As Michael Porter of Harvard Business School said, “the essence of strategy is choosing what not to do”. At the heart of Porter’s view of the world is the concept of trade-offs. In a world of unlimited resources, there would be no need for trade-offs or strategy. But we live in the real world. Our resources are limited, and on a long enough timeline, the survival rate for everyone drops to zero. So, we’re going to need a property strategy, quick.
Although it might sound like rather a grand term, a strategy is nothing more than a plan to achieve your long-term goals. We’ve looked at how to set property goals previously. We’ve even touched on how to turn those goals into long term action. In this post, we’re going to look at how to turn your goals into a strategy that works for you. We’ll do that by looking at some of the key questions you should ask yourself when you’re creating that plan.
Picking a property strategy that’s right for you
Throughout the property world, there are lots of property ideas, approaches, and tactics you can use to reach your goals. These ideas are neither good nor bad in themselves. However, they might be better or worse for you depending or your goals and your specific circumstances. For example, the play that achieves the best ROI may be no good for you. This might be the case if it requires lots of time and you’re time poor. We’re going to keep things pretty high-level, rather than consider specific investment approaches. Here we’re going to cover the five key questions you should ask yourself when you’re deciding on your property strategy.
1. What’s your timeframe?
If you’ve followed our previous advice on goal setting, you’ll have set some goals that are both measurable and meaningful. One of the key factors in determining your property strategy is your timeframe for achieving those goals. For example, suppose your goal is to generate £2,500 per month in rental profits within five years. If you have £200,000 to invest over this period, you’re unlikely to achieve this with basic buy-to-let investments. So, you’ll need to look at another approach.
2. How much capital can you invest?
You should think about how much capital you have to invest. This is both in the shorter term and over the longer term via additional savings. The amount of capital you have to invest is a key determinant in how quickly you can build your portfolio. This is key to understanding whether certain strategies are open to you in the first place. For example, it may be possible to secure a discount and buy below market value if you buy in cash. But that’s only a useful approach to you if you have cash available.
3. How much time do you have?
Each investment approach will have its own time requirements. If you’re time poor and working 80 hours a week in the city, certain higher yielding strategies like houses in multiple occupation (“HMOs”) or self-management of basic buy-to-lets might be off the table. You need to be honest with yourself about the amount of time you have available. You need to think about what trade-offs you’re willing to make.
4. What’s your risk tolerance?
Each investor will have their own view of what’s risky. Each investor will also need to get comfortable with the risks inherent in the projects they’re taking on. For a conservative investor who’s not a big fan of debt, sticking to a moderate amount of leverage and investing in buy-to-lets in areas with high tenant demand might be as “risky” as they’re prepared to go. For a skilled tradesperson with good local contacts, refurbishing a property and selling it on for a profit may not seem risky at all, provided the price is right and there’s margin for error in the calculations. It’s all a matter of perspective and what works for you personally.
5. What’s your superpower?
When picking your strategy, you should think about what unique abilities you have that could unlock extra value. If you’re a great negotiator, think about how to use that. If you’re a skilled interior designer, then pick a strategy where you can use your superpower to generate supernormal profits. Carry out an audit of your skills and try to be honest with yourself. Enlist the help of a good friend or partner (not a parent) to help determine your strengths and weaknesses. Come up with a plan to work on your weaknesses and make the most of your strengths.
Common pitfalls and mistakes
There are lots of potential pitfalls and mistakes that people make when they’re picking a strategy. Here are a few common ones.
Picking something you’ll hate
Sometimes, the strategy that’s right from a financial perspective and which takes into account all your constraints turns out to be something you’ll hate. If that’s the case for you, think about how you might relax one or more of your “constraints”. For example, you might consider working to a longer timeframe or lowering your income or wealth target.
Overestimating your resources
Whether it be free time or capital to invest, lots of new property investors overestimate their available resources. Even worse is when investors don’t agree the trade-offs they’re making with their life partner. Good luck explaining that you can’t pick little Billy up from football practice, because you decided to self-manage one of your properties and the tenant just locked themselves out of the flat.
Not moving with the times
Property, like any other business, is constantly changing. Good areas to invest two years ago are yesterday’s news. Property financing strategies that once worked like a charm are no longer available. If you’re going to succeed in property (or any other business) over the long term, you need to be clear about where you want to go, but flexible about how you get there.
Finally, it’s worth a comment on celebrating your successes. Property investors (the successful ones at least) can be driven types who are good at sticking to a plan and working themselves hard to achieve remarkable things. If you fall into this camp, remember to take the time to celebrate your successes every once in a while. It doesn’t have to be reaching a big goal, it can be filing your first set of annual accounts or finding a tenant for your latest property. This kind of positive reinforcement can help keep you motivated over the long term. It will also buy you some brownie points for that time when you leave little Billy hanging. In all seriousness, be kind to yourself and celebrate your successes.
Further reading on choosing a property strategy
That brings us to the end of this post on choosing a property strategy. This post is based on a chapter from our book, The Property Investment Playbook – Volume 1, which is available on Amazon. If you enjoyed it, why not check out the book.
Until next time, best of luck with your future property endeavours.
There’s lots of talk in property investment circles about buying below market value (or BMV) properties. This fascination with buying below market value properties and BMV property deals appears to stem from the idea that buying below market value can help you grow a portfolio quicker by “baking in equity from day one”. Personally, I blame Robert Kiyosaki of Rich Dad Poor Dad fame for all his talk about no money down deals. And although it’s certainly true that buying below market properties is theoretically possible. And, it can help you to grow your portfolio quicker. It’s not an easy thing to do at all. In this post, we’re going to look at what a BMV property deal is, what it’s not, and show how buying BMV can help you.
An introduction to BMV property
Buying below market value properties is possible
To buy a property below market value first requires knowledge of the property’s market value. This is generally defined as the estimated sale price of a property agreed between a willing buyer and seller. It assumes the property is marketed properly and each party is fully aware of the characteristics of the property being sold. Crucially, it assumes that neither party is in an undue hurry to achieve a quick sale that could distort the sale price.
To see why buying BMV is possible, it’s useful to take a look at where the definition might not hold. Firstly, this includes any circumstances where the seller is keen to achieve a quick sale. For example, this might include a seller facing repossession. It could also include a seller undergoing a stressful event like a bereavement and wanting to wrap up the sale of a property as part of settling a family estate. Secondly, it also includes situations where the property has not been marketed well. This is more common than you’d think and can force sellers to reduce the price to achieve a sale. In these situations, buying below market value properties is very much possible.
