Category Archives: Investing

Time To Exit The Property Market?

During the 2016 Christmas break I put some time aside to think about whether my strategy still makes sense given the new risks and opportunities that have recently appeared.

My strategy is simple: to grow my net worth at an average rate over a long period of time that exceeds the return I could get from doing nothing. If I cannot do this, then I should not bother running a business – simply investing my funds into a low cost stock market tracker fund, say an ETF, would deliver better results for less risk and no work. Smart investors estimate a long term return from the stock market of 6%-7%.  That would turn £100,000 into £1.8-£2.9m over 50 years. A return of 12% would instead result in £28.9m. No wonder Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

image

Since most people prefer high returns to low, especially in a low interest rate environment, so the competition for deals must increase. This has led to prices for many investments spiralling out of any sensible bounds that a value investor would consider paying given the likely long term return and risks involved. Property prices for example have increased much further and faster than rents suggesting a high level of speculation (people buying because they think market values will continue to increase).

screenshot-2016-12-31-at-17-08-56
Source: FT

One vivid example… An old Severn Trent water pumping station near me recently went to auction. The property had the potential for conversion and extension to form a block of flats. Severn Trent sold the property on the basis that the buyer would give ST a range of pretty restrictive rights, for example the permission to dig anywhere around the perimeter at any time they wished. They also wanted a share of any planning permission uplift for a long period of time, over 30 years I believe.

I figured there could be an investment here at the right price, having taken the challenges into account. I valued the property at only £45k to account for the risks involved. The eventual buyer went to the auction expecting to buy something else, missed out, then blindly bidded for this and wound up paying £92k. The story doesn’t finish there… Having realised his mistake, he then put the property straight back into a different auction and sold it to someone else for £128,500! Another friend recently put a property on the market expecting £250k, maybe £300k at a push… He sold it for £450k – way over it’s investment value. I can think of many other examples – we went for a property and it sold for way more than we thought it was worth.

This disconnect between risk and return, must indicate that inexperienced investors are actively buying, since they are less likely to understand what can go wrong and account for that by insisting on a margin of safety. Low interest rates are pushing them into risky assets that will perform poorly should market conditions deteriorate. This phenomenon is not just limited to property – it is pervasive.

Recent changes affecting investors – 3% stamp duty surcharge, loss of mortgage interest relief, wear and tear allowance changes etc.

There are around 2m landlords in the UK, who own around 5m properties. About 65% of all these properties are owned entirely mortgage free. The remaining 1.75m are mortgaged at only around 46% on average. So, overall, the changes to mortgage interest relief are going to disproportionately affect the small subset of property investors who are entering the market at high LTV’s, purchased relatively recently with a high LTV mortgage, or refinanced to the same position. Newer entrants are much more likely to be on interest only loans, which are a new invention, and since they are not paying down the debt over time they are going to be doubly hit.

The 3% stamp duty surcharge will only affect those entering the market or adding to their existing portfolios. True long term investors will simply factor the 3% into their calculations and try to negotiate a discount on the purchase price, or swallow it since the long term return, which includes all net rental income received and capital gains, is hardly affected. New entrants to the market are more likely to be put off.

These changes discourage entry to the market which helps not hinders long term investors.

These legislative changes can only be good news for experienced investors who leverage their investments sensibly and manage their properties intensively. Since just 1% of the UK’s housing stock is owned by institutions, compared to 13% in the US, 17% in Germany and 37% in the Netherlands, it seems likely these are the types of investors these Government interventions have been designed to encourage.

Should property investors get out of the market? 

An uncomfortable fact: the vast majority of renters would prefer to own a house than rent one. However, out of control property prices have resulted in their ability to buy becoming greatly diminished, impossible in many cases. This does not make landlords as a whole particularly popular (only 2% of the population owns more than one property). This is why we are vulnerable to changes in government policy – nobody really cares about us (did your tenants send you Christmas cards?)

By reading Internet comments related to property articles, it is clear that (rightly or wrongly) some people resent how investors are making it hard for them to get on the ladder. I think the issue could be deserved vs undeserved wealth. I do not think people generally have a problem with deserved wealth (nobody seems to mind when an Olympic cyclist makes a packet for example), but wealth generated by people who do not seem to have worked very hard for it angers people.

Let’s face it, many property investors have been lucky. I do not recall speaking to anybody or reading anywhere, that properties purchased in London in 2011 in London were going to skyrocket in value over the next 5 years but that is pretty much what happened. Those who had the ability to buy, and did so, did very well.

Lucky we have been, but will it continue? The current property price trends do not look sustainable – prices can diverge away from average income for only so long and the UK is way out in front for expensive property on this measure:

screenshot-2016-12-31-at-18-33-27
Source: Economist.com

An adjustment in prices, assuming people who currently rent and have deposits to buy could buy, would be good for everybody and what we should be hoping for. And lets not forget, there is the side benefit of long term investors being able to buy a few more investment properties.

In the meantime, I will continue to buy and sell.

