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Back to Basics

Property investment is very simple. It boils down to three questions: firstly is my money safe in this investment, secondly will it be going up or down after I invest, and lastly when and how can I get my money out, if required?

When stripped down to its core this forms the basics. The return on property can only come in two forms, one is capital growth and the other is rental income; there is no third way. The first is lumpy, meaning it will be a lump of money out in the future, and the other is a more regular monthly income.

Looking at the first question is your money safe, let’s consider the worst-case scenario: you make an investment and the price of the property drops to less than you have paid for it. You still have two saving graces, firstly the assurance the price will not go to zero. The property has an intrinsic value and so does the land it occupies. It is scarce in nature, what you use to purchase it i.e. money is not. To date the powers that be have injected £375bn into Britain’s economy under quantitative easing since 2009. Where has this money exactly come from? There seems to be no scarcity in producing it.

The second, you will not make a loss until you sell. Given enough time property has a way of bouncing back, it’s rather like having a bad haircut. It will grow back in time if you just wait. It’s worth remembering a property crash generally means prices are dampened for a temporary period of time. Not that the property disappears, like some companies on the stock market or indeed some banks.

Even in the current post credit crunch environment banks are still lending 75% on the value of a property. Try and get them to lend 75% of practically any other investment; you will be hard pressed to do so. They are not stupid, you may not but come rain or shine they generally make heavy profits. You may lose your money but they will ensure they will not lose theirs. This means property is a safe bet for banks otherwise they will not agree to be the majority stakeholder in such an investment.

The second question regarding investments is will the asset class go up in the future? The past after all is the past and doesn’t necessarily reflect the future.

This question actually may or may not have relevance depending on the reason you’re purchasing property. If it’s purely for rental yield then it’s the rentability which counts the foremost, which overrides the need for capital growth. The capital value is important at the point of sale or refinance. If you never sell and simply go for income, it’s less of an issue. There are many investors who focus on HMO investments and purely aim for rental yields and nothing else. The future rise in property value is however important as this is generally how the bulk of money is made.

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If you’re purchasing for capital growth then a downturn in price will of course be an issue. There are ways you can maximise the chances of growth occurring. The first is to purchase below market value, this has now become a bit of a buzz word; in short this is known as BMV.

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This alone does not however guarantee you security against future decreases in house prices. For example you can purchase below market value, but a decrease in prices the following year might mean this investment is now not below market value, but the market value is now below what you paid for it a year ago.

Many of the BMV deals currently being touted on the market are in questionable areas on the outskirts of cities with little or no future growth prospects. With the economy not having found its feet this is a questionable strategy. In a rising market buying BMV is a good thing, as it gives you an extra gain on the capital growth. However in a falling market all it serves to do is cushion the fall. But a fall it is.

The dynamics of why prices rise or fall are based on supply and demand. Strong demand and finite supply means prices will rise. Strong supply and no demand means prices will fall.

In one sense you can simply state property is almost finite in supply and is likely to be so in the future. Currently the output of new homes in the UK is running at around 100,000 per annum and the majority of these developments do nothing to ease the housing requirement in cities due to a lack of space.

The UK population is currently circa 52 million and is predicted to grow, although in general both people and houses share an upward trend, their rates of growth may differ. Between 1990-2010, population growth accelerated while the annual number of completed dwellings fell, probably reflecting changing economic circumstances, and creating housing shortages. A variety of projections to 2035 and later years, based on different assumptions for life expectancy, fertility and net migration, have been prepared by the Office for National Statistics (ONS).

The principal projection for England shows a massive 19% increase between 2010-2035. Furthermore currently 350,000 families in London are on social or affordable waiting lists.

New home starts in London dropped from 25,000 in 2004 to around 10,000 in 2010. London is generally acknowledged to be in a housing crisis which is likely to worsen with projected population growth.

The above seems to point to a fundamental inability for supply to meet the demand.

The demand of course is dependent on the availability and the cost of credit, if this dries up the demand decreases. However the impact of this is felt less so in some locations.

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London for example attracts buyers from all around the world, therefore the availability of credit in the UK may not be a principle requirement for them. Many banks operate over many continents, and some overseas buyers have their credit lines already secured, independent of the UK credit market.

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Indeed I asked a Jewish money lender why on earth he was lending money at 12% per annum when I knew he was making more on his other projects. The answer surprised me. The money he was loaning out was money based offshore; and it was earning a paltry rate of interest. The primary aim of these funds were to keep them offshore and not to attract a good rate of return. The banks who were releasing the money here had a guarantee on the funds in another jurisdiction.

The third question is when you can get your money out. Property is not as immovable and illiquid as many tend to think. You can resell a property potentially in 28 days from the day of an auction. You can refinance it in about the same amount of time, and of course if prices have dropped you can always rent it and hold out for the values to rise again.

You may even find the net rental income you make will be higher than what your funds many have been earning in a bank.

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It is also possible to get all of your money out from a property and still own the property. A property we purchased in Shepherd’s Bush for £650k is now being sold for £912k only nine months later. If we were to keep it and refinance it all of our original money would come out of the deal.

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Many clients come to us and have this vague idea of rather than paying for rent they should purchase a property instead. Generally our advice is to keep the two separate. Buying for an investment in the right location is a great idea, but to mix it with the sentiments of your son or daughter may not be the best combination.

They may have their own personal preferences. The aim of an investment is to make as much money in the shortest possible time. When someone wishes to live somewhere their own sentiments come into play. Therefore it is better to get a solid investment in a strong location and use the income and growth from there to fund your children’s rental stay instead.

It always pays to strip things down to their core skeleton. I hope you have found this article useful, we have many ways you can invest in property both direct and indirect, give us a call to discuss how we can help you.

Suresh Vagjiani

Sow & Reap

A Property Investment Company

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!Tips of the Week

The money you invest in property will grow in direct proportion with the location you invest in.

To generate good profits by flipping properties you need to pick the right property, in the right location, at the right price. And all these require the right knowledge.

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