Many people have turned to property investment as a means to get their money to ‘work for them’. Or even better still – somebody else’s money (investor/lender etc)!
TV shows about buying fixer-uppers at auction and flipping them to make money fast have empowered folks to dip their toe into the world of property development. Likewise, with traditional banking offering less in terms of growing our savings, we the public have taken back the reins and are looking for more creative ways to grow our money.
This is great, but like anything that puts one’s financial security at risk, it must be done with caution and careful consideration.
accessfunds have seen some common traits in the successful ventures amongst our clients, whom we have been able to assist with funding. We do not give advice on the pros and cons of building your property portfolio – but hope that our top points resonate with a good common sense approach to growing your portfolio, and sourcing the best funds.
1. Do Your Research
The research phase may not be the most exciting, but it is essential – knowledge is power! It’s important to explore the ins and outs (and ups and downs) of any venture that will put your finances – and often much more – at risk. Stay objective and honest.
The skill to developing a successful property portfolio relies as much on being familiar with research, planning and pricing, and being able to haggle and source finance, as it does on building and design.
Where to start
Research may take many forms, from getting to know other property investors, joining some like-minded groups, being mentored, or simply taking a long hard look at the pros and cons of the market. The internet is a wonderful resource – provided you use established and proven sources. Subscribe to relevant and popular websites, newsletters and blogs to keep up to date with market trends and vital information. Social media sources, such as Facebook and Twitter, are used by businesses now more than ever, so ‘like’ away, join groups, keep an eye on what your peers are posting and tweeting about.
Changing laws
You need to be familiar with the changing laws and tax laws, particularly as a landlord. For example, in the summer budget of 2015 it was announced that buy-to-let mortgage interest relief will gradually be cut back to 20%, between 2017 and 2020. This will have major ramifications on the profits of private landlords. Additionally, from April 2016, landlords now have to pay an extra 3% stamp duty on second/subsequent property purchases, ouch!
You need to compare the likely return on your property investment versus a high-yielding savings account, and don’t forget to consider what an eventual rise in mortgage rates may mean for you.
Consider your objectives: financial and emotional
Are you looking for HMO, buying a house and converting into several flats? Will that involve splitting the title? Are you keen on serviced letting or long-term lets? Or do you just want to turn a house into a home and sell quickly for profit? Begin to write your list of objectives, and consider the physical work involved in attaining these objectives, and the emotional toll. Don’t jump into something that will be a burden. Much easier to start with a small transaction and risk less while you are learning the ropes.
Consider the areas
A property on your doorstep is not always the most cost-effective place to invest, however, you will inevitably have better control if you know an area and can supervise the work and manage the property yourself. But if your strategy looks at income flows as well as appreciation in value, then you may have to look further afield where local demographics better suit your financial objectives.
Planning permission
Are the planning permissions in place? Consider buying with an option that lets you fix a price, for example, subject to achieving the permissions necessary to achieve your plans. No point in buying a home to split into multi-occupancy that has restrictions, or land that you cannot get permission to develop.
Doing your research seems like an obvious first step, but so many people fail to see this phase through fully. Remember the (tried and tested!) saying, Poor Planning = Poor Performance.
2. Exit is part of the Entry Process
Call this the prenuptial part of the investment. We think it is critical to plan the exit as soon as you start thinking about a new project. Starting with the end in mind will give you a more objective direction – and help tune your actions along the way. It will assist in determining your best approach, framing it in a pragmatic time-frame, and then giving clarity to how you want to fund the activities, recognise cash flows and build the asset.
You will want to buy something to alter, rebuild or tweak as necessary in order to add value. Assuming that the planning questions were answered in your research, and you have established what you want to do, you need to consider how to structure the transactions. We see many clients identifying the protection afforded by an SPV (special purpose vehicle) as the ideal way to ‘house’ their next transaction. That is setting up a company specifically for the purchase, funding, development, and possibly eventual disposal or retention of the finished article.
Exit Factors
There are several key factors to take into consideration when planning your exit strategy. Ultimately, the potential profitability of each deal is correlated to the respective strategy that is chosen. Understanding each plan will help maximize returns on your investment.
Unfortunately, there is no golden rule that differentiates between each strategy for particular scenarios. Therefore, knowing which property exit strategy to use is dependent on the investor’s familiarity with the following factors:
- Short and long-term goals
- Experience level
- Purchase price
- Terms
- Property value
- Condition of the property
- Market conditions
- Supply and demand
- Financing options
- Profit potential
- Location of the property
Understanding each of these individual factors will essentially determine which of the exit strategies an investor should pursue.
