2 Red Flags
4 Certainty
Foreseeing any issues that may arise is absolutely necessary when appraising a property. Things like structural issues, subsidence, if it’s going to struggle to get a mortgage or if there might be any planning issues. You need to know as early as possible if anything is going to slow the project down or make a project completely untenable. The agent should tell you of any problems with the property that they know of, and it’s a good idea to get your builder in too so you understand all of the costs.
You need to know if you’re going to be able to execute your chosen exit or if an alternative exit might be more profitable. To know this you need to gain a good understanding of the demand in the area.
If the property needs planning permission, make sure you will have enough cashflow to take you through the application period and also throughout the build, as this is often where people come unstuck. The project might be on track to make £200,000 when it’s complete, but that might not be for 18 months, so you need to make sure you’re covered until then.
3 Numbers Your acceptable profit margin should always be determined by your long-term goals. If 8% return works with your financial situation to move you toward your long-term goals, then great. If you require 20% then that is how you determine what deals work for you. (Remember to build in your contingency before you calculate the profit margins.)
This is all about research, so you understand exactly what’s going on in your area and what the different markets are like (buyer’s market, seller’s market, financial market). Once you understand all those areas, you’ll be in a better position to come up with the best exit from day one. If you’re changing a house into an HMO, is there a tenant demand for an HMO in that area? With HMOs a good place to start is SpareRoom. Chris advises if you’ve got at least four people looking per room then your room will get filled within 28 days. If you’re going to do a title split and split the house into flats, is there a demand for flats in that area? For flips, you need to know what the appetite is for flats, two-beds or three-beds – propertydata.co.uk is a fantastic source where you can look at the area stats to help you to calculate the demand. Gather as much data as you can until you’re comfortable you’re going to be able to facilitate that exit. And always have two or even three exits and do your research on all of them to ensure you have a good safety net.
The key numbers you need to understand are:
Total investment Purchase price + all costs (including refurb, searches, solicitors, stamp duty etc)
Yield Annual net rental income / value of the property
Return on investment (ROI) (sale) (Profit from sale / all money invested) *100
Return on investment (ROI) (rental) (Annual net rental income / all money invested) *100
Capital employed Purchase (deposit only) + all costs (including refurb, searches, solicitors, stamp duty etc)
Return on capital employed (ROCE) (rental) Annual net rental income / capital employed x 100
Return on capital employed (ROCE) (sale) Profit from sale / capital employed x 100
Step 3 Know when to walk away The due diligence process can sometimes be a real labour of love and it can be easy to become excited and emotionally attached. When it starts to look like a project isn’t viable after all it can be very difficult to walk away. At this point you have to let the numbers speak for themselves.
“When the numbers don’t work, walk away”
If the numbers don’t work, there really is no point pursuing a deal and it’s time to take a step back and refocus on your goals. Trying to make them work can be dangerous, so avoid doing that. Instead, walk away and go and find a property deal that’s got the right level of margin instead of wasting time on something that hasn’t. It’s hard, but it’s the right thing to do and will save you time and money in the long run.
7
