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How to calculate your REAL return on Investment: 5% becomes 35%

The REAL Return on Investment

Traditionally property return on investment is calculated by rental yield, especially when it is being compared to returns of other types of investments. However I believe it is a much more exact science, and can vary significantly depending on specific properties and on how the investor structured the deal when purchasing the property. A traditional yield of 5% can actually be 35% if the deal is right.

Let me start with a simple example. A two bedroom flat, bought with standard Buy-to-let 75% finance, at 5% interest only for £200,000 that is renting out for £10,000 per year. Traditional yield will be 5% (rent/value=10/200=5%). Under the way I calculate it, the rent less the mortgage interest divided by initial money in, therefore for this deal ((£10,000-£7,500)/ £50,000) so its 5%. The “real” return on investment is still the same.

But wait, what about capital gains, this is still a form of returns even though they may only be realised at a much later stage when selling and that will be liable for Capital Gains Tax. Well that is not strictly true, if the investor remortgages again after a year with similar terms, 75% of the capital gain can be realised. So if we make a very conservative and modest assumption in present gloomy market conditions of a 5% increase in value that is £10,000 and if we take 75%, and add it to the surplus cash from earlier that is a total of £10,000 return, effectively 20% return on the deposit paid. That is an amazing return, which I can’t see any other form of investment where the risks are so low and the investor has so much control over the asset.

There are certain things we have not considered like remortgage costs, legal and stamp duty, maintenance, and tenants. These will of course change calculations. Also the reason I simplify with a interest only mortgage, because if it was repayment that add to the capital or equity of the property so in effect cancels out the cost, although in realisation it will only be 75% realised when remortgaged.

Let’s be a bit more adventurous now, and add a few more clever changes to the model. We have to cap the borrowing at 75% LTV because that is the realistic maximum in the current lending condition. Let’s say the purchase price was 15% BMV (below market value) but the Mortgage was LTV, and the investor used a £10,000 personal loan at 10% compounded with capital and repayment due in two years, to part gather the deposit. So the initial investment in, is £10,000, the rest is the personal loan and the BMV saving. Assuming rent is steady; let’s look at the situation in 2 years time.

Property value in two years is now £220,500, so a refinance would raise an £15,375, less the loan that needs to be paid back (£12,100), plus £5,000 rent surplus which means £8,275 cash inflow, or 82.75% over two years on what was invested, so that is 35% return on capital invested per year.

There are incredible deals available; you can look around yourself, internet sites, auctions, personal contacts. If all else fails, contact us, info@PropVestment.com. You have to be clever with the way you invest, market condition are against us so we must beat the system and be innovative in our thinking.

Please take caution in tricky deals and do all your due diligence, the figures I use are fictional but are close to what is really possible.

How do you calculate your return on investment?

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Stagnant UK Property Market: Sellers’ Perspective

It has been widely reported that the current market conditions are such with very low volume of transactions, falls in mortgage approvals, and an overall stagnation in the UK property market.

House Price Crash shows very clearly the levels of mortgage approvals and the graph illustrates this with fine detail. Click on the link.

The amount of new mortgage approvals for house purchase, (but not yet lent), rose to 45,940 in May 2011 from 45,447 in April. However May’s approval figure was lower than the average for the previous six months despite the slight increase, according to figures released by the Bank of England.

Nationwide’s index has prices remaining stagnant since May, and down 1.1% annually, while Halifax has prices up 0.1 % in the same month and down 4.2% annually, while the Land Registry has prices down 2.3% annually. Overall there is clear evidence of stagnation in the market.

It is important to analyse the factors causing this and the mind set of Sellers’ and what is causing them difficulties.

Once again today the UK Base rate was held again at 0.5% for the 28th month running. It will be interesting to see the divide in the Bank of England committee when the minutes are released.

Lending to individuals

At PropVestment we sight two major problems causing this stagnation. Firstly Sellers are too over optimistic, thinking that their property should have risen along the same rise levels as seen before the credit crunch, and cannot come to terms with a possible drop in value, so they set their asking price above what is realistically achievable and representive of their property.
This means that many properties stay on the market longer, the few that are closer to realistic values and are lucky enough to attract attention of the buyers suffer from a secondary factor. Price agreed, next step acquire a mortgage approval.
When the bank valuer goes to value the property, its significantly undervalued relative to the asking price, the mortgage offer comes at a LTV of this valuation, leaving the buyer with a shortage to complete. Result, the deal falls through.