But don’t believe all the hype
At this point, it’s worth acknowledging that there is a degree of subjectivity in all of this too. The market value of a property is an estimate, not a fact. And all valuations are ultimately just opinions, as they’re based on assumptions. Even a professional valuation carried out by a qualified surveyor is only expected to be accurate to within 10 per cent. The acceptable bracket can also be larger than this in more challenging circumstances. As such, it’s important to take what most investors and estate agents say about BMV opportunities with a pinch of salt. Yes, it’s all about securing a property for the cheapest possible price. However, at some point you need to ignore the hype and make up your own mind what’s right for you.
How buying below market value properties helps you
There are two ways that buying BMV can help your investment progress. One is more short term, and the other is more medium to long term.
Buying BMV property will improve your financials
Firstly, securing the property for lower than its market value will help improve the financials on a deal. Whether you’re looking for a BTL investment or a holiday rental, buying BMV will improve your yield and your ROI. Likewise, if you’re thinking about flipping properties for a profit, then buying BMV will increase your profits from the project. This is the immediate short-term benefit of buying a property BMV. These benefits are available from day-one, without any waiting necessary.
It builds equity you can tap into later
Secondly, securing a property BMV builds equity in from day-one. Say for example you manage to buy a property worth £200,000 for £180,000. That is, you secure a 10% discount to its market value. Let’s assumed that you financed the deal using a 75% LTV mortgage. Then, you’ll have put down a £45,000 deposit and taken out a £135,000 loan. However, because the property is really worth £200,000, you actually own £65,000 of equity on day-one. That is, your equity is £200,000 less your outstanding loan of £135,000. This is equity you’ll be able to tap into later (say when you remortgage) to expand your portfolio.
In practice, any equity you generate by buying BMV will likely be tied up in the property for several years. That’s because it’s almost impossible to get your lender’s surveyor (who’s likely to err on the cautious side with their valuation) to agree that a property that you just bought for £180,000 is really worth £200,000. However, if you combine this strategy with a refurbishment, you may be able to justify an immediate increase in value. Otherwise, you will need to wait at least a couple of years to extract this equity.
Where to find BMV deals
There are lots of ways to buy property BMV and plenty of places you can hunt for deals. Common strategies include buying repossessions and buying property at auction. You could also consider using a property sourcer. With most of these approaches, there’s usually some advantage that you are leveraging to secure the property BMV. This might be an ability to complete a deal quickly or bulk purchasing power. It could also be your ability to take advantage of a network of contacts. There’s lots to talk about with each of these strategies. So, we’ll return to some of these strategies in future blog posts. For now, we’ll leave our discussion of BMV property there.
Reversal
If you can achieve it, buying property below market value is one of the best things you can do to help grow your portfolio and your wealth. However, these deals are hard to achieve. After all, why would anybody willingly sell their property for less than it’s worth. And they’re certainly less common than the property gurus may lead you to believe. So, to provide some counterbalance, I want to stress that you shouldn’t let an obsession with buying BMV hold you back and prevent you from investing at all.
In the long run, buying a good rental unit at a fair price is still likely to be a positive for your finances. It’s usually better to take some action than none at all. At a certain point, you need to stop obsessing over getting the best deal possible and simply make a move. There’s a quote from Warren Buffet that’s relevant here – “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”. Put slightly differently, it’s important not to let an obsession with low prices and BMV deals prevent you making an otherwise great investment.
For more on below market value properties and BMV property deals
That brings us to the end of this post on buying below market value properties and BMV property deals. This post is based on a chapter from our book, The Property Investment Playbook – Volume 2, which is available on Amazon. If you enjoyed it, why not check out the book.
Until next time, best of luck with your future property endeavours.
This post is all about how to use the 18 year property cycle to build your portfolio over the long term. The property cycle is one of the most misused ideas in property investment. Many people have heard of it. But lots of the discussions around it are either overly simplistic or overly definitive. Many pundits use the cycle predictively to express grand views about the future direction of the market. This often includes giving very precise predictions about when the market will peak and crash. In my view, this is just not possible for markets as complex as the housing market or economic systems in general.
In this post, I’m going to try to set the record straight. I’ll give you my views on the 18 year proposed cycle and what’s possible as far as predicting the future goes. Firstly, we’ll run through the basics of the 18 year property cycle, what it is, and why it happens. Then, we’ll look at some rules you can follow to take advantage of the cycle. We’ll talk about how you can position yourself at various points in the cycle to increase your chances of success. The best you can hope for is to tip the odds in your favour. That’s because no-one knows how the future will play out. However, being able to spot the trends and avoid expensive mistakes can give you an great advantage.
What is the 18 year property cycle?
The 18 year property cycle is a sequence of recurring events, a pattern if you will, that plays out across property markets. Like other investment types, property tends to follow a fairly predictable cycle. The cycle itself has four different phases. I’m going to walk you through each of these phases with commentary on what typically happens at each stage.
The recovery phase of the 18 year property cycle
Let’s start out with the recovery phase. At the beginning of this phase, prices have just fallen in a recent market crash. Prices have in fact fallen to a level where yields are strong and cash flows are good. This is because prices have fallen more than rents. For contrarian investors with cash to spare, this is a fantastic time to be buying property.
At this point in the cycle, there will be few active buyers in the market. The average investor will have been badly burned in the crash and still licking their wounds. They may have sold at the bottom of the market and crystallised large losses. The media will be downbeat, even though the worst of the recession appears to be over and property prices have stabilised. As rents and cash flows start to increase and brave investors lend support to prices, the recovery phase starts to develop. More and more buyers acquire the confidence to re-enter the market. Property prices start to rise. This happens in the prime locations first. Early price growth happens mainly in the big cities and city centre hotspots. Then it starts to ripple out.
The boom phase of the 18 year property cycle
With the recovery gathering pace, the market will move into the explosive boom phase. At the start of the boom, it will now be clear that prices are increasing. More investors will be returning to the market. The banks will have repaired their balance sheets, and they are keen to lend again. This will provide a boost to the market, as cheap-and-easy financing increases.
