13 minute read
DOES PROPERTY INVESTMENT STILL MAKE SENSE?
With inflation stubbornly high, interest rates squeezing margins or even seeing some make a loss, is the end nigh for property investment? Alex Daley looks at the facts and offers some solutions for those willing to stick at it.
The year is 2023 in post-apocalyptic Britain. You wade through dozens of used COVID masks as you get through your front door. Slamming it shut to keep the warm air in, the same warm air you’re hoping to keep in until the winter months to avoid having to put on the heating. Dinner is a little less enjoyable with the 50% extra you spend on the weekly shop. But you’re safe now, inside your home with the TV on. And anyway, you have a plan, a plan to make things a little bit more comfortable, a plan to build towards your retirement, a plan to build some kind of legacy. Property.
As the TV flashes on the first thing you see is the latest interest rate hike. We’ve somehow come off the back of almost two decades of historically low interest rates and now this. Have you missed the boat? And still, property prices haven’t crashed, but some guy on the TV 12 months ago said they’d come down by 20%?!
So, we’ve got mortgage interest rates north of 5% across the board, we’ve got house prices that still haven’t come considerably down and don’t even get me started on the government changes with tax and section 21.
Property. Dream. Over.
Or perhaps not?
Look, let’s not hide away from the fact that it’s a much tougher landscape now than it was a few years ago. It is though, possible to do very well investing in property and there’s no reason why you can’t do just that. Whether you’re looking at starting your property journey or considering whether you should expand or not - we’ve got you.
First, let’s remind ourselves of the challenges, of which there are... Well. Many.
FINANCING
Mortgage interest rates - your cost to finance your property purchase, previously was in the 2-3%s, now its over 5%. On an interest-only mortgage, this means you could be paying double what you’d have been paying two years ago. Ouch.
Stress tests - The lender’s test to see if the property stacks, based on purchase price, interest and rental income. With interest rates so high, lots of ‘deals’ just don’t stack anymore.
GOVERNMENT
Section 24 - Lack of ability to claim interest on your mortgage as a business expense if you buy under your personal name. Note, you can purchase under a company (LTD) to continue to allow you to expense interest. This is though, slightly more expensive. A solid property accountant will be able to help get you on the right foot here, we recommend Astonia Associates but won’t shoot you if you look elsewhere.
Section 21 - The planned removal of the ability to evict a tenant without fault as England follows in Scotland’s footsteps. Renters (Reform) Bill - “A Bill to make provision changing the law about rented homes, including provision abolishing fixed term assured tenancies and assured shorthold tenancies; imposing obligations on landlords and others in relation to rented homes and temporary and supported accommodation; and for connected purposes.” (UK Parliament)
GENERAL DIRECTION
The bottom line is generally, the government hasn’t seemed to be
too kind to landlords, if that’s the direction things are going in, it may continue to get worse. What that means exactly is crystal ball territory and OTH’s ball is being serviced currently so we are unable to lean on that.
Warren Buffet is often quoted as saying ‘be greedy when others are fearful’, and that bloke knows a thing or two about building long-term wealth. Is now such a time? Let’s take off the fear goggles we’ve put on by watching the news and look at this properly. Why might you start your journey now? Or even, why might you continue to grow during these unsettled times?
RENTAL INCREASE
The last two years have seen rental prices go higher than Snoop Dogg on a Friday night. And according to the Office of National Statistics, we’re still getting higher. Recording 4.4% in the 12 months prior to January 2023, up from 4.2% the year before. What’s also interesting to think about is if this landlord exodus which we keep hearing about does actually happen, there will be even less supply on the market. You don’t need an economics degree from Oxford to guess what might happen then.
Do the increased rental figures make up for the increased interest costs? Well maybe not quite the full whack, but it will certainly help see you through these increased cost years. And that’s what this is, of course, a long-term game. With rents going up currently by 4% per year and your annoyingly high mortgage rate locked in for 2-5 years, by the time you start getting to the tail end of your fixed term, the landscape has changed. Your rent roll is in a different place. Lendlord has a really neat deal stacking calculator where you can put in an annual rent increase of X% and see how that changes your deal.
YOU’RE IN GOOD COMPANY
If the giants of this world are buying and building rental properties, maybe this isn’t such a bad business after all. We learned in our build-to-rent article that Lloyds Banking Group are building 50,000 homes over the next ten years, Legal and General has over 5,000 apartments in operation or being built and Goldman Sachs group are buying up properties like there’s no tomorrow. So if you’re buying. You’re not in bad company. Goldman. Lloyds. You?
HUMMUS, KETCHUP OR PROPERTY?
What’s your favourite dip?
We’ve been promised a dip for a while now. All those crystal ballers saying ‘this is the month’ each time the first of the month rolls around. If and when they’re finally right, if you’re in a growth stage in your property journey, it can be to your advantage. Baron Rothschild said the best time to buy is ‘when there is blood in the streets’. Having cash ready to be put to work if and when that happens, is not a bad plan at all.
RECESSION-PROOF INVESTING
So, we promised you that we’d help you put in place what you need to build a portfolio that works in the worst years as well as the best, and here it is. It’s not quite an exact blueprint, but rather, general principles that if you implement, you won’t go *too* far wrong.
Principle 1: Be ultra-critical about what you buy. Realistically, right now, you need to stress test deals at least 8%. If a deal stacks at an 8% interest rate, you’re likely insulated against tough times. The first thing people say is ‘I can’t find anything that works at 8%’ and that’s fine, better to wait until something that works comes across than buy a bad deal. Most properties shouldn’t work for BTLs, don’t kid yourself.
Here is our simple beginner’s guide to stacking with a free stacking spreadsheet download to get you started.
Principle 2: Buy (or build) yourself a safety buffer. I like a bit of fat on my steak, but a tonne of fat in my deals.
