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, 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.

Where to Invest your Money: Property or Pension?

Property is the way

Lots of companies have massive holes, gaps, shortfalls in their pension funds because the stock market has performed so badly, or the decisions made on where to invest have been very poor by the company.

If you are like the masses you probably have a defined contribution pension scheme.  The risk falls 100% to you. All the scheme defines is what you have to give them!

Let us do the maths, making a few assumptions along the way, based on our experiences. Read more

Landlords: How to Protect Against Bad Tenants

In these modern times, where recession has bitten and made people desperate and bitter, we have a new phenomenon: The Professional Bad Tenant.

They go from property to property without paying any rent, leaving bills and council tax arrears, and they successfully do it for a living, leaving behind a trial of innocent landlords in debt.

Unfortunately, this is becoming common practice, and these professionals seem to be getting away with it. How do they do it? These professionals have become all too familiar with the legal system and know every trick in the book. Every time a landlord attempts to evict them, they appeal with various excuses for example “I didn’t pay rent because the property was in bad condition.”

The problem is, every time a tenant appeals eviction, the process of eviction is lengthened because the court needs to look into the issue before being able to dismiss it. The claims usually get dismissed because they’re fictional, but by the time each appeal goes to court, months and months pass, leaving the landlord severely out of pocket while the tenant still remains. The system definitely isn’t perfect by a long way, but it is what it is, unfortunately. Sometimes as a Landlord you almost wish it was like the good old days where you could send a couple of big lads round to shake the rent out or throw the tenant out, however that is not something that is advised or endorsed my us.

Top Tips:

1. Be wary of cash payers

2. Don’t accept the first tenant that comes along to avoid costs

3. Take into consideration your tenants employment and social status

4. Credit Checks

5. Employment records

6. Be Wary of DSS tenants

7. Get References

Read more

What the new shorthold tenancy classifications for UK private property landlords means

  • Deposit guarantee scheme for all properties earning upto £100k rental per annum
  • Failure to do so in 14days means no Section 21 (eviction order) can be served
  • Fines up to three times the original deposit
  • Student accommodation and multiple occupancy also affected
  • Advice: Use a reputable and experience lettings agent, email for our quote and special offers.
  • New legislation mainly affects high rental properties in particularly in London
  • Extra Red Tape that makes it difficult for honest, reputable Landlords

Read more

House Prices increase £91 a day

The surge in property prices will reassure landlords and investors worried by reports suggesting the housing market faces a dramatic collapse.

Figures released by the Halifax yesterday also show how prices have rocketed over the past decade, giving property owners potential returns unmatched by any other form of investment.

Semi-dethatched properties have risen 111 per cent in ten years.

Halifax says the big winners over the past year have been detached houses which soared by 13 per cent – the equivalent of £91 a day – between June 2009 and June 2010 to stand at an average of £299,295.

But bungalows, flats, semis and terraced houses all spiralled upwards too, with price gains of between eight and nine per cent. The average cost of a detached home was 63 per cent more than the average house price during the second quarter of this year.

However semi-detached properties saw the biggest gains during the past decade with values soaring from an average £81,706 to £172,196 – and by £35 a day over past 12 months alone.

The average value of a terraced property jumped by 110 per cent during the decade while the price of bungalows rose by 109 per cent. In the past 12 months the average terrace house rose by £29 a day while bungalows went up £49 a day.

The value of detached homes rose by 102 per cent during the decade. Flats were the only property type not to double in value, though prices went up by an average of 81 per cent over the ten years and rose £35 a day in the year to June 2010.

Yesterday it was reported that house prices are set to rocket by 20 per cent in five years, fuelled by a shortage of homes. This would add £30,000 to the value of the average three-bed semi.

And last week July data from the Land Registry’s official House Price Index, based on actual sale prices, showed an annual increase of 6.7 per cent, taking the average property value in England and Wales to £166,798. The monthly change from June to July was an increase of 0.4 per cent.

Article adapted from the Daily Express, information from Halifax.

What does this mean in real terms for investors, firstly the long term capital gains from property are still strong, for the active investor the appreciation means that if they were to re-mortgage every year to pull out equity in order to reinvest (£91×365 daysx75%BTLmortgage=£24911) they can raise just under £25,000 per detached property or just under £10,000 per flat.

Using this appreciation, reinvested properly in finely selected properties that result in a cash flow surplus can support a great income stream as well as sustainable organic growth or your property portfolio.

If you want any advice or discussion of your options please email me

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An Alternative Investment: Thinking outside the Property Box

This week there is a small deal which will appeal to most of our readers. It is a studio flat on Edgware Rd W2 minutes from Edgware Rd Station and Hilton Metropole. It is a self contained studio with a separate kitchen. The property is in a popular purpose built block called Cambridge Court. The property is off market and available exclusively through us.

This deal has been packaged as an investment only. The property comes with the benefit of a tenant paying £300pw. The block has a lift and is well maintained.

This may seem a lot of money to rent a studio property for those not familiar with the area. We assure you this is not an enhanced rental designed to encourage a sale. It is the market rental for this area. In fact in the summer the property can be rented for well over £500pw as a short let. A short let is a period less than 6 months, typically 1 or 2 months. Many use this as a cheaper alternative to hotels in the area.

There are two ways to purchase this property.

One the normal, boring, old school way: you buy the property, it is transferred over to you and you take a fresh mortgage.

The other is an ingenious alternative way, fresh thinking outside of the box by us:

The current owner has a mortgage of £167,000 on the property with the Bank of Scotland. He is paying 1.94% on this amount. This comes to £270pm. In order not to lose this we have created a strategy whereby you can benefit from the same terms. The mortgage terms would be passed on to the buyer via a document mirroring those same terms. This agreement will come with an option to purchase within a fixed period of time.

Though this way is a little out of the ordinary, it will be completely water tight and will come with full legal guarantee. Looking at the property this way you would need to put £70,000 into the property and will be postponing the actual purchase of the property.

We however appreciate many will not want to go down this route especially with it being a relatively low cost property and may prefer to do things in the conventional fashion.

Under this way you will need to put in 25% of the property value which comes to £60,000. And the rest will be borrowed. The table above illustrates both methods more clearly.

A note worthy point is even the more modest return of 5.9% will easily beat the best return offered currently by banks. According to the recent survey by the Money Supermarket the return offered for a 5 year bond is 4.9%. The yearly yield from our property beats this marginally.

This is not where you make your money in a property however. The bulk of the return is made on capital growth. If we assume a modest rise of 5% per annum the property at the end of the year will be £306,000. This means the property has increased buy £66,000, a 100% increase over the 5 year period. A 5% increase for this location is a very cautious estimate; this location was pretty much immune to the effects of the recent credit crunch, especially properties less than £500,000.

To confirm this property you will need to call our offices and place a deposit of £5000 down on this property.

This article is an extract written by one of my mentors Suresh Vagjiani, MD of Sow & Reap

Old School Way New Way
Purchase Price £240000 £240000
Deposit £60000 £70000
Loan Amount £180000 £170000
Annual Mortgage Payment £9000 £3298
Service Charge £1500 £1500
Management Fee £1560 £1560
Annual Rent Income £15600 £15600
Net Income £3540 £9242
Net Return on Deposit 5.9% 13.2%