House prices start to increase at a faster pace. Prime cities and city centre locations will switch into another gear. Unloved secondary locations will start to see their first price rises. Better times and an improved economic backdrop will make providers of capital more optimistic. Banks will start to forget the lessons of the last crash, as financing becomes easier still. Now, we’re well into the boom phase. Yields have fallen and higher property prices have made cash flows less strong, except perhaps in secondary locations. Savvy investors are struggling to make property deals work. They can’t find value anywhere, so they stop striking deals. They might even sell a property or two to lock-in their gains, but no-one will pay attention. The public, encouraged by the recent price rises, begin to speculate on property. Property shows are once again all over the airwaves.
The mania phase of the 18 year property cycle
At a certain point, logic appears to leave the market and groupthink takes over. We’re now entering the mania phase. Banks have relaxed lending criteria as far as they can go. Credit standards are what can only be described as lax. The higher prices go, the more everyone believes that they will continue to do so. The vast amount of money pouring into the market keeps prices going up and up. We’re now into the last couple of years of the explosive boom phase. This is often called the “winner’s curse”. If you’re person who buys at the peak, then you’re the one who takes the hit in the crash. And the next crash is just around the corner.
The crash or slump phase of the 18 year property cycle
Just before the crash, the market is driven purely by sentiment, not fundamentals. At some point, confidence starts to dip a little. The banks begin to look at their ballooning loan books and worry about whether these loans will be repaid. Financing suddenly dries up, almost overnight it seems. And confidence evaporates completely, taking the market with it.
Property prices plummet. Individuals and investors who are over-leveraged will go bankrupt. This triggers a wave of repossessions and forced sales which add to the downward pressure on prices. The media stokes the fire with bad news headlines. And speculators who bought at the peak and are in negative cash flow positions sell up, crystallising their losses.
After a year or two of falling prices and bad economic data, we start to see the first green shoots of recovery. Unemployment peaks and rents stop falling. Brave investors start to look at deals again. To their surprise, some of these deals start to look attractive. If only they could raise the capital to invest. The odd bank agrees to start lending again, albeit the financing terms are tougher. Investors are asked to put more money down on deals. The recovery phase gets underway, and the cycle starts again.
The length of a typical cycle
In the narrative above, I’ve described how elements such as investor psychology, attitudes to risk and availability of financing feed into the property cycle. These are elements most financial cycles have in common, including the property cycle. But the 18 year property cycle incorporates one other element that other financial cycles don’t share, and that’s long lead times.
The impact of long lead times
In the property market, there can be significant lead times before buildings come on to the market to meet additional demand. Developers need to carry out economic feasibility studies. They need to find and purchase a new piece of land or a development site. The building has to be designed, planning permissions have to be granted, and financing has to be secured. And all this needs to take place before developers can put a spade in the ground. All in all, the property development process can take years. For a major project, the process can take more than a decade from start to finish.
Long lead times in the development process are then a major driver on the supply side. This influences the length of a typical property cycle. Property cycles can in practice last anywhere between 15 and 25 years from peak to peak or from crash to crash. The cycle can also interact with other cycles in the wider economy. The important thing to remember is that property prices generally increase in line with inflation over the long term. But the cycle means these price increases don’t happen in a straight line. Prices will increase faster in the boom phase, and they will fall or stagnate in the crash or slump phase. But the overall trend is generally upwards and in line with inflation.
Spotting where we are in the cycle
We can get some clues on where we are in the cycle by looking at the things going on around us. For example, in the recovery, we’ll have recently experienced a fall in prices and property will be out-of-favour. Plenty of people will be in negative equity, and the press headlines will be downbeat. Financing will be hard to get, and building projects started in the boom will be left unfinished. The odd brave developer might take on one of these projects as a repossession, and as activity starts to pick up, prices start to rise a little.
In the boom phase, lenders will be lending, and builders will now be building. People will have forgotten the pain of the last crash and property will attract headlines as prices soar. Lots of new building projects will be started and cranes will fill the skyline. In the final years of a boom, the media will be blurting out all kinds of nonsense. Financing will be cheap, and massive vanity projects like huge skyscrapers will be announced. Prices will make no sense. It will feel like a bubble, because it is one. Then comes the crash or slump. No description is needed. You’ll know when you’re in a crash.
How to use the 18 year property cycle
To finish off this post, I’m going to look at how you can use the property cycle to grow your portfolio. I’m going to give you my five golden rules of portfolio building. Some of these are straightforward. However, one of the hardest things to do over the long term is to keep your investment focus crystal clear and to keep your head when others around you are losing theirs. I hope you will keep these golden rules in mind over the years.
Golden rule # 1 – Only invest in properties that provide cash flow
This really is the most important rule of property investing. If a property doesn’t provide you with a monthly cash, preferably one with a good margin for safety, then you shouldn’t be doing the deal in the first place.
When it comes to the property cycle, the best time to be buying from a cash flow perspective is in the recovery phase and at the start of the boom. Later on in the cycle, yields will have fallen, and cash flow will be hard to find. That doesn’t mean you shouldn’t be investing at all later in the cycle, but it does mean you’ll likely have a much harder time striking good deals.
If you follow this rule diligently, it’ll mean being more aggressive and ramping up your investing activities when cash flows are at their strongest in the early part of the cycle. It’ll also mean refraining from bad deals later in the cycle.
Golden rule # 2 – Use the ripple effect to your advantage
Predicting which areas and which properties will experience good capital growth in the future is a difficult thing to do. The best tool in the property investor’s tool kit is to try to take advantage of the ripple effect.
As we saw above, different towns and cities experience growth at different points in the cycle. Let’s take the 2007-2008 global financial crisis for instance. After falling to a low in 2009, property prices rebounded in London. First, we saw growth in the prime areas of central London, then price increases rippled out to the surrounding areas. It took several years before prices in Leeds started to rise. Between 2014 and 2018, however, prime properties in the city centre of Leeds experienced strong growth, but properties on the outskirts of town have yet to experience major growth.
Let’s try to generalise this rule. Early in the cycle, properties in prime cities and prime locations will likely experience the first bout of capital growth. This growth will start to make properties slightly further out look comparatively cheaper, and so price growth will ripple out. To take advantage of the ripple effect, you need to buy in the right location at the right time. You’ll need to study how prices are increasing in different area at various points in the cycle and try to buy in ahead of the trend.
