintenance, and will have to insure athis own cost. 26
  26. 26. To get a true analysis of the return on their capital investors will calculate the yield net ofcosts. This means that they will take into account all potential purchase costs and the costs ofowning the property. If we go back to the example of the lock-up garages which ourinvestor calculated would produce £4,000 a year in rent, and for which he wanted a yield ofat least 15%, we saw that he would pay £26,500.The yield of 15% is what the market is currently paying for this type of investment.However, we can consider the 15% yield to be a “gross yield” because it only takes accountof the rent received. What the investor will want to know is whether he is really getting 15%on his capital.In this example costs would not include stamp duty as the purchase price would be below thecurrent £60,000 threshold but would include solicitors conveyancing fees and possiblysurveyors fees. If he appoints a managing agent to 1ook after the garages and collect therent, they will charge a flat fee of 10% of the rent collected plus VAT. The investor wouldalso be well advised to set aside a contingency sum to cover essential one off repairs andmaintenance. With these costs in mind he can now calculate the total costs of purchase, thetotal income receivable after costs, and the actual return on his money as follows:Purchase Price ( as before) £26,500Solicitors fees and other costs say £ 1,000Total capital expenditure £27,500Income £ 4,000less repairs at 10% per annum £ 400less management @ 10% plus VAT £ 470Net income £ 3,130He can apply these to the formula:Yield = Income/purchase price x 100Yield = 3130/27500 x 100 = 11.38%So he can calculate that the true return on his money, or the net yield, is actually 11.38%.For the moment, that’s as far as I think I can go on this subject. There’s an awful lot that Ihaven’t said. For example, I haven’t talked about the valuation of leasehold properties, or thevaluation of reversionary properties, that is properties where you know that the rent will begoing up at a specific date to a specific amount. That’s the stuff of university lectures andmusty text books.But I think I’ve given you enough of a background to be able to undertake a fairly simpleanalysis of sales. and to get a feel for the returns you should be looking for. And hopefullyI’ve given you enough information to do a basic back of the envelop valuation of the typesof investment property you are most likely to be looking at, so that you can at the least cometo an informed view whether a proposition is worth taking further and whether you need totake more expert advice. 27
  27. 27. A quick guide to “residual valuations” and development appraisalsThe “residual” method is the principle method of valuing• development schemes• redevelopment schemes: and• properties for refurbishment.As well as finding the value of land or a building before redevelopment or refurbishment it isalso a very useful analytical tool for analysing and appraising whether a particulardevelopment or refurbishment scheme is profitable.As the name suggests the method involves finding the residual value, in other words theamount left over if you take the costs of construction and other associated costs away fromthe end value of the scheme. Associated costs include professional fees, marketing andinterest. If you are analysing profit you will find the residual after also allowing for the costof purchasing the land or building subject to the scheme.This is a very subjective process and changing any one of the many constituent parts canhave a disproportionate effect on the end result. So the valuation or analysis will only be asgood as your knowledge or research. Like the computer saying “rubbish in, rubbish out”.Here is an example template of a classic residual valuation to establish the value of adevelopment plot, or a property for refurbishment or redevelopment.Gross Capital Value (once completed) £Less agents costs of disposal £Less legals on disposal £Net Capital Value £ALESSBuilding costs £Building finance £Professional fees £Interest on fees £Promotion/marketing £Contingency sum £Agents/letting fees £Developers profit £Total costs £BResidual land value £A - BThe amount left for the residual land value will include an amount for acquisition costs, andinterest on the funds used to purchase the land or property which is rolled up because it isassumed that the acquisition costs occur at the point of purchase. 28
  28. 28. To get to the land value the acquisition costs and the interest can be stripped outalgebraically by:Sum available for land, acquisition costsand interest (residual land value) £xFinance on landInterest rate/100 x No of months = yAcquisition costsCosts x interest rate/100 x No of months = z1+y+z=xLand value = x/1+y+zIf the cost of the land is known, by substituting this for developers profit, the appraisal canbe used to calculate the profitability of a specific project where all costs are known.Don’t forget that if you are doing a “valuation” a lot of this will be a purely hypotheticalexercise as the market value is often based upon “a market average”. However, if you areundertaking an appraisal, for example to determine the profitability of a particular scheme,then you will use figures that are as accurate as possible for that scheme.A good example is building costs. On a particular plot of land you know that the only likelyplanning consent will be for a three bedroom house, and that because of prevailing levels ofvalue in the area most developers would construct it to an average