Exiting
Investors are expected to delineate between each option based on their desired outcome. The exit strategy they choose depends on the amount of cash they want to invest in the project and their level of experience. It is important to note that there is no right or wrong strategy. However, knowing all of the different ways to exit from a deal can increase profitability, as you will know how to navigate even the most marginal of deals. The following is a comprehensive list of exit strategies you need to consider in the future:
- Flipping: Simply put, a wholesale deal where the investor acts as the middleman between a seller and an end buyer. Essentially, the investor will find and quickly sell a property for a respectable profit margin.
- Refurbishing: Refurbing allows for the largest profit margins, as it allows an investor to sell the subject property at full market value. A refurb involves purchasing a house, renovating it and selling it at the desired GDV, being more than the original investment costs (purchase price and light refurb costs).
- Buy & Hold: Instead of selling the renovated property, an investor chooses to rent it out to receive monthly cash flow. This is a popular exit strategy for those looking to build up equity in an asset while the rental may cover the mortgage and management costs, for example.
- Lease Option: A lease option, otherwise known as rent-to-own, allows the owner to rent the property to a tenant, but with the option to purchase it at a later date.
- Property Auction: While not your standard exit strategy, learning how to navigate property auctions can result in some great deals.
Factors That Can Ruin an Exit
There are risks that every investor must take into consideration. Specifically, certain factors may impede or even ruin a projected exit strategy.
- Tenant ‘issues’ resulting in lost rent.
- A distinct lack of demand, or the backing out of a lender may prevent a property from being flipped.
- Anticipated planning permission refused (you should avoid the risk)
- Unexpected maintenance costs can cancel out profits.
- Poor property management can diminish value and hurt potential cash flow.
- Depreciation or a stagnant local market.
Understanding the factors that may prevent an exit strategy from working is critical. However, savvy investors counteract potential obstacles with multiple strategies. A backup plan is critical, as things can change at a moment’s notice. Having multiple exit strategies will proceed to lower impending risks and allow you to achieve the maximum return on their investment.
New investors should always start with projects that require minimal work. As they gain more experience, they can begin to take on increasingly larger projects that require more complex, and perhaps more profitable, exit strategies.
Exit strategies will also determine the types of funding available to you to best suit your plans. There are many ways of approaching the funding of a development. Specialist lenders, as well as the larger banks, are available and often located via an intermediary broker like us. Funds can be sourced on (typically) a secured basis, driven by the nature of the transaction, or other assets held. They may be for the purchase and development, with releases that can be upfront, or staged based on the development milestones.
Bridging a development is common place, with the exit strategy often being a sale or refinance of part or all of the new project.
Finally, it is important, as part of the exit strategy, to have done the maths – and also considered back-up plans.
3. Doing the Maths
We all know the value of budgeting – and that the devil is in the detail. It’s not sexy – but another critical part of success.
There are a number of aspects that we could talk about when talking ‘maths’ in relation to your property portfolio.
Here we just focus on the maths of funding a property purchase/refurbishment – linked back to your exit strategy.
We tend to find that a number of our clients are inevitably looking to buy properties that require a certain amount of refurbishment – and are therefore going to require some form of staged financing until they are complete and the exit strategy (hold, sell, etc) is realised. Many of these redevelopments become multi-occupancy lets or split-title flat sales.
In the short term, if you are looking to refinance your property once it is converted into, say an HMO, the following are the most obvious ways to secure the purchase:
- Cash
- Bridging Finance
- JV/Private Equity Investor Funding
Cash
Cash in the pocket gives you buying power. Not everyone will have cash readily available, and you may prefer to use funds that do not eat all of your working capital. In certain circumstances, our clients may raise funds against their existing portfolio, which provides a hunting-fund and gives flexibility. If you have the cash, it is the easiest way to complete a transaction, and after redevelopment, the asset can be refinanced and cash extracted for the next venture.
Bridging
If we take the HMO conversion as an example, financing is usually completed in two distinct phases – an initial bridge (which will be more expensive but key to the transaction) and then a long-term refinance.
Deal or No Deal? Although Bridging Finance can be viewed as more expensive finance, it may be the difference between securing a transaction or walking away from a profitable venture.
Firstly, don’t think that a lender will readily provide the full fund. The lenders are relatively inflexible and work to a standard format. They have a risk appetite that we need to recognise, and can therefore readily work with. Although HMO’s are a commercial venture, lenders are conservative and although we are seeing some of the less traditional folks taking a riskier (but priced accordingly) view, many still see this as just a bricks and mortar property deal. Advances are therefore typically in the 65<75% LTV range – with the lender looking for the client to have some skin in the game personally.