Golden rule # 3 – Manage your leverage carefully
If you’ve bought well during the recovery phase and used the ripple effect to your advantage, you may well have experienced strong capital growth by the later part of the cycle. At this point, you might be tempted to remortgage one or more of your properties and pull out some of your capital to expand your portfolio. If you do decide to do this, make sure you model the impact on cash flows (see Golden rule # 1). The increase in borrowings will increase your finance costs and reduce your cash flow. So, only do this if the property has experienced an increase in market rent and cash flows.
Some investors, I’m one of them, like to keep an unencumbered property or two in their portfolio. Having properties with no mortgage means you’ll have a stronger monthly cash flow to ride out any dip in market rents or an increase in interest rates. You’ll also have a strategic asset you can sell or mortgage, if you suddenly need to find a chunk of cash quickly. Being over-leveraged is the biggest risk for property investors, so make sure that you manage this risk carefully
Golden rule # 4 – Avoid the winner’s curse
The last couple of years of the boom period are the winner’s curse. Avoid it like the plague. In short, don’t buy any new investment properties and don’t refinance. Use this time to get ready for the crash that’s coming.
Golden rule # 5 – Build a tactical cash buffer before the slump
We’ve all heard the Warren Buffett quote “we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”. Well, Golden Rule # 4 covers the first part, but what about the second bit of this mantra?
To take advantage of a crash or slump, you’ll need to build up your resources during the boom phase to take advantage of the crash. You should aim to build as big a cash buffer as you can in the years before the slump. If you’ve stopped doing deals and your cash flows are strong, then this should be achievable. Likewise, if you’ve kept one or more properties unencumbered, there may be creative things you can do to secure new borrowings.
Finally, managing your emotions will also be key here. You’ll feel like you’re missing out on the end of the boom phase and that you could be putting that cash to much better use, but don’t. Stay disciplined, and you’ll be thankful. Controlling your emotions and sticking to your principles is actually the hardest part about investing for many people, so don’t overlook this point. Investing with a partner and making decisions together can help here, as can coming up with a set of financial metrics or decision-making rules that define when you will and won’t invest.
Further reading on the 18 year property cycle
That brings us to the end of this post on the 18 year property cycle. This post is based on a chapter from our book, The Property Investment Playbook – Volume 2, which is available on Amazon. If you enjoyed it, why not check out the book.
Until next time, best of luck with your future property endeavours.
If you bought a home a number of years ago, you may well have a decent chunk of accrued equity. You might also be thinking about using this equity as a deposit for future property deals. It’s a simple idea that property investors casually throw around in conversation. But how do you go about doing something like this and what are the keys to getting it right? We’ll take a look at all this and more in this post.
A worked example
Assessing the equity available
This strategy is relatively straightforward and it’s easy to execute. Let’s take a look at a simple example. Let’s say you and your family bought a home ten years ago for £120,000. You used a 75% loan-to-value repayment mortgage to finance the deal at a 2% interest rate with a term of 25 years. That means you put down a deposit of £30,000. You also took out a mortgage of £90,000, which you’ve been paying down since.
Ten years and 120 mortgage payments later, the property has seen good capital growth. Its market value is now estimated to be around £180,000. In addition, we’ve been making monthly repayments against the loan. So, the amount we owe has decreased from £90,000 to £60,000. Taken altogether, that means we have £180,000 − £60,000 = £120,000 of equity accrued in the property. We can potentially use some of this to finance future deals.
Pulling out the funds
In order to pull out the cash to invest, we’ll need to remortgage. Let’s build off the example above. Suppose we decided to remortgage the property based on the £180,000 valuation using a new 75% loan-to-value mortgage. This would leave 25% × £180,000 = £45,000 of equity in our property. We would take out a new loan for 75% × £180,000 = £135,000. We repay the £60,000 outstanding loan amount on the original mortgage. This leaves us with £75,000 of cash in our bank account to invest in new property deals.
The impact of the remortgage
That’s the easy bit over with. The harder part is understanding whether it makes good financial sense to use the equity we’ve accrued in this way. To understand this, we’ll need to do a few more calculations.
Impact on our mortgage repayments
When we went through the remortgage, we increased our outstanding loan from £60,000 to £135,000. That is, we borrowed an additional £75,000. As a result, our mortgage payments will have increased. You can use your favourite online mortgage calculator to check the following figures are correct. We have one available on the Essential Property website here. However, the refinance will increase your mortgage payments from £382 per month to £572 per month, assuming we’re still able to secure a 2% interest rate (the same as the original loan) and that we respread the £135,000 loan amount after the remortgage over a new 25 year mortgage term starting at the refinance date. That is, our monthly mortgage payments will increase by £190.
The returns from investing the capital raised
Let’s take a look at the other side of the coin, i.e. what we’ll do with the money raised. Well, if we invest the £75,000 of cash raised in buy-to-let deals that generate an ROI of 6%, then your new investments will generate 6% × £75,000 = £4,500 per year or £375 per month before tax. Overall, we’ve been able to improve our cash flow by £375 − £190 = £185 per month. This is before we take tax into account. In addition, because we’ve taken out a new repayment mortgage, we’ll again be building up equity in our home afterwards.
We also have a bigger property portfolio
Finally, it’s also worth noting that by using the equity in our own home in this way, we’ve also been able to expand the size of our property portfolio. Before the remortgage, we owned one property worth £180,000. Afterwards, we might own additional properties worth £75,000 ÷ 0.25 = £300,000. That’s the case if we bought the extra buy-to-let properties using a 75% loan-to-value mortgage. So, the total value of our portfolio is now £480,000. We’re more leveraged, of course. However, this increase in the size of our portfolio positions us nicely if property prices continue to rise in the future. This strategy has the potential to seriously increase our net worth over the long term.
Keys to success
As with all of these strategies, there are things you need to do to get it right. Here are a few of the keys to success for this approach.
Make sure your partner is onboard
Anything to do with your own home has the potential to be emotive. You should make sure your partner is onboard with this strategy and that they understand the benefits and risks it can bring. If they’re struggling with the concept, you could always consider taking out less equity.
Getting confident with the numbers
The figures we looked at above worked because the ROI we were projecting on the new investment was high enough. To make this worthwhile, you need to get confident that the ROI you can achieve is significantly in excess of the interest rate on your mortgage.
Getting comfortable with debt
This play only works if you’re comfortable taking on extra debt and increasing your leverage. It’s best to avoid this play in the latter stages of the property cycle. This is because the ROI on new investments will likely be low at this stage in the cycle.