Most BTL mortgages these days are 25% deposit, which means you hold 25% equity at the start (duh). If you buy properties that allow you to add value through renovation, and let’s say you now have 35-40% equity, you have a huge safety buffer. You may never need it, but should values drop to the extent that those YouTube experts say they will, you’ve protected yourself. And half the battle is protecting yourself. Buffett famously said - “The first rule of an investment is don’t lose money. And the second rule of an investment is don’t forget the first rule. And that’s all the rules there are.”
Should prices not drop that far, well you then have extra equity to pull out when you remortgage (whenever that is) and then you can go again, and again and again.
Of course, the other way to buy yourself an equity buffer is to negotiate hard - lowball and see who bites. This is the ‘below market value’ you see talked about all the time. It won’t work on every seller, but if they’re motivated and there’s not enough traction from buyers, you may have some luck. This does take time and likely making 100s of offers which will get rejected until you strike gold. (Want to be a deal-closing ninja? Check out this article we compiled on all the latest expert negotiation advice and techniques.)
Let’s remember Wes’ advice in the BTL strategy piece: “Now more than ever you need to make sure you are able to add value to a property before you purchase. This can be in the shape of title splits, refurbishment, development or conversion. If you can’t add value
there is absolutely no point in purchasing it, it’ll leave you very exposed in the current economic climate.”
Before you undertake your first renovation project, make sure you learn from the master Martin Rapley, with this how-to guide.
Principle 3: Be adaptable
Most landlords are in the simple, vanilla, BTL game. It’s simple, predictable and has served many investors well for many years. As the market tightens, it’s worth considering other strategies as well.
Rick Gannon - who lives and dies by HMOs says: “Going into BTLs right now is going to be largely fruitless, with interest rates where they are and yields where they are, it doesn’t take a rocket scientist to work out you’re only making your yield in the portion outside of your mortgage.
HMOs and SA (serviced accommodation) have strong market opportunities. I don’t think HMOs will ever go away, it’s a really good, affordable option for tenants who want a transient lifestyle, they can budget, live with other people and get that communal living. It’s such a strong strategy.”
If you’re interested in HMOs, we did an info-packed two-piece series on the strategy in previous OTH issues. Part one can be found HERE and part two found HERE. And our service accommodation piece can be found HERE
Principle 4: Leverage, leverage, leverage
With interest rates going up, you’ve only to look on the Facebook group to see just how much focus there is on paying down mortgages or buying in cash. Which can work. But if you buy the right deals with leverage, you can far outperform unencumbered properties. Property Hub recently did a podcast where they uncovered some hard truths. The main one was on average, property has not outperformed inflation over the last 20 years. This means if you have a house with 100% equity, you’ve not beaten inflation. If you have 25, 30, 40% equity, however, you start to really outperform the ‘I’ word. Leverage, when used properly, is a game-changer.
WHAT THE EXPERT SAYS…
We’ve never pretended to be economists, so we’ve brought in an expert to add his commentary on the big picture when it comes to the economics of the property world. Enter, Ytzen Van Der Werf, who is programme leader for MSc Real Estate Finance & Investment and senior lecturer at the University West of England.
“When assessing the property market or more specifically residential property prices, people often think that the only way is up. There are even schools of thought that claim prices could double every 10-15 years (see above). Of course, there are periods in history where prices (nearly) doubled over a short period of time (recently 1997-2007 and 20132021), but that is clearly not a long-term sustainable trend,” explains Van Der Werf.
He points to research that shows that house prices over a long term (i.e. more than 400 years) only rise with inflation but the question is when will inflation abate?
“Most of the inflationary rise is caused by high gas, energy and commodity prices. Gas is already back at pre-war levels, commodities are not yet. As a result, inflation is only coming down slowly, although most economists expect it to be substantially lower at the end of 2023,” says Van Der Werf.
“Albeit, in the long-term, house prices seem to grow in line with inflation, short term they are not affected by inflation in the same direction. Inflation clearly has a cost implication as well, which affects the owners of residential property as well as the disposable income of their client base, the 30-40% of society that is renting. Both effects are not positive in the short run.”
If Van Der Werf’s colleagues are accurate and inflation does cool later this year and into the next the market could start to look up again.
“This suggests that a lower inflation rate in 2024 might be positive for the residential rental market.”
“However, there is an economic indicator that is even more influential on residential property: the Bank of England interest rate and its derivatives, residential mortgage rates. Interest rates have increased exponentially over the last 18 months, and one could wonder whether the peak has been reached. This has clearly increased the cost of owning property (when financed) and this generally drives sale prices down.
“Rents are not necessarily a function of sale prices and yields,” continues Van Der Werf “…but tenants that are comparing the cost of living in a rental unit with buying their own dwelling might be enticed to switch to owneroccupier when sales prices are driven down further, and this move from the rental submarket might drive the rental prices down as well.”
“All the above is likely to happen in a market that is in equilibrium, in terms of demand and supply, and this is where the residential market seems to fail. The undersupply of residential property is, and has been over the last 20 years, very prevalent and this has been a very strong driving force for a healthy residential investment market. From the landlord’s point of view that is.”
SO, SHOULD I INVEST?
The bottom line is that even though there are major forces at work in the property market that could drive down prices and rents in the short to medium term, fundamentals of the property market such as high demand, an expected increase in highly skilled immigration and economists predicting a cooling in inflation means investors with a longer-term perspective can still make property work to their advantage. Stick to good purchasing and deal-finding principles, always be stacking and if possible build cash reserves. Then you could well be very well-placed to take advantage of the fear and what could well be a buying opportunity of the decade.
For more considered and useful advice to supercharge your property investing journey visit: https://linktr.ee/btlgroup