Why should a seller sell? Well with current interest rates, many PropVestors have mortgages around the 1-2% mark, they are enjoying a healthy surplus on rents and selling just means, realising Capital Gains Tax.

Therefore if one does not need funds else where, logic says to stay put, not sell and lose a chunk to the tax man and instead enjoy the cake of higher rental yields to mortgage installments.

Further as stated in our last article, it has been stated that rents, in particular in Central London, are expected to rise 8-10% in the year to come. Investors are well placed to get great returns. Especially where the mortgage costs are not looking to rise due to the base rate on hold.

The UK mortgage market is still quite inactive, even though data is showing an recent increase, from our personal experience and that of our clients, the lending criteria is very strict and stringent and only those that fall into a model profile, income base, age and credit history are the ones where mortgages are being approved. Further to this the LTV (Loan to Value) is still surprisingly low in comparison to boom times. Sellers do not want to accept the lower valuations and feel their properties hold more value so will not sell at current market prices.

PropVestment concludes that from a sellers’ perspective the primary factor why sellers are not as active as they would like to be is simply that the returns are just too good, and staying put is the best option. Even those looking to sell, find the potential buyers are not capable of securing the finance to meet asking prices.

LENDERS START LENDING, SELLERS & VALUERS GET REALISTIC

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How to calculate your REAL return on Investment: 5% can becomes 35%

The REAL return on Invetsment

Traditionally property return on investment is calculated by rental yield, especially when it is being compared to returns of other types of investments. However I believe it is a much more exact science, and can vary significantly depending on specific properties and on how the investor structured the deal when purchasing the property. A traditional yield of 5% can actually be 35% if the deal is right.

Let me start with a simple example. A two bedroom flat, bought with standard Buy-to-let 75% finance, at 5% interest only for £200,000 that is renting out for £10,000 per year. Traditional yield will be 5% (rent/value=10/200=5%). Under the way I calculate it, the rent less the mortgage interest divided by initial money in, therefore for this deal ((£10,000-£7,500)/ £50,000) so its 5%. The “real” return on investment is still the same.

But wait, what about capital gains, this is still a form of returns even though they may only be realised at a much later stage when selling and that will be liable for Capital Gains Tax. Well that is not strictly true, if the investor remortgages again after a year with similar terms, 75% of the capital gain can be realised. So if we make a very conservative and modest assumption in present gloomy market conditions of a 5% increase in value that is £10,000 and if we take 75%, and add it to the surplus cash from earlier that is a total of £10,000 return, effectively 20% return on the deposit paid. That is an amazing return, which I can’t see any other form of investment where the risks are so low and the investor has so much control over the asset.

There are certain things we have not considered like remortgage costs, legal and stamp duty, maintenance, and tenants. These will of course change calculations. Also the reason I simplify with a interest only mortgage, because if it was repayment that add to the capital or equity of the property so in effect cancels out the cost, although in realisation it will only be 75% realised when remortgaged.

Let’s be a bit more adventurous now, and add a few more clever changes to the model. We have to cap the borrowing at 75% LTV because that is the realistic maximum in the current lending condition. Let’s say the purchase price was 15% BMV (below market value) but the Mortgage was LTV, and the investor used a £10,000 personal loan at 10% compounded with capital and repayment due in two years, to part gather the deposit. So the initial investment in, is £10,000, the rest is the personal loan and the BMV saving. Assuming rent is steady; let’s look at the situation in 2 years time.

Property value in two years is now £220,500, so a refinance would raise an £15,375, less the loan that needs to be paid back (£12,100), plus £5,000 rent surplus which means £8,275 cash inflow, or 82.75% over two years on what was invested, so that is 35% return on capital invested per year.

There are incredible deals available; you can look around yourself, internet sites, auctions, personal contacts. If all else fails, contact us, info@PropVestment.com. You have to be clever with the way you invest, market condition are against us so we must beat the system and be innovative in our thinking.

Please take caution in tricky deals and do all your due diligence, the figures I use are fictional but are close to what is really possible.

How do you calculate your return on investment?

Two Sides of the Coin: Landlords should be the Heads

Your call, Heads or Tails?

There has been a great deal of negative press associated with the property market over recent weeks. But I believe every cloud has a silver lining, every disappointment is an opportunity and that there are always two sides of a coin. Head and Tails. I like to consider myself along with fellow investors as the heads side. Here’s a few instances where this is the case.