Use a good mortgage broker
I would always recommend using a mortgage broker when you’re refinancing any deal. However, they can be particularly useful with this strategy. They can help you get the best rate and explore the impact on your monthly cash flow of various loan-to-value options.
Watch out for early repayment charges
When you remortgage with a new provider (as opposed to a product transfer with your existing lender) you’re using the new loan to pay off the previous lender. If you’re still in your fixed-rate period, you should watch out for any early repayment charges.
Using equity as a deposit – Reversal
There are times in life when this approach is not the right one for some people. If you’re later in life and your children have flown the nest, you may be better off selling the property, locking in those gains, and then downsizing your home. With new mortgage products coming on to the market all the time for those later in life, you might still be able to get a mortgage on your new home purchase, and it could unlock even more funds to plough back into future investments.
Likewise, if you’ve got a young family and might soon need a bigger place, you may want to use the equity you’ve accrued as a deposit on the new home instead. Although the cold calculated, numbers-driven investor in me is at pains to admit it, there are times in life when other things are more important than making an optimal investment decision. Starting a new family and bringing children into the world are certainly amongst them.
Further reading on using equity as a deposit
That brings us to the end of this post on using equity as a deposit. This post is based on a chapter from our book, The Property Investment Playbook – Volume 1, which is available on Amazon. If you enjoyed it, why not check out the book.
Until next time, best of luck with your future property endeavours.
The biggest problem most people face when trying to work out how to build a property portfolio is a lack of funds. There’s no quick and easy fix to this problem. However, there are strategies you can employ to stretch your capital further. In this post, we’ll look at one of the techniques property investors can use to lower the capital they need. This is known in property circles as “buy, refurbish, rent out, and refinance” or BRRR for short. We’ll look at how this strategy works, the risks you’ll face in execution and the keys to success.
How to build a property portfolio with BRRR
The basic idea behind this strategy is straightforward. You buy a property, carry out a refurbishment, rent it out, and refinance it. This releases some (potentially all) of your capital, lowering the amount of cash tied up in the property. The strategy shares a number of similarities with property flips. Firstly, the core principle at work here is that you need to “add value” to the property. Therefore, you should focus your efforts on those areas that will add the most value to the final price. Secondly, you need to know your end market well. That is, you need to be confident you can refinance at your target price. Lastly, it means you’re likely to be taking on projects which need a heavier refurbishment. That’s where the potential to add value and drive an uplift in the market value can be greater than the cost of the works.
Aims and objectives
In this post, we’ll look at how this strategy works with a simple buy-to-let investment as the end goal. At a high level, this strategy has two principal aims and objectives:
To lower the capital required – If you get it right, you should be able to cut down the amount of capital tied up in the final investment.
To build your wealth and income faster – By “forcing equity” and leaving less money tied up, you can build wealth and income faster.
With this strategy, it’s all about finding the right property to work on. You’re looking for a property that needs a bit more work than most people are prepared to do. Then, you’re using this to help you strike a better deal. At this same time, you’re looking for a property you’d be prepared to buy and hold for the long term. Therefore, the refurbished property needs to meet all the investment criteria you would apply to a regular buy-to-let. This will include your target capitalisation rate and ROI, and the property’s potential for capital growth.
A worked example
Let’s look at a worked example. We’ll start with the figures for a basic buy-to-let investment. Then, we’ll compare these figures with what we could achieve using BRRR.
The basic buy-to-let investment
Our basic buy-to-let investment, Property A, is a two-bedroom apartment near Leeds City Centre. Our key assumptions are as follows. We can secure the property for £160,000. The deal is financed by a 75% loan-to-value interest only mortgage at a 3% p.a. interest rate. The flat needs no work, but we let the property out furnished, with the cost of furnishings being around £2,000. Our investment generates £208 of profit per month or around £2,496 per year before tax. Our total cash tied up in the deal, after allowing for the additional cost of stamp duty, legal expenses, etc, is £50,000.
The equivalent BRRR investment
Suppose that instead of buying a basic buy-to-let investment that’s ready-to-go, we buy a similar property in need of a refurbishment. This is our equivalent BRRR buy-to-let property. We’re going to assume that because the property needs a lot of work, we can secure it for a knock-down price of £110,000. We’ll spend time, money and effort bringing it back up to standard to reinstate its “true” market value of £160,000. Our assumptions are as follows. We purchase the property using a 70% bridging loan. The building works will cost around £20,000, including a 10% contingency fund. We incur financing costs of £8,430 in relation to the bridging finance, with an estimated time of six months to complete the works and an additional two months to complete the refinancing.
How to build a property portfolio – An example of BRRR at work
Property A
Property B
Purchase price
£160,000
£110,000
Deal financing
Financing method
Mortgage
Bridging
Loan-to-value
75%
70%
Loan amount
£120,000
£77,000
Deposit
£40,000
£33,000
Cash invested
Deposit
£40,000
£33,000
Stamp duty
£5,500
£3,300
Furnishing costs
£2,000
£2,000
Building works (with 10% contingency)
–
£20,000
Financing costs (see later for breakdown)
–
£8,430
Fees (e.g. valuation, survey, legal advice)
£2,500
£2,500
Total cash invested
£50,000
£69,230
How to build a property portfolio with 50k – Example of BRRR at work
The figures above set out the total cash invested for both deals. For our basic buy-to-let investment, this is £50,000. This includes the deposit plus costs like stamp duty, furnishings and fees related to the purchase. For our equivalent BRRR investment, we’ve invested cash totalling £69,230 before we refinance. This includes the cost of the deposit, stamp duty, furnishings and fees related to the property purchase. However, it also includes the additional cost of the building works and the bridging finance.
Here comes the magic
At this point, we’ve invested more cash in the equivalent BRRR deal than the basic buy-to-let. However, all that’s about to change. With the works complete, we’re going to refinance the property using a traditional mortgage. For this, we’re going to assume we can refinance using an equivalent mortgage to that used in the basic buy-to-let example. That is, we will use a 75% loan-to-value interest only mortgage at a 3% p.a. interest rate. When we do so, we’ll borrow 75% of the uplifted value of £160,000. That’s what we (and hopefully the mortgage provider) believe the property is worth. So, we’ll borrow £120,000 (75% × £160,000). Then, we’ll use this to pay off the bridging loan of £77,000. Let’s take a look at how this works.