specification. On thisbasis you can determine the value of the land using building costs that reflect the marketview.On the other hand, if you decide that you would like to retain the property and live thereonce the building is completed, you may decide that you want to build to a higher standardthan the market norm. You can then use your estimate of the enhanced building costs todetermine whether this project is still viable.A word of explanation about the constituent parts of the calculation:The end value of the project, i.e the gross capital value, is found by using either the directcomparison method or the investment method. The cost of sales like estate agents andsolicitors fees are deducted to get to the net capital value. This is the money you would haveleft over when you sell the completed project.The building costs will already be known if estimates are available. Otherwise you may needprofessional help from a quantity or building surveyor, or an architect.Because in theory building costs only need to be financed as they occur, i.e when thebuilding contractor sends in his bill at the end of each completed stage of building, it is usualpractice to average out the interest charges on these costs. There are two ways this can bedone relatively easily – firstly, apply half the interest rate to the whole of the building costfor the whole of the estimated length of time the building works will take, or, secondly applythe whole interest rate to half the building costs over the estimated length of time forbuilding works. 29
  29. 29. Promotion and marketing ? Well once you’ve built it, there’s an assumption that you’ll wantto sell it. How much should you allow? For smaller schemes this will probably be wrappedup in estates agent fees, and you won’t need to make a separate allowance here.Developer’s profit. If you are doing an appraisal this will be whatever return you wish tomake on the project. If you are doing a valuation you will use figures that reflect what anaverage developer in the market will require at the moment. Usually this won’t be less than15% of the end value of the project, but can be 20% or more.Agents and letting fees are again usually applicable to larger schemes. For smaller schemesthis figure will most likely include an allowance for promotion and marketing.Although a residual can be very complicated the rationale behind the method is sound anduseful. However, you may be wondering whether it can be quickly and easily applied tosmaller projects. I’ve set out on the next page a very basic residual I developed on aspreadsheet, which I have used to appraise the viability of a number of refurbishmentopportunities I have looked at. I must stress that this is only a very rough and ready reckonerand I wouldn’t argue for its infallibility as a valuation tool. However, it has provided mewith enough of a guide to be able to assess from my desktop whether a project is worthresearching in more detail. I’ve made it fairly adaptable so it is relatively easy to add ordelete fields to make it bespoke for each individual situation.The example shown is for a relatively small refurbishment of a low value house. You can seethat the end profit was minimal and this opportunity was considered not to be profitableenough to justify the time and effort involved. 30
  30. 30. Gross sale price 77500agents inc Vat 1821.25legals inc Vat 235Net sale price 75443.75LESSRefurbishment costsRoofDampTimber 160Bathroom 280Kitchen 1250Wiring 1128Plumbing 300Windows 1950Cheating 2000CeilingsReplastering 210clear gdnSkiphire 300Decorating 1000Contingencies 2101.85Total Development 10679.85Other costsInsurance 397.37SurveyValnTravelling 804.96Legals 462Electricity 20.03Gas 22.53WaterBank 17.5 1724.39Purchase Price 54000gross profit 9039.51FinanceDevelopment for 3 mths 133.49813Property for 14 mths 4410Arrangement feeprofit on property 10 %legals on loanTotal Finance costs 4543.4981Stamp dutynet profit 4496.01 31
  31. 31. If you want to write your own spread sheet be careful about how you handle the interest andfinance section. It is easy to get dragged into circular arguments and achieve onlymeaningless mathematical solutions.As ever I advise that if you use your own residual model be very cautious about relying uponit. By all means use it as a rough guide, but before you spend thousands or even hundreds ofthousands of pounds of your own money, get an independent view and take professionaladvice. You will probably have to pay for it, but there’s no question that it will be moneywell spent if it means that you avoid an expensive mistake. 32
  32. 32. Why You Don’t need to be able to afford to buy a whole propertyThe secret almost every successful property investor hasused is… I’m now going to tell you probably the most important secret known by andused by all the great property investors. I think you are going to be surprised. “Nobody everrises above mediocrity who does not learn to use the brains of other people and sometimesthe money of other people too… it takes a combination of the two”. So said Napoleon Hill,the man who through his philosophy of personal achievement probably helped to createmore self made millionaires than any other person in history.The trouble with using other peoples money is that debt makes us squeemish. From an earlyage we are told that debt is bad and should be avoided. And that is true, or at least partlytrue. There are certain types of debt that we should avoid at all costs, but like it or not anybusinessman will tell you that most businesses cannot grow without the proper use ofinvestment debt.This is especially