  • Tails: Headline says “No Buy-to-Let”

Heads: High Rental Yields. It is true that banks have been very tight on buy to let mortgages, and we haven’t seen anywhere near the 85% lending we did a few years back, moreover many deals fall through because valuators are being very pessimistic with valuations. So what does this mean, well if the number of buy-to-let properties is not increasing that means supply is not increasing. Demand in the UK continues to rise, especially in London and the South East, this is pushing up rents as there is more potential tenants for each property, this is great news for Landlords. It means properties can be let faster and rents will be higher also. In my opinion Investors should embrace this and make it a win-win situation, hold steady and enjoy the higher returns on your investment.

  • Tails: Headline says “Falling House Prices Falling- Negative Equity

Heads: BUY BUY BUY. If House prices are falling, if you have the ability and cash, you should buy, these lower prices will only be a short term phenomenon, and they will recover strongly, land is a scarce resource especially in our ever growing cities and the populations are rising, its simply economics that prices will rise. Furthermore lower house prices only affect you if you want to sell, why would an investor sell and face such high capital gains liabilities. It’s about building a strong portfolio over time that can provide a steady income stream for years to come. Negative equity is meaningless and lower prices means greater rewards in the future, so buy.

“Interest rates rise to 8% in two years”- Never

Yesterday I read this article in the Telegraph, of which I provide a summary:

“Interest rates may rise to 8% within two years to choke off soaring inflation, according to radical new research by the influential Policy Exchange think tank.

The rise could happen as the recovery beds in and Government measures to stave off a recession lead to an explosion in the money supply.

Mr Lilico, Chief Executive of the think tank also warned of a return to “boom and bust”, as ballooning inflation threatens to tip the economy back in to recession in 2013 or 2014.

“Given the constraints of late 2008 and the absurdities of subsequent fiscal, finance and regulatory policy, if we can get away with a recession of only 6.6pc, deflation of only 2pc and inflation of only 10pc for one year, [Bank of England Governor] Mervyn King will deserve a medal,” Mr Lilico said.

A brief double dip recession early next year is likely, he said, but it “would be quite compatible with a boom thereafter”.

That boom would quickly run out of control, as the £200bn of “money printing” by the Bank during the crisis would lead to “a huge expansion in the money supply, which will lead to inflation”.

He estimates that the Retail Prices Index (RPI), the inflation measure favoured in wage settlements and against which annual rises in train fares are priced, would rise “above 10pc”.

The Consumer Prices Index (CPI), the inflation measure that the Bank is responsible for keeping at around 2pc, will top 6pc, Mr Lilico reckons.

This week, official data from the Office for National Statistics is expected to confirm that the economy grew 1.1pc in the second quarter of the year – reinforcing hopes that the recovery is strong enough to withstand the Coalition’s planned spending cuts.

To control inflation, “interest rates will rise rapidly as well”, Mr Lilico says. “To keep [RPI] inflation down to only 10pc for one year, the economy will have to be able to tolerate interest rates of perhaps 8pc.”

High interest rates, however, could prove too much for households, which are currently benefiting from historically low average mortgage rates of 4pc.

Mr Lilico added: “There is a risk that… the economy will not be able to tolerate 8pc interest rates without the mass defaulting on mortgages that we are trying to avoid. If that is the case, then interest rates may have to be kept lower for an additional nine months and the consequence will be inflation peaking at 20pc rather than 10pc, as in the 1970s.

The consequence of interest rate rises will be another recession in 2013 or 2014,” he said.

The concluding remarks of the Telegraph showed disagreement with this report and we agree. Even though since 1997 the primary objective of the MPC has been to control inflation and it is considered a separate entity to the Government, there is no chance just to control inflation interest rates will be put up this amount. The MPC and the coalition government has learnt a hard, tough lesson through the recession and are not about to stop the nation recovering solely to control  inflationary pressure.

A rise of this magnitude would result in major default on variable mortgages; not only from homeowners but also investors, mortgage costs for certain properties will increase 4 or 5 fold.  The result would be loss of confidence, major repossessions, reduction in disposable incomes and therefore a significant impact on consumer spending. This would significantly knock the economy into shock and we could return to the black days of the early nineties or worse. I do not think there is anything to worry about, worst situation in my opinion is interest rates rising two to three percent, like in the early noughties, this will help control inflation, Understandably the rate rise would mean less surplus for landlords on variable rate mortgages, but homeowners on the brink may face selling or losing their home; end result a boost for rental markets, and potential cheap quick sales available for investors.

Overall interest rates of 8%, not in the next decade!

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Reply to original article by Philip Aldrick in The Telegraph on 21st August 2010