How to build a property portfolio – How the refinancing element works
Total cash invested before refinancing
£69,230
Less: Money received from new loan (75% × £160,000)
(£120,000)
Plus: Repayment of bridging loan (70% ×£110,000)
£77,000
Total cash invested after refinancing
£26,230
How to build a property portfolio with 50k – How the BRRR refinancing works
We originally invested £69,230 in the BRRR deal, but the refinancing allows us to take £43,000 out of the deal. This is simply the difference between the new borrowing of £120,000 and the outstanding bridging loan of £77,000. Therefore, we’ve now got just £26,230 of our cash tied up in the deal, compared with £50,000 for the basic buy-to-let investment.
The impact on ROI and our net worth
The impact on our ROI
Let’s take a look at the overall impact of this strategy on the ROI achieved. We’re going to assume that the final profit and cash flow achieved is the same for both Property A and Property B. That is, both will generate an annual pre-tax profit of £2,496. However, the ROI achieved with the BRRR strategy is higher, owing to the smaller amount of cash needed. The basic buy-to-let investment generates an ROI of 5.0% p.a. (£2,496 ÷ £50,000 cash invested) before tax. The equivalent BRRR investment generates a pre-tax ROI of 9.5% p.a. (£2,496 ÷ £26,230). That is almost double the ROI. This makes sense, as the investments generate the sameprofit, but the BRRR deal leaves us with less cash invested in the deal.
The impact on our net worth
The BRRR strategy is also a more effective wealth-building tool. Let’s take a look at why. With the basic buy-to-let investment, we’ve acquired assets worth £42,000 through the purchase of Property A. That is, we own £40,000 of equity in the property (market value of £160,000 less the outstanding loan of £120,000) plus the furnishings which are worth £2,000. We’ve acquired these assets for a total cash investment of £50,000. However, with the equivalent BRRR investment, we have acquired the same assets worth £42,000 for a cash investment of £26,230. In short, we have spent £23,770 less (£50,000 less £26,230) with the BRRR strategy to acquire the same assets. We’ve done this by driving a hard bargain during the initial purchase and by using a refurbishment to add value.
A word on bridging finance
In general, it’s not appropriate to use a mortgage to finance the initial purchase using BRRR. Mortgages are a longer-term financing product and they’re supposed to be held for a number of years. So, even if you are able to find a mortgage product that doesn’t have any specific penalties for early repayment, lenders don’t like it if you refinance too soon after the initial purchase. So, if you are planning to refinance quickly after your refurb is complete, you’ll need to use bridging finance instead.
Recap on bridging finance
To recap, bridging loans up to 70% loan-to-value are typically available for this kind of project. The fees you pay tend to vary quite a bit between lenders. In the worked example above, I’ve estimated the financing costs associated with the bridging loan as the sum of the following:
an initial valuation fee, e.g. £500 in this example
an arrangement fee of 1%-2% of the loan, e.g. 1% × £77,000 = £770
the interest costs, e.g. 1% per month × 8 months × £77,000 = £6,160
the lender’s legal fees, e.g. assumed to be £1,000 here
In this example, the fees and charges come to £8,430. However, in practice there could be other charges on top. Some lenders add exit-fees, which might be say 1% of the amount borrowed. Also, if you arrange the loan through a broker, their fee could be up to 1% of the loan amount. So, it isn’t cheap, but it can give you access to projects you don’t have the savings for yourself. Just make sure the costs are factored in to your calculations.
An alternative option
If you’re prepared to wait for a number of years before you carry out the refinancing step and live with having a larger amount of cash tied up in the deal over this period, you could consider using a traditional mortgage instead. In this case, you should opt for a short, fixed rate mortgage of say two years. You can then refinance at the end of this period.
The reality of how to build a property portfolio more quickly
Now that we understand how BRRR works, it’s worth discussing when it works well what kinds of results are possible.
What types of markets work best?
BRRR opportunities are easiest to find when the general activity in a local market is slightly depressed. When there are few buyers but ample sellers and when there’s a lack of competition for these types of projects, you’re more likely to be able to secure the property for a lower price. This will give you the best chance of securing the margin you need to recycle part of your cash. However, you need to be confident you can refinance at your target price. So, there needs to be sufficient activity to be able to point to those recent sales and comparables.
What types of areas work best?
You want to be hunting for these deals in areas that haven’t yet become the next property hotspot. An area that’s on-the-up and at the early stages of a turnaround is ideal. You can use the fact the area is becoming fashionable to your advantage and to lower your downside risk. That is, given the choice between an area where prices in general are increasing and one where they’re decreasing, pick the former. At the very least, you should pick an area where you expect local prices will remain stable over the time frame of the refurbishment. The fact that you’re going to rent the property out rather than sell it on also means you’ll want the property to meet your regular investment criteria as far as ROI, yield and capital growth prospects are concerned.
What does good look like?
If you do everything right and you don’t have any hiccups, you should be able to achieve good results with this approach. But what does good look like? For us, good means the following: (a) being able to pull out half or more of the cash you’ve invested after the refinancing; (b) securing a decent uplift in the final ROI versus a basic buy-to-let investment. Both these elements need to be present in a BRRR deal to justify the time and effort that goes into a project like this. It’s sometimes possible to achieve even better results than this. There are stories of experienced investors being able to pull out all of the cash they’ve invested and achieving an infinite ROI. These deals are rare in practice, but they do make for fantastic headlines.
Common pitfalls and mistakes
There are plenty of potential risks with a project like this. The sheer number of letters in the BRRR acronym is a dead giveaway. Let’s run through some of the main pitfalls and mistakes and how you can avoid them.
Getting your figures wrong
Overestimating the property’s market value or underestimating the cost of the building works can be fatal. Be conservative with your estimates and build in a margin for prudence.
Buying in an area with few comparables
When it’s time to remortgage, it will be harder to secure your target price if there are few comparables. To boost your chances of success, make sure you buy in an area with enough market activity.
Buying before a market fall
A fall in property prices in the local area will make it harder to refinance on the terms required, and your cash could be tied up for longer. Although there’s no easy way to protect against this, you can avoid buying late in the property cycle and keep your projects as short as possible. Both of these steps will reduce the chances of a general market fall affecting the outcome of your project.
Trying to move too quickly
Although you should try to keep projects short, in most circumstances you won’t be able to refinance until you’ve owned the property for six months or more. Make sure you build in at least six to eight months of payments on your bridging loan.