true of property where the sheer scale of the figures involved mean thatonly the super rich can afford to be seriously involved without some form of debt. If youwant to build a sizeable and profitable property investment business the truth is that you willrequire some short term debt.So the first rule is “ investing in property works better when you use someone else’smoney”. I’ll show you later how borrowing the money you need is probably easier than youthink.There are two main elements to this first rule that I would like to show you.Firstly, when you are looking at a potential property to purchase don’t be put off by thepurchase price. Remember that you don’t need to have the monetary equivalent of the askingprice, or put a better way, you don’t need to be able to afford to buy the whole propertyoutright.Most people don’t take the idea of themselves as being property investors seriously becausethey assume that they can’t afford to buy properties. You may think that they have a validpoint, after all property is expensive. But the simple fact is that you don’t need to be able toafford the asking price, you just need to be able to pay the part of the price that the bankwon’t lend you.I’ll show you later that even if you do have enough money to buy an investment propertyoutright, it will almost certainly be to your benefit not to use all your own money.You may be able to apply this rule in other contexts but I think it is best illustrated if we lookat investment properties. For simplicity I shall refer to residential investments but theprinciples apply equally to commercial properties. Most banks or other lenders participatingin the buy-to-let scheme will lend between 75% and 80% of the lower of the purchase price,or the value of the property, depending upon the individual circumstances of the case. 33
  33. 33. This means that when you want to buy a property the question to ask is not “can I afford it?”but “can I afford 15% to 20% of it?”Looked at another way, if you have a sum of money which you intend to invest in property,for example let’s say £10,000, rather than looking for a property worth £10,000 you shouldbe asking yourself “if I can borrow 80% of the purchase price where can I find a suitableinvestment costing £ 50,000?”As a purely hypothetical example, suppose you see a nice flat that you think would make agood investment when it is let to a tenant. Because it’s in a good area you are sure it will beworth keeping for a few years because the value is almost certain to go up. You have foundout that the asking price is £62,500 but you think you can get it for £60,000. You askyourself “Can I really afford a property worth £60,000?” Wrong question. If you can borrow80% what you should be asking is “can I raise £12,000? ”This is why I think that probably the most important part of raising money for property isn’tto finance the purchase as such, but is to finance the balance not covered by the loan. If youcan find the first 20% to 25% of the purchase price, and as long as your existing income andthe rental income from the property you want to buy cover the lenders criteria, you will beon your way.If you have sufficient savings you will be ready to put in an offer and start talking to a brokerabout a loan for the balance. If you don’t have the cash in the bank a flexible lender mayallow you to use equity in your home as security against which you can raise the money forthe deposit through a second mortgage, or an equity release loan. I’ll tell you more aboutlenders and how to approach them next month.Now, let’s look at the second reason why “investing in property works better when you usesomeone else’s money. The reason is gearing, and this really is the star of the show. Let meshow you the amazing and powerful affect that it can have on your personal finances.If there is a key to success in property this is surely it. When you understand what happensyou will see why buying property with other peoples’ money is much more profitable thanbuying property with your own money. Remember I said that even if you do have enoughmoney to buy a property outright it would pay you not to use all your own money? Let meprove it.Going back to our earlier example of the flat let’s assume that your offer f £60,000 isaccepted and your purchase goes through. As you are cash rich you don’t bother with a loanand you buy the property outright. The flat is let to a decent tenant at £500 per calendarmonth which you know is the going rate in that area. We can easily calculate that if theproperty cost £60,000 and the income received is £6000 per annum, you will be getting areturn of 10% on your capital invested. Not bad.But now let’s compare this with the return you will receive on your money if you borrow tofund part of the purchase price. Still using our earlier example, we know that you haveaccess to £12,000. Your mortgage broker has told you that it will be possible to borrow 80%of the purchase price of a property and so, applying the rough rule of thumb, you startlooking for a property with a value of five times the amount of cash available to you. 34
