Are property flippers about to crash the property market?

ITS OFFICIAL- Flipping Property For Profit Is Back!

According to Countrywide, the estate agency, the number of speculators flipping property has reached it’s highest level in a decade.

I wanted to investigate this a bit further so I got hold of the land registry price paid data for the UK since 1995. I then isolated all the transactions for my County (Leicestershire) and discovered some interesting trends.

Before I go into the analysis, you may be thinking…

Why bother??

Because it’s really important to know the total picture since the average investor will always make the average amount of profit. When the average is high, it is easier to turn a profit, and when it is not, it is harder.  When the average is low, we need to be more wary (the same thinking apples to gambling which obviously always results in a negative average outcome for players yet lots of people still play and lose their money because they don’t understand the odds – don’t fall for the same mistake in property).

During the 2008 crisis, some mortgage lenders got burnt lending on investment properties. A number of changes came about which are still in place today, for example lenders generally will not lend on properties bought and sold within 6 months. Developers must declare all incentives given to buyers, finders fees paid and the existence of any parties in between buyer and seller such as investment companies.

A 3% stamp duty surcharge is also in place for those who own >1 property, which many flippers and landlords will fall into. Mortgage lending is more strict now too.

So with all of that in place, you would think flipping would have largely gone away, right? 

Take a look at this chart which shows a resurgence in property trading, close to the levels last seen in 2007:

Much of the property trading is occurring because properties are relatively expensive compared to yields and prices are still going up in some areas, so it makes more sense to extract the value than to hold. Low interest rates also are a factor – why sit on savings in the bank when they can be put to work in a relatively low risk leveraged property trade?

Lending is plentiful and short term commercial lenders are able to charge high fees due to high demand (the shares of Shawbrook have more than doubled in the last 12 months). These and other factors mean trading will continue as long as the market remains buoyant.

As mentioned before, some of the restrictions on lending today are due to new build flippers in the previous boom. Here we can see that new builds represented almost 30% of all properties flipped at the previous peak:

Nowadays, new builds represent only a small portion of flipped properties, perhaps due to the much restricted lending environment so that is not so much of a worry this time around.

Let’s now turn to profit per flip. It’s a crude calculation based on the difference between price paid, and price sold and does not include the cost of refurbishment. Those costs would even out over lots of transactions, so we get a decent, but not perfect picture as presented below:

This is really interesting because we can see that the best profit margins are made just before property prices take off (late 90’s to 2002 and 2012-2013). Margins also tend to drop when property prices increase, perhaps due to the entry of unsophisticated investors, making sensible purchases harder. Everyone has to accept thinner margins if they want to continue doing deals.

We are now in negative (average) margin territory, so if you are thinking of flipping, be sure to get a really good deal. I do not think property flippers will cause a crash or anything like it, but I do think it is a mistake doing a deal today where there is an expectation that prices will keep going up.

As always, drop me a line about this post with any thoughts or drop by and see us at our office in Leicester. It’s always nice to share ideas and talk about investing.

Parmdeep Vadesha

 

 

 

 

Under 40? Invest £4k per year in a LISA and wind up with up to £1m at 60.

From April 6th 2017, a tax efficient savings account will be available for anyone between the ages of 18 to 40. I fall into this age bracket so I decided to put together a basic spreadsheet to figure out whether LISA’s are worth looking into – you can  look at my spreadsheet  below if you like (there is a download link below the spreadsheet).

You can find a good summary of LISA’s here at moneysavingexpert.com so I will not explain them in detail. The wrinkle I have added is a very simple strategy of investing in a low cost investment vehicle. I did the analysis using a stocks and shares LISA not a cash LISA, which in real terms given current interest rates would wind up costing you money (since inflation > interest earned on cash).

This is the investment vehicle I have used in my calculations. I have assumed a long term return of 6.5% per annum which includes dividend reinvestment. It is designed to replicate the performance of the FTSE 100 index and charges only 0.09% in fees (over time this fee can make a substantial difference to your overall return).  For example, an 18 year old paying in £4,000 per year until age 60 would be £359,314 worse off paying 1.5% in fees rather than 0.09% – amazing but true (see for yourself using the calculator and read this book – you will understand why money managers get a much better result than their clients).

Compared to pensions, LISA’s have their pro’s and con’s and I will leave it to you to figure out which you should invest your money in (if you are not sure get some advice from a properly qualified professional – but be mindful of fees!) Also bear in mind, the 25% government bonus could be reduced at any time.

I just wanted to illustrate a simple, tax efficient and low effort way for anyone starting out to invest for the long term without taking excessive risk.

Parmdeep Vadesha

Download link: https://docs.google.com/spreadsheets/d/1nI36S4y1jSsWa5w0-K_f3oiwH-dVI1dXf90KAEi5FYU/edit#gid=967393783

 

 

 

 

 

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/