Not having a cash buffer or contingency fund
This type of strategy tends to attract investors who are looking to stretch their investment capital further. However, things can and will go wrong on complex projects like this, and you don’t want to run out of cash midway through.
Before you embark on a venture like this, think through all the things that could go wrong. Have a plan to deal with each of these scenarios. It will take some of the stress out of the project, and it help you make better decisions when challenges arise.
Keys to success
We’ve covered some of the keys to success as we’ve gone through the details in this post. However, there are some additional things you can do to maximise your chances of success. Here are a few more of our top tips.
Consider a range of scenarios
If there are a range of refurbishment options available, consider modelling each scenario separately and see which one gives the best outcome.
Prepare some sensitivity analysis
The final outcome of a BRRR project can be susceptible to changes in the variables. This includes the development costs, financing costs, and the market value at refinancing. You can use sensitivity analysis to show how both the cash left in the deal and ROI might change as these key variables change. This can be useful for ballparking the range of potential outcomes and making sure the project is likely to be a success, even if one or more of the key variables goes against you in the execution.
Marketing the property early
When the refurb is nearing its end, you should start marketing the property or ask your letting agent to start promoting the property to prospective tenants. The income generated will help cover the cost of the bridging loan until the refinancing is complete.
Don’t leave the refinancing to chance
Although it’s not fully in your control, you should do everything in your power to demonstrate to the lender the value you’ve added. This will help you remortgage the property at the desired price. Supply the lender with before and after photos of the property, along with a full schedule of the works completed and their cost. There are no guarantees, but being proactive here will definitely help.
Consider whether to go all cash
We’ve talked about using a bridging loan to finance your project, but if you do have the cash available, you could consider a cash-only execution. Buying the property in cash can help you drive an even better price reduction at the outset. It also lowers the cost of the project, as you no longer have to cover the cost of bridging finance. Also, it can buy you time to ride out a dip in the local market, if prices do fall.
Consider a specialist mortgage
On a similar vein to the previous point, there are some specialist mortgage products in the market precisely for this kind of project. These are products where the lender provides a loan based on the original purchase price, then agrees to advance you funds based on the new higher value once you’ve completed the works. The interest rates tend to be lower than bridging finance, and it saves you paying two sets of fees.
Have a back-up plan
Have a back-up plan. It’s worth considering and fleshing out a plan B, in case you can’t refinance on the terms you need. If you’re not prepared to leave your cash tied up in the investment, you could consider selling the property. If you’re right about the market value, you’ll see a profit on sale.
Finally, it’s also worth noting that the financing products available are constantly evolving, so if you’re planning on making BRRR a core part of strategy, make sure you have access to a good broker with strong ties to this market and stay on top of the latest developments. Better still, involve your broker in the planning to see if they can add some value. I promise you won’t regret it.
Redux
This basic idea can be extended to other types of deal and other property rental businesses, including holiday lets, serviced accommodation and even HMOs. Therefore, when you’re thinking about how to build a property portfolio more quickly, you should also be thinking about how you can use it in combination with the other property strategies. There are also other ways to add value to a property, including things like solving a structural problem, extending the lease or solving a tricky legal issue, or simply riding out a difficult and uncertain situation, e.g. think about cladding issues.
How to build a property portfolio – Wrapping it up
This is an approach which requires strong numbers skills, good old fashioned graft, and the mental resilience to see each step through. It’s not a strategy for the faint-hearted, and there are risks you’ll need to manage along the way. However, if you’re prepared to put in the hard work, this is a great way to build your portfolio. At its core, this strategy is about stretching your capital further, and you can use it to build a larger portfolio for a fraction of the money required with basic buy-to-lets. The upfront cash requirements are actually higher than for a basic buy-to-let investment, as you’ll need to cover the cost of the building works. But you’ll get the money back on refinancing. This strategy is well-suited to investors with good refurb skills, a strong network of tradespeople, and time on their hands to carefully manage each step in the process.
Further reading on how to build a property portfolio
That brings us to the end of this post on how to build a property portfolio more quickly using the BRRR strategy. This post is based on a chapter from our latest book, The Property Investment Playbook – Volume 2, which is available on Amazon. If you enjoyed it, why not check out the book.
Until next time, best of luck with your future property endeavours.
It’s not the sexist topic, but saving up for that first deposit is super important. It’s important because the quicker you make it happen, the quicker you feel the benefits of compounding. That is, the quicker the “snowball effect” kicks in, and the faster you can start to build real wealth through property.
In this post, we’ll look at how to calculate the amount you need to save for your first investment. We’ll also look at where to stash your cash while you’re waiting to invest. We’ll discuss some of the Government schemes you might be able to take advantage of along the way. And, using some simple calculations, we’ll show you how the snowball effect can start to do some of the hard work for you over time, as your portfolio grows.
Calculating your savings target
How much you need to save for your first investment depends on where you’re planning to invest. It also depends on the kind of property you want to buy. If you’re planning to invest in a northern powerhouse city like Manchester, Liverpool or Leeds, you’ll need less cash than if you plan to invest further south. Also, you’ll need less money down if you’re planning to buy a one-bedroom apartment, as opposed to a three-bedroom family house.
A simple example
Let’s take a simple example and walk through how to calculate the amount you’ll need. I’m going to assume you’re aiming to buy a two-bedroom apartment for £160,000 somewhere in the north.
The deposit – For a simple buy-to-let investment, you’ll need to put down a deposit of at least 25% of the purchase price. So, you’ll need to save at least £40,000 for the deposit.
Stamp duty land tax – You’ll need to pay stamp duty of £5,500 on a property worth £160,000. This figure includes the stamp duty surcharge you’re subject to as a UK property investor.
Furnishing and redecoration – If you plan to do any redecoration after you buy the property, you’ll need to pay these costs upfront. Let’s assume we’ll spend £2,000 on redecoration and £1,500 on furnishings.
Legal and other fees – Legal fees could be up to £2,000. This includes the cost of independent legal advice on personal guarantees, if you’re investing through a limited company. In addition, the mortgage valuation fee might be £500, and a mortgage broker could be £500.
Therefore, you’d need to save £52,000 to do this deal. This includes all the funds you need to get the property into a great condition to let out.