 

Parmdeep Vadesha

P.S. Housebuilders are finding this a good time to buy and sell judging by their profit margins – they are back to where they were when the market last crashed.. Food for thought:

image-1Source: Annual reports, Persimmon & Barratt

P.P.S. If you have development deals that you want to JV on, or you want to invest in some of our projects (please note there is a waiting list for investors as we generally have more money than deals) then visit this site to find out more http://www.hawkblue.com/

Are You Overpaying For Property Deals?

“How much should I pay for a property?”

The answer to the question seems obvious:

“Work out the value after refurbishment. Take off the refurbishment costs, take off 20% profit and that’s the most you should pay”

So for example, on a property worth £2m after works, you would take off a 20% profit margin (=£400k) and your total costs of say £300k to arrive at a maximum purchase price of £1.3m, but and this is a BIG BUT…

 

This Simplistic Answer Misses A Number Of Critical Considerations!

 

  1. How sure are you of selling the developed property for £2m?
  2. How long is the property likely to take to sell?
  3. How sure are you of controlling the £300k of costs?

A property that will almost certainly sell very quickly for £2m or more  is clearly going to be superior to one where £2m is an optimistic projection of value based on the market continuing to go up. Likewise, an experienced developer is going to be more certain of  costs than a beginner.

Property investors will generally think about these issues, but it’s often instinctive and not hanging on a methodical framework. In this article, I am going to share one of the ways we think about purchase price at http://www.hawkblue.com/. We have found this method to be very useful for avoiding deals that look promising at the outset but in reality involve too much risk. 

To keep things simple, let’s assume a buy, renovate and sell scenario within a 12 month period of time. Lets also remind ourselves that a deal like this is essentially a gamble. Placing a regular bet with a book maker does not make any sense because the odds are never going to be in your favour – in other words virtually all gamblers will lose money over the long term.  

On a property deal, if you calculate the odds carefully, and they are heavily in your favour then you are making a wise decision – even if the occasional deal doesn’t work out as planned, you will make money over time.

 

Let’s Start With Evidence…

 

Here is a recent deal we did. The postcode is LE3 0LT. I will be using this deal as a case study for this article (you may want to open it in a separate window).

Start with this website http://www.rightmove.co.uk/house-prices.html. Type in the full postcode of the property, then on the next page restrict it to the last 2 years, look ¼ of a mile around, and choose the appropriate property type (e.g. flat).

Now you need to search for reasonable comparables. Look for properties with the same number of bedrooms. Since our case study is not new build, we filter these out. If few sold properties come up by the way, we would look for properties for sale and make a judgement on what they will sell for (beware: unless you know the market well, you could make your analysis less accurate so be realistic and talk to local estate agents!)

You should see something like this:

property-investment-comps

By the way, it’s really important here to get as much evidence as possible. If there aren’t many sales to compare against, then I would recommend adjusting the purchase price downwards to create an extra safety cushion. So for example, a bungalow in a village would be hard to value if the area has little turnover of property, so you would increase your profit margin to 30% or more (thus lowering the purchase price). Otherwise you may find yourself holding an illiquid property that could wind up losing you money.

At this point in the analysis it’s really, really important to think about how your plans might be derailed by unforeseen circumstances and how likely each of those events are to occur (rough guesses are ok).

  • Property prices might plummet (as they tend to do every once in a while).
  • Your builder could go under.
  • Costs might go out of control due to unforeseen circumstances.

Most sane people would not play Russian roulette with a loaded gun for any amount of money, so why do it with your finances by taking on a deal that if it tanked, would wipe you out?


If You Cannot Afford The Worse Case Scenario… Walk Away!

 

The reason a deal like Cherryleas Drive was so good from a risk perspective is that we were not exposed to any really bad scenarios… Various armageddon scenarios such as fire damage for example were covered by our insurance policy so we did not need to worry about those.

It only needed a quick refurb so we were not exposed to construction risk, for example the builder going bankrupt and leaving us with a half finished development. The turnaround was quick, so risks related to property prices falling were eliminated.

We were exposed to a short lease risk, since the leasehold had only 49 years remaining. This is not generally mortgageable, so we mitigated this risk by getting a commitment to extend the lease at an agreed price with the freeholder. If the property had not sold we would have extended the lease and sold the flat later at a higher price.

Having thought about mitigating risks, we need to figure out the purchase price. For this property I can see 14 reasonable comparables. We pop these into column B of the calculator below (note: divide by 1000 so £92,950 becomes 92.95).


Thanks to Ben Collins for help with the chart.

To check the likelihood that we will be able to achieve a sale price of £75k (our minimum) I can pop 75 into cell E8 and the probability turns out to be 79% (cell E9). This is good but remember it’s only a guide since comparable sales included nicely done up properties that did not have a short lease issue – we account for this by lowering the probability accordingly.

The average sold price for this type of property is £82.7k (cell E2). The standard deviation is 9.5. This simply measures how spread out your comparables are. If they are pretty tightly grouped (stdev is low), then it will be easier to predict what the property will sell for. You will be able to see this in the normal distribution chart (click the other sheet from the bottom left)- a skinny blue line is preferable to a fat one.

The analysis now moves into a decision tree format where you will be able to see the various alternatives. You will need the probability that you have just worked out and this post walks you through how to finish the analysis.