Consider the maths. If you can secure a 65%LTV advance at somewhere between 0.6%<1.6% per month [deal/risk dependent], and roll up the interest, and accept the fees, searches and duties and still show a profitable turn of 20%+ or more on the end result.. why wouldn’t you?
As mentioned in our section on the Exit strategy, it’s not only the maths; lenders are also interested in:
- Your experience
- Affordability – your income details – from this proposed property (and any other)
- Existing HMO ownership
- Current portfolio
JV/Investor
That missing 30% ‘deposit’, right up to the full amount can potentially be raised by way of the JV or private investment. Firstly look at your close friends and family. This is, without a doubt, the best entry point for private funds. If you already have a term sheet from a lender, who has thoroughly vetted you for the bulk of the facility, then the private investor will have greater confidence in supporting you. There are many folks or family offices with funds to invest – and a paltry return from simple savings vehicles is not interesting to them. All investment sources have their respective ups and downs and risk elements, but given today’s climate a circa 1% a month return, coupled to a percentage of the exit profit is viewed by many as an attractive proposition. It is important to know clearly how your investor operates, what his/her end game is, and can you really operate as a joint venture? If you find the right partner, then you can have a long-lived and very profitable relationship. But as always, in any partnership, you are giving up some decision-making and ownership.
When the lender does the maths they consider:
- Do you have any skin in the game (they will not offer a 100% advance)?
- Do you have any experience?
- Does the proposition suggest a sensible exit plan and an enhanced GDV?
- Will they get their money back if things don’t work out for you?
- What is your overall exposure to them or across your portfolio?
When you do the maths on a purchase consider:
- Have I placed the transaction under an SPV? Makes sense on a number of fronts, not least protecting you personally.
- How does my property value in terms of bricks and mortar (neighbours)?
- What will my property be worth as b&m, AND as a business once I have converted/refurbished?
- Is the cost of refurbishment appropriate to the works – and its eventual use?
- Have you analysed all of the costs, fees etc as well as the likely financing cost?
- Is there a buffer in my fund if things overrun?
- Time is money – is the works likely to be delayed – and what is the cost of an overrun?
- If the property doesn’t sell (if that is the exit plan) quickly – how is your profit affected?
- Do you have a back-up plan?
- Can you return at least 20%?
4. Picking the Right Deal
Finding the ‘best deal’ is a multifaceted challenge.
First-off there is no one size fits all. But if you have a clear strategy, ensure that you are following its main tenets.
A good deal is one where you can generate value. Positive short-term or long-term returns for you, while impacting the community positively.
This can often come from a combination of having strong local knowledge and good connections. If you are a modest property investor or plan to do some of the remedial works yourself, then being comfortable on your home turf removes some risk. The entire cycle of sourcing a property, to design and build, requires many skills and service providers that you may be managing to ensure a timely and cost-effective result.
Supply and Demand
Having determined your strategy – and why you are looking to invest in property, quite often the next step is to identify the territory. This is driven by your local knowledge, and underscored by local market economic conditions. We know that for example, London has its own financial climate. Property prices have risen dramatically, and rents demanded can be significant. Has that opportunity peaked? Probably not, but if you are new to this area, it may be cost-prohibitive as an entry point. Alternatively, if you can find a good conversion opportunity – say a warehouse or office that can gain planning for HMO or lets, that additional creativity can make significant returns.
The best opportunities will lie in areas where there is high demand. With a growing population, and housing shortages, that can be inner city – but it can also be found in holiday lets near places of unique interest, where the tourist population may be underserved by traditional hotels etc.
Networking
The best deals are usually not on the open market! It may require a lot of digging and some disappointment, but often properties come to the attention of solicitors, accountants, and agents and may be snatched up before they are formally marketed. Maybe the owner has passed on or moved and the family wants to sell rapidly. Or you may think that going in with a low-ball offer or buying at auction will also give you a strong advantage. But remember that a deal that looks too good to be true often is. And ensure that you have a surveyor look over before you commit, to avoid unplanned nasty surprises.
Fixer-Upper
The majority of property deals will require something updating or modifying – and considered as light refurbishment. Structural or change of use builds are significant and will require a different approach. This depends on your strategy, exit plan, and capability. The more you develop in a rebuild, the more the costs can mount up and timeframes run away. That’s where good budgeting and managing the maths comes into play. Equally, with the right additional works, the greater the hidden potential value that may be unleashed!
Location
They say, Location, Location is key. And they are right. It is important that the area in which you buy benefits from all the property ideal facilities: shops, schools, transport links, major employers and major investment. Each brings a premium, but will also make the finished product easier to let or sell, and when/if there is ever a market stagnation – proximity to the basic facilities will always add value, or move the property quicker.