  34. 34. You are offered a flat which is let at £6000 per annum, and from your research and fromattending property auctions you calculate the property is worth around £60,000. As you canget an 80% loan you can afford to pay this.To keep things simple let’s assume that you can obtain an interest only loan at 7.5%.As the purchase price is £60,000, you will be able to borrowPurchase Price £60,000Loan ratio 80% 0.8Amount Borrowed £48,000The interest you will pay on the loan is:Amount Borrowed £48,000Interest charged at 7.5% 0.075Annual interest payments £ 3,600The interest will be paid out of the rent so you will make a profit ofRent received £ 6,000less interest £ 3,600Profit on rent £ 2,400After paying the interest on the loan you will be left with £2,400 each year.As before we know that the gross rent, that is the rent before the deduction of interestcharges, represents a return on the full purchase price of 10%. The return on the purchaseprice represented by the profit left over after the payment of the interest is only 4%.But let’s see what the return is on the money you have actually put into the deal. You haveput in your available cash of £12,000 and you are now receiving a net profit of £2,400 eachyear. We can calculate that the return on your capital is:Profit (net rent)/capital (own money) x 100 = £2,400/£12,000 x 100 = 20%.So, by paying only part of the purchase price yourself and borrowing the balance you havebeen able to increase the return on your money from 10%, which is all you would get if youpaid for the whole property outright, to a massive 20%. In effect you have doubled yourprofit just by borrowing the majority of the purchase price.This means that even if you had £60,000 and could afford to buy the property withoutborrowing, you would be better off splitting your capital to fund the purchase of severalproperties, and borrowing the balance to increase your total return. In this instance if youbought five identical properties, the profit you would receive in actual rent would increasefrom £6000 per annum to five times £2400, in other words £12,000 per annum.This is a very simplistic example just to illustrate the point. In real life the calculationswould be more complex and would have to reflect extraneous matters like stamp duty, andthe costs of arranging the various loans. It’s also unlikely that you’ll find five identical 35
  35. 35. properties let on identical terms. But it does prove that in property you don’t want to putyour eggs all in one basket, it’s better instead to spread your capital over several purchases.This is the power of gearing and the effect is even more pronounced with higher yieldingproperties, and when you are able to arrange loans at lower interest rates.That’s why being able to supercharge the returns on the money you put in makes property soattractive, and gearing a property investors best friend.These kinds of returns aren’t the sole preserve of residential properties. A couple of yearsago I was offered a secondary shop in a fashionable and historic south east town, let to a soletrader. The lease was a little bit short having only about 9 years left to run, which somelenders may feel uncomfortable with, and the rent is £20,000 a year which is still slightlymore than the current market rental value, having been agreed in the late 1980’s. However,retail rental values in the town were picking up and it seemed that they should catch up againfairly quickly if things kept going the way they were.The freehold of the shop used to be owned by a property company but they went bust and aReceiver was appointed to dispose of the assets and pay off the creditors. This property soldfor £75,000 representing a return on the sale price of 26.6 %. But assuming that thepurchaser was able to fund this purchase the return on his money would be substantiallymore.Let’s assume that the buyer was be able to borrow at 9%, which is a fairly commercial ratebeing 2.25% over the base rate as it then was. Also that as this is a fairly tertiary shop with aless than substantial tenant the bank would want to reduce their risk by restricting the loan tovalue ratio to 60%. For simplicity let’s again assume that the loan will be interest only.If the investor could borrow 60% of the purchase price, ie £45,000, he would have to put in£30,000 of his own money. We can calculate that the return on his own capital is 66.6%.In the property world the expression “you get what you pay for” is often proved to be true,and I wouldn’t recommend a purchase like this for a first time buyer or inexperienced buyer.I’ll show you in a later article what influences whether a yield is high or low, or somewherein the middle. In this instance the yield reflects the risks of ownership, for example if thetenant went bust this shop could have taken some considerable time to re-let, and then almostcertainly at a lower rent.This is the type of property you’d want to tuck away in an existing portfolio, if it works outyou’re quids in, if not the rest of the portfolio will cover it until it comes good. Even so,there are plenty of properties out there which are suitable for smaller investors, and wherethe benefits of gearing can be reaped big time. So start looking and in the meantime startsaving up for your deposit, with any luck you’ll need it sooner than you think. 36
  36. 36. Other peoples money and how to get it Now that you can see that not only do you not have to be able to afford a wholeproperty, but it actually works out better that way, we’re going to have a look at borrowing.If you have enough to cover around 25% of the purchase price, and you concentrate onbuying reasonable quality investments at the right yield, you should be able to borrow therest from the bank.For a lot of us this is where things start to get scary. Let’s face it, until you’re established andhave proved you’re a good risk, no bank is likely to throw wide the doors and welcome youwith open arms when they see you coming.As an aside, one of many great ironies in the property world is that once you are established,you can afford to lose millions on highly speculative and disastrous ventures, and still beconfident that you will get a another backer. If you don’t believe me, just look at the numberof big names who completely blew it in the 1980’s along with millions of pounds of otherpeoples money, who are making a come-back at the moment.Have you considered what it means to be a property owner, and how much you are preparedto pay and risk to achieve this? How are you going to feel when you put your money on thetable? How are you going to feel when you spend the bank’s money? After all, it’s easy to beglib but the chances are that you won’t get a penny without signing a personal guarantee, andif it all goes horribly wrong these people will think nothing of taking the shirt off your back.So, you’re absolutely sure you want to buy property but dont have any ready money of yourown. Don’t worry. Youve heard the expression "you need money to make money". Thismay be true, in part, but it doesnt say that it has to be your money. Actually I think thatdesire, commitment and action are more important to succeed in property. If you wantsomething badly enough you will find money somewhere, somehow. You’re just going tohave to use creative thinking.There are two main places to start looking. Using very broad and general headings the firstof these is the “bank”, which includes all formal lenders and lending institutions and brokers,and the second is friends, relatives, and acquaintances including prosperous individuals youtake on as backers for specific projects.Here’s a brief guide how to get what you need. The BanksYou’ve probably already worked out for yourself that paradoxically the more money youhave the easier it is to borrow. This is how the banks operate. If you have money theyll lendyou more. If you dont have money it’s going to be hard work. The description of a bankeras being someone who will lend you an umbrella when the sun is shining but who wants itback when it rains is absolutely true.There is one thing you will have to accept from the start. Unfortunately no institutionallender is going to lend you 100% of the purchase price even if you go through a broker. Thebest you are going to get is probably 75% to 80%. You are also going to have to have pay 37
  37. 37. more in interest than on a standard residential mortgage; commercial rates are usually quotedat about 2% to 2.5 % above bank base rate but you may well be able to haggle and get thisdown by a quarter of a point. I have tried this successfully before but some lenders won’tbudge.A word of explanation, “commercial” in this context refers to your status, not the type ofproperty you are purchasing. As the loan is not for buying your principal dwelling, but sothat you can make a profit, the bank will treat you as a business. So you can be buyingresidential properties and paying “commercial” interest rates. This does not apply when youapply for a loan under the ‘Buy to Let’ Scheme which we’ll look at later.The one thing you can count on is that for all their training bank managers are not businesspeople, their role is to be administrators, and you cannot expect them to understandentrepreneurs. Unfortunately, the moment you sit down in front of a bank manager you arenegotiating from opposite interests. Business people like you and me are by definition risktakers, but bankers are conservative; it’s their job to protect their money and make sure theymake only safe, sensible loans. If you are going to succeed you will need to learn how to getaround that obstacle.Approaching a BankIf banks make their money by lending money, why do they make it such hard work toborrow from them? The answer is, of course, that bankers know that if they make the wrongloan they lose money and their jobs. This is why it’s up to you to prove you’re worth therisk.When you start it’s worth taking time to select your target bank carefully. Some banks aremore flexible than others. The big four or your high street bank may feel more comfortableto deal with but the smaller foreign banks, which are mainly clustered around centralLondon, are often prepared to be more flexible. However they are more likely to want tolend larger sums than you can afford to borrow.Before you choose a bank to make your first approach it’s worth doing some homework.Even the main high street banks vary in the way that they deal with enquiries andapplications. When I first started and wanted to borrow some money to buy a property torefurbish, I contacted all the main banks in my town to ask for an appointment to see themanager. Before they would make an appointment I was asked a few questions to find outwhat I wanted to talk about so I explained that I was interested in buying a property forrefurbishment but I wanted to establish whether in principle whether the bank would beprepared to lend to me, and if so how much. Then I could work out how much I could affordbefore I went out and spent time seriously searching.To me this seemed extremely logical. In fairness for three of the banks this wasn’t a problemand I was able to make appointments to meet the respective bank managers. However, forthe fourth bank this was impossible. I was told quite categorically that I would not beallowed to see the bank manager unless I had first found a property. In vain I tried to explainthat this was going about things backwards but this didn’t cut any ice at all. The girl on thephone wasn’t at all interested in letting me through their door and wouldn’t even transfer thecall so I could explain to someone who may understand. Needless to say I didn’t do businesswith them. 38