So putting it all together, we have:

  1. Thought about what the property is likely to achieve in the market (by considering the evidence).
  2. Considered the worse case scenario and whether we could live with this (walk away if we cannot – its really dumb to play Russian Roulette for a bit of extra money).
  3. Worked out expected values based on various scenarios.
  4. Decided on a course of action (do the deal or walk away).

Oh and one final thing… Using only last two years of past sales data is not going to take account of a crash in the market which you will need to do in your worse case planning. See my blog post here for some suggestions on figuring out whether the market is currently under or overvalued. If you think the market is overvalued, then increase your desired profit margin to compensate. 

Persevere with this. It gets easier (I promise!) and you will soon find that putting your potential deals through a rigorous analysis will force you to question ideas and beliefs that might have led to unwise investment decisions.  

If you need some guidance feel free to drop me an email on support@tycoonsystem.com and I will point you in the right direction. 

 

Should I buy a property in London?

A friend with spare savings wrote to me the other day, asking whether London is worth investing in right now for income, should she look abroad, or  hand over the cash to a financial advisor and let them do the work? She also wanted to know how I educated myself on investing. Here is my reply:
====================

Hi xxxx

I agree the rents are very high in London, but prices more so. London seems to be in the middle of an unsustainable bubble, where prices are rising much faster than long term averages for no sensible economic reason. Here is a chart that I created showing house prices in London increasing at a much faster rate than rental income from 2005 to 2015:


source: ONS

When prices rise faster than rental income, yields are squeezed, reducing the attractiveness of long term buy and hold investment.

The following graph shows that anybody buying at this point is paying an exceptional premium compared to say 1995 when prices were only 2.7x the average income:
Inline images 1

Remember we are talking averages – London is not worth buying at the average price. That is not the same as ‘do not buy in London at all’. For instance, if your generous auntie May bequeathed a  London flat to you in her will, you would not turn that down would you? So the real issue here is what you pay (the price) for what you get (rental income). If you happen to have a lot of cash and get offered distressed properties in London, then you will have an edge (on price) and perhaps you could speculate to make money – that would work until the market corrected.

How did I learn? I simply studied the most successful investor in the world http://www.berkshirehathaway.com/letters/letters.html. Buffett turned $10k into $60bn over a period of time and once you understand what he did, it is easy to see that you will make a lot of money over time but most people do not have the patience to follow what he does. Value investors think 10 years ahead, most people think forward 2 or 3 years at most. His philosophy is don’t lose money whatever happens, 95% of people think about maximising their profits and lose sight of risk.

I have probably read 30 books related to value investing, watched 100+ videos, read a few hundred articles and then I implemented. I also have MBA and finance degrees which help, as does having a genuine passion for looking for undervalued investments. For example I recently purchased VW shares when they dropped, and made a very good tax free return on investment.

When it comes to investing abroad, be very careful. Lots of horror stories related to Thailand http://www.bbc.co.uk/news/magazine-34346620. Do not believe agents claims about rentals, you will almost certainly get less than you expect. There are also tax issues, and hidden expenses such as annual levy’s on foreigner owned property.

I do not work with financial advisor’s either but that is because I commit significant time and effort to learning how to invest myself. The stock market produces about 6% per year over the long term and you could get this by holding a FTSE ETF (an automated fund that tracks the stock market for almost 0% fees) over a long time period. Check out what happens if you instead have a 2% advisor fee every year – after 30 years the advisor has reduced your total stake by roughly half (assuming the advisor matches the FTSE 100 which most do not do):

year YOURSELF   ADVISOR @ 2%
1 £100,000.00 £98,000.00
2 £106,000.00 £101,802.40
3 £112,360.00 £105,752.33
4 £119,101.60 £109,855.52
5 £126,247.70 £114,117.92
6 £133,822.56 £118,545.69
7 £141,851.91 £123,145.27
8 £150,363.03 £127,923.30
9 £159,384.81 £132,886.73
10 £168,947.90 £138,042.73
11 £179,084.77 £143,398.79
12 £189,829.86 £148,962.66
13 £201,219.65 £154,742.41
14 £213,292.83 £160,746.42
15 £226,090.40 £166,983.38
16 £239,655.82 £173,462.34
17 £254,035.17 £180,192.67
18 £269,277.28 £187,184.15
19 £285,433.92 £194,446.90
20 £302,559.95 £201,991.43
21 £320,713.55 £209,828.70
22 £339,956.36 £217,970.06
23 £360,353.74 £226,427.29
24 £381,974.97 £235,212.67
25 £404,893.46 £244,338.92
26 £429,187.07 £253,819.28
27 £454,938.30 £263,667.46
28 £482,234.59 £273,897.76
29 £511,168.67 £284,524.99
30 £541,838.79 £295,564.56
Difference £246,274.23
I am running a free investment meetup at one of my developments on the 20th of February. You can learn more about how we think and look at deals we are doing, plus meet some interesting like minded people. Here is the link to reserve a free ticket: https://www.eventbrite.co.uk/e/property-investors-champagne-reception-tickets-20259792585