Consider the following:
Retail
Your future tenants will need to be able to conduct their daily life easily and conveniently. Properties that are near shops, off-licenses, and takeaways will be in higher demand. Look for large shopping centres, small shopping malls, and local shops within walking distance for emergency and convenience goods (such as bread and milk).
Schooling
Your tenants may have children, and they’ll want to be within the catchment area of good schools. Properties here will command a higher value and rent more easily. You’re looking for junior schools, senior schools in particular (unless you are targeting college students).
Travel
Most people commute to work, even if it’s a short distance. Road, rail, and bus links will be vital. It is especially true if your target tenants are young business people. Think also about tenants who may have to travel locally for work. Look for tube stations, bus routes, train stations, and easy access to major roads.
Employment
Prospective tenants may be looking for a fresh start. There may be few job opportunities where they currently live. An area with a good local economy will present better opportunities for landlords and investors. Properties that are within easy reach of employment opportunities are more sought after. Look for areas that benefit from numerous major employers of over 100 people, lots of small and medium-sized enterprises, and employment hubs such as industrial parks, shopping centres, city centres, and built-up areas within easy reach.
5. Property Funding Options
As we have touched upon in the preceding 4 sections – there are numerous types of projects; and associated with that, many ways that funds may be raised. There is no single solution, and the process can be complicated – but is very accessible to even the least experienced investor or developer.
Light, Heavy or Ground-Up Building Development?
If you are buying a property to convert or refurbish – you could seek a bridge, which funds 3–18 months of building costs, and might have an option to convert into a mortgage later on. Alternatively, the exit could be a sale or ‘external’ refinance. This facility would cover most light and heavy refurbishments.
For ground-up development, you may need to cover both land purchase and building costs. Typically, a lender might finance 50% of the plot purchase and then stage the financing of some 70% of the build-out. Clearly, in this example, the lender is looking for the developer(s) to have some skin in the game and use some personal funds (or in some cases, if available, refinance other assets to raise the investment).
Having some property, capital at hand, and experience – will generally enable you to take on larger projects and find the funding solutions that are least costly.
Forms of Funding
The best way for a small developer to start a project is by using personal funds, or those borrowed from friends and family. Perhaps an investor may be found who will also contribute. The downside of this is that we don’t all have spare capital at the moment an opportunity arises, and tying up all liquidity in property is not always the most sensible avenue to pursue.
There are many products available, and as brokers, we can work with you to find the best blend or options available to you.
For example:
Bridging Finance
This is usually a short-term funding option (typically around 6<18 months) that helps pay for building and development costs. It assumes that the purchase will require some light refurbishment to change its use or make good for purpose. Usually this is really just aesthetic activity and may be completed well within 6 months. Terms are usually offered where interest may be rolled up for the duration of the works. Fees may be added at the outset, and at redemption.
Heavier refurbishment or renovation could require moving internal walls, amending services, adding rooms and external walls, or partial demolition and rebuilding.
Finally, ground-up projects will entail starting with a plot of land, or a very heavy refurbishment where the building is essentially shelled-out.
No lender will lend 100% – as the risk is always that the unexpected might happen and funds will run short – or schedules extend. In all cases the lender will look at the experience and plans, the value at acquisition and the GDV upon completion – and of course the exit strategy, to ascertain what can be advanced and over what terms/timeframe.
Commercial Mortgages
These are available for any purchase and development that is non-residential. Commercial Mortgages are long-term funding arrangements used to fund property like shops, offices, and warehouses.
The longer a business has been trading, and developed some strength in its balance sheet – the easier it will be to obtain a commercial mortgage. Like a residential mortgage, the lender will only lend a percentage of the value.
If you are not able to fund the “deposit”, it’s sometimes possible to secure 100% of the finance using additional security — for example offering a charge on another property or personal home.
Hunting Funds
Having a line of credit agreed – or cash in the bank – is always an advantage if you are looking to buy below market, from an estate disposition or auction.
Once you’ve made the winning bid, auction houses usually require the funds within 28 days, which means you have to move fast to secure funding.
Experienced developers with portfolios are often able to raise a fund based upon their current assets, generating a Hunting Fund. However, there are also lenders who can move quickly within (for example) the 28-day time frame, and assist in the funding of that transaction.
Finally, if it’s really too good to be true, it often is – so read the small print and take appropriate advice. Research and planning are essential, and raising an in-principle decision in advance is always a good strategy if the objective is to be fleet of foot and speculative. Always know your exit strategy, and have a back-up plan.
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