Adapting these workings
You can adapt these workings as needed to set your own savings target. You should base your figures on the areas you’re looking to invest and the kind of properties you’re planning to buy. Remember to make sure you’re working from the latest stamp duty rates and thresholds. You can find the latest rates on the gov.uk website. Also, remember to make sure you build in the 3% surcharge for second homes.
Where to invest your funds
Depending on your target, it could take a number of years to build up enough funds for your first deal. While you’re waiting, you should keep your savings somewhere safe. Also, you should try to generate some extra return by investing them. This will lower the amount you need to save to meet your target, so it will help you get there a little bit quicker. Let’s look at some key considerations when choosing where to park your monies.
Time horizon
Your investment time horizon is likely to be fairly short. That is, you’ll probably want to withdraw your funds in a couple of years’ time at the point where you’re ready to invest. In practice, therefore, you won’t want to keep your savings locked away for periods longer than one or two years. So, this will rule out fixed-term, higher rate savings accounts that keep your money tied. It will also rule out a variety of long-term bonds, e.g. five or ten-year government and corporate bonds.
Volatility
Because your investment time horizon is short, you should avoid asset classes that are too volatile. In practice, this means you should avoid the stock market, cryptocurrencies like Bitcoin, and investments where the volatility is typically in excess of 15% to 20% per annum. Afterall, you don’t want to save hard for two years to build a deposit of £50,000 only to have the stock market crash and the value of your savings fall to £30,000. Falls of this magnitude are possible in the stock market at times of market turmoil and stress. Therefore, you should make sure you’re not exposed to this risk.
Tax efficiency
Finally, you should also look for savings options that are tax efficient. In the UK, you might, depending on your circumstances, need to pay tax on savings interest. You can check out the gov.uk website for full details on the various rules and allowances that cover tax on savings. In practice, it’s often simpler and easier to stick with one of the tax-exempt savings vehicles. This includes cash ISAs (Individual Savings Accounts) or Premium Bonds, offered by NS&I. The prizes on Premium Bonds are tax-free, and the effective interest rate is better than you’d get in most bank accounts right now.
Schemes to help you out
It’s also worth thinking about whether there are any government schemes you could use to speed up your progress. You won’t be able to use them to invest in buy-to-let properties or to carry out that next flip. However, these schemes might help you if buying, refurbishing or extending your own home forms part of your property strategy.
The Lifetime ISA
You can use a Lifetime ISA to buy your first home or save for later life. The general idea is that you can put in up to £4,000 each year and the Government will add a 25% bonus to your savings, up to a maximum of £1,000 per year. You can withdraw your money and use it to buy your first home, provided that the property costs £450,000 or less.
Help to Buy Equity Loan
With the Help to Buy Equity Loan, you can get a low interest loan from the Government to put towards a deposit.
The home must be a new build available through one of the Help to Buy Agents and be the only property you own. You can’t sublet it or rent it out. The price must be less than £600,000 in England (or £300,000 in Wales). You need to put in a 5% deposit, the Government will lend you up to 20% to top up your deposit, and the rest you’ll buy with a mortgage. You pay no interest on the Government loan for the first five years. After that, you’ll be charged a fee of 1.75% p.a. of the loan value.
You’ll need to pay back the loan when you sell the property. The amount you pay back will be scaled up or down in line with the increase or decrease in the market value of the property.
Staying up to date
These kinds of schemes change all the time, so you should make sure to check out what’s available to you at the time you’re deciding on your own strategy. Check out the gov.uk website for the latest detail on all these schemes.
Also, don’t fall into the trap of letting the tail wag the dog. That is, don’t let your strategy be determined by one particular scheme. If you find you’re trying to twist your plans and tactics just to make use of a particular scheme, then it might not be right for you in the long run anyway.
What is the snowball effect?
Getting started in property is hard. It takes a special kind of determination and belief to stick with it over the long term, setting aside savings month after month, year after year, with an uncertain future payoff. But for those who stick with it, the rewards can be handsome, and at some point the snowball effect will start to help you out along the way.
To illustrate how this concept works, let’s take a look at the length of time it could take for us to save for each extra property that we’re planning to purchase. There’s no fancy mathematics here, and we’re not employing any other strategies that might speed up your journey. We’re simply taking a look at how long it would take us to grow a portfolio of 20 properties through the brute force approach, i.e. via raw savings power only.
The snowball effect in action
Suppose we’re aiming to buy several properties around the £160,000 mark. Per our example above, we’ll need to save around £50,000 for each deal. Therefore, let’s assumes that we’re capable of saving around £2,000 per month or £24,000 per year. This means it will take us £50,000 ÷ £24,000 = 2.1 years to save for our first deal. However, if we achieve an ROI of 6% p.a. on our cash, then our first property will generate £50,000 × 0.06 = £3,000 per annum or £250 per month of additional cash flow, which will help us save for our next property deal more quickly.
In the table below, I’ve set out how long it will take us to save for each property in our portfolio using this approach.
Property
Annual savings
Time taken to save
1
£24,000
2.1 years
2
£27,000
1.9 years
3
£30,000
1.7 years
4
£33,000
1.5 years
5
£36,000
1.4 years
6
£39,000
1.3 years
7
£42,000
1.2 years
8
£45,000
1.1 years
9
£48,000
1.0 years
10
£51,000
1.0 years
11
£54,000
0.9 years
12
£57,000
0.9 years
13
£60,000
0.8 years
14
£63,000
0.8 years
15
£66,000
0.8 years
16
£69,000
0.7 years
17
£72,000
0.7 years
18
£75,000
0.7 years
19
£78,000
0.6 years
20
£81,000
0.6 years
The Snowball Effect – Time taken to save for each property
The power of the snowball effect
From the table, you can see that it will take us 8.6 years to save for our first five properties, 5.6 years to save for our next five properties, 4.2 years for the next five, and 3.3 years for the last five. That’s the power of compounding and the snowball effect. Therefore, even if you started your property journey at 45 years old, you could still grow a portfolio of 20 properties bringing in £5,000 per month by the time you retire. With the help of some capital growth along the way, you might even be able to do a lot better than this.
Further reading on saving and the snowball effect
That brings us to the end of this post on saving for your first investment and the snowball effect. If you get disheartened or need a positive reminder of why you’re doing all this, I hope you’ll re-read this post on the snowball effect and that it will help you see the light at the end of the tunnel.
If you’re looking for some specific advice on saving, then you might like to check out the following websites:
