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An Introduction to ‘Pricing’ Development Land

Note, this article should be read in conjunction with the Property Speculator’s Excel-based Residual Valuation Calculator.

The primary use for a residual appraisal is to produce a figure for land or undeveloped property purchase, in addition it can also be used to:

Establish a required profit from a project and place that figure into the calculation.
Consideration of the maximum value available for build costs, above which the project will become less financially attractive.

The undeveloped property might be:

Brownfield or Greenfield land where buildings have never stood.
A cleared site where the property has been demolished.
A property that requires renovation or conversion to a lesser or greater degree.

© Copyright Robin Webster and licensed for reuse under thisCreative Commons Licence

The very basic formula for a Residual Valuation is:

Gross Development Value or Value completed

Less

Costs and Profit

Equals

Amount available for Land Purchase/Pre-Development Property

The first value that has to be established is the Gross Development Value. This is essentially the total value of the completely finished project. In most cases, the comparable method of valuation will be used to obtain reasonably accurate values for Sq Ft or Sq M. Recent transactions can be analysed and the selling price or annual rent compared to the property in question. Although the comparable method is not flawless, it is about the most accurate method to establish (completed) property value available.

Some important considerations are:

If a project containing multiple dwellings is to be analysed, the GDV will be based upon the total value obtained from the sale of all the units. The value that can be obtained on the market can be expressed as a rate per M² and can be established through the study of comparable, similar properties recent sold prices (NOT the values they are offered at).
When establishing the total value of the finished project, remember that common areas such as stairways, hallways and foyers are not included within this value, but they will be included in build costs.

The amount available for land purchase is the absolute maximum that the developer would pay for the undeveloped project. In practice however, this figure is likely to become the Gross Land Value because he has to:

Allow for professional fees and SDLT or property taxes.
Pay interest charges on any money borrowed to fund the development.

When the above have been subtracted, the Developer is left with the Net Land Value.

The second value to be looked at is the total costs of the project. This will include build costs, consultant’s fees, finance costs, infrastructure/landscaping costs and any obligation for S.106 agreement (a contribution to the Local Council in connection with the project) or Community Infrastructure Levy (CIL). Considerations are:

As mentioned above, build costs will include the total value of the units to be sold and any common built areas (based upon Gross Internal Area). Build costs can range from £600 per M² to £1600 per M² depending on the area of your project (obviously London/South east will be more expensive than Northern England and Wales) the required quality of finish and who you intend to do the work (Main Contractors is the most expensive route). Click on the link for information on build costs. VAT can often be reclaimed on many costs involved with new-builds.
The amount spent on consultants will vary according to the size of the project. However for the purpose of appraising the project, using percentages is the most appropriate way for the majority of projects to be looked at. Examples are: Architect 5-7.5% of build costs and a Project Manager around 2% of build costs) VAT will almost always be payable on consultant’s fees.
Site infrastructure will include drainage, water, gas and electricity supplies. For small projects, the cost will be negligible and the same goes for landscaping costs. This is why a percentage calculation is appropriate.
Finance costs will depend heavily upon the amount borrowed and the rate it’s borrowed at. If the project is intended to be solely a development (rather than a development with the aim of letting at the end of the construction phase) then the costs should be recouped as soon as possible. Obviously the longer it takes to recoup all construction costs; the more must be paid in finance costs. For the purposes of calculation, a construction period of 1-12 months and a post-construction marketing period of 2-8 months should cover the vast majority of situations.
S.106 costs will be related to how the project as a whole ‘fits in’ to the local environment. A contribution is often requested by the local authority to pay for changed infrastructure to serve the project. This might be a widened road leading to the development to serve the occupants. Follow the link to read more about s.106 obligations for developers.
Estate agents fees are quite negotiable depending on the size of the development. It would not be unreasonable to attempt to negotiate a slight discount of half a percent or so for sole agents that will be acting for a large development.

The next figure is the required profit level. This is often calculated as a percentage of the GDV value. It’s important that the profit is considered in the equation, because it’s surprising how many novice developers regard a profit as a bonus. To continue developing property must be regarded as a business. If no profit is made, then the business will not survive for long.

Clearly, the higher the required profit level, the less will be available to purchase the land. So a balance must be struck. Pre-recession profits could be around 33% of GDV (a very crude assessment of a property development was’ 1/3^rdfor land costs, 1/3^rdfor build costs and 1/3^rd for profit’). It’s very doubtful whether this would still be attainable now, in practice a rate of around 15% of GDV is realistic. It certainly helps to be conservative and cautious when appraising a development.

The final and eventual figure to be generated is the sum available for land purchase. This can be changed considerably if the input figures are changed. In fact one of the criticisms of the residual valuation method is that for relatively small changes in the input figures, large changes in the eventual values can be seen. This is why it helps to be cautious with input figures, overestimation of costs is better than underestimation.

The land purchase figure is the figure that forms the basis of your negotiation. If the property is being bid on at an auction, obviously no opportunity to negotiate will exist. It will however provide you with a good idea of how your project finances will work and if you bid above your ideal value, the other figures will be reduced accordingly (profit is usually first to suffer).

To download the very finest guide to Assessing Land Value, the Residual Valuation method and Gross Development Value currently available on the internet for only £5, please have a look at my ‘How to Price Development Land‘ page.

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Apr 29th, 2012

13 Steps to Getting a Property Sold

If you are planning on developing a property, the very final stage is the sale at the end. No developer wants a long wait to sell the property, no capital or rent is coming in and meanwhile mortgage repayments have to be covered. The longer it stays on the market, the more the developer will financially lose out.

So, to ensure that you have the very best chance of getting the completed property sold, here is a checklist to run through so that you know you are less likely to miss out.

© Copyright Carl Ayling and licensed for reuse under this Creative Commons Licence

Establish your position. You have to realistic about selling the property; if the market is currently flat in the area you are selling in you might well have to reduce the price at some point in the marketing process. If you are not in a particular hurry to sell, you might feel that reducing the asking price is not an option you want to consider. Don’t rule it out though.
Consider the purchaser’s aspect when pricing the property. Clearly it will depend on what the property is valued at but remember that houses are usually priced strategically just below the Stamp Duty Land Tax thresholds. This is not coincidence. If a property is priced just below the threshold and a competing one is just above it, the difference between them might only be a few thousand pounds but the cheaper one is likely to be on the market for a shorter length of time.
Consider your market. Much is made on TV property programmes of selling to ‘young professionals’; however there are occasionally people outside this category who buy properties. Of course, I recommend buying a development property with a particular customer in mind but you should certainly be selling it knowing who should be buying it. Students for example (or rather their parents), will be considering different things than a young family or a retired couple. Far better to cater for an existing local need than trying in vain to sell a property that’s being marketed to the wrong people. Speak to Estate Agents (several), they should be able to tell you where the local needs lie.
Ensure that the work that needs to be done, is actually done. If you’ve just had work done on the property then there shouldn’t be any excuse for leaking gutters, damp or mildew on walls or dodgy hinges on doors (for example). Not every developer will be carrying out a complete ‘gutting’ of the property, so if the turn-round is a rapid one to get it back on the market, make sure nothing is overlooked. If someone is having a viewing and looking round the property, if they find one obvious fault they might start to look for others.
Always have an idea of what the property is worth. Property valuation is not rocket science; it’s easy to get to know a particular area’s property market. After a few weeks you will probably be able to gauge neighbouring property prices to within around 5% of what a professional valuer would put it at. This will definitely help when it does finally get to the stage of accepting an offer, you will be able to distinguish between a silly offer and a realistic one. Having a look on a couple of property websites will help to get an idea of what neighbouring properties sold for (www.nethouseprices.com or www.rightmove.co.uk).
Choose the right estate agent. Some are good, some are bad but it’s highly likely you will be stuck with them for at least 6 months if the property does not sell. Word of mouth is a good way to get an idea of true reputation, and don’t be taken in by their sales pitch, remain sceptical! If you choose to put the property on the market with a single agent, there’s no reason why you should have to pay more than 1% (plus VAT) of the sale price. If you go with dual agents, it’s very likely you will be charged 2% (plus VAT).
Once the property is on the market, make sure it’s kept tidy inside and out whenever possible. Potential purchasers will do ‘drive-byes’, where they drive past a property to have a quick, discreet look and get a feel for the area without committing to a viewing. If there’s rubbish or builders waste left outside the property, it can be really off-putting for them.
If the estate agent has promised you that the property is displayed in their window and being aggressively marketed, periodically check that they’re telling the truth. Speaking from experience, an agent had stressed that the particulars of a house was in their window for all passers-by to see; but upon arriving at the shop, my wife and I found that not only was it not in the window it wasn’t displayed inside the shop either. They were poor agents and this was the final straw in making the decision to sack them.
Be picky about the property details produced by the agent. Their job is to get your property sold as quickly and efficiently as possible. If you feel that the details are not satisfactory, don’t be afraid of telling them. You will ultimately be paying for this service so they should always be acting in your best interests.
Pester the agent for feedback on viewings. Agents are not always the most communicative of people so they might need prompting occasionally. You might be fobbed off with a vague comment the agent picked up from the viewee, but after a few weeks of pestering them for accurate feedback, they’ll make sure they have proper answers for you. Some aspects of the property might be unavoidable, such as parking. However some things might be easily solved such as borrowing some furniture to ‘pad-out’ an empty property.
Consider exactly what you might be prepared to put in the property for the purchasers. For example you could throw in all the fitted carpets if the purchasers pay full asking price; they don’t know that you managed to get a load of inexpensive carpet from a friend. Same for curtains, you (as developer and vendor) might feel that putting up some (decent quality) curtains is of such little consideration as to be next-to worthless to the purchaser. This is not the case, buying and fitting good quality curtains and rails can run into thousands of pounds in some cases. If you can source them cheaply, you might well swing the deal in your favour.
When an offer does come along, you should have a figure in your mind that marks the border between what would be acceptable and what wouldn’t. This value has to be realistic though. In the current climate, buyers are looking for bargains and if you won’t consider dropping the price at all then it might be a while before the property sells. It’s a difficult market and sellers have to do what they can to keep their businesses running. Obviously a reduction in selling price over what you might have expected will reduce your profit margin, therefore consider this very carefully.
Do anything possible to increase the exposure of the property. Sarah Beeny’s website Tepilo is very good, and free. You won’t lose anything by making use of it! If you look around, websites and blogs can be free too these days (for example www.wordpress.com), give the property its own site! You have nothing to lose and it should not affect the arrangement you have with your estate agent.

Jul 3rd, 2011

3 Principles to Guard Against Property Investment Scams

I have to admit that I feel quite naive today. I was drawn to a post on one of the forums I look at occasionally where a guy had invested money in one of the numerous companies around that promise that you can become a millionaire property investor in 12 months or something like that. The general principle is called something like NMD (No Money Down).

What was supposed to happen, was that the potential investor or developer would find a property which he believed (and had reasonable evidence to suggest) was dramatically undervalued. The man on the forum had found a property he felt was worth around £290,000 and the vendor ended up accepting his offer of £204,000. The company (which I will not mention) then charged him several lots of fees to get the ball rolling. They put him in touch with a mortgage broker who began to fill out the application form for a property worth £290,000. The guy let it slip that he was only buying the property at £204,000. The mortgage broker immediately informed him that he could definitely not obtain a mortgage for a higher value than he was purchasing the property at. This amounts to mortgage fraud and will land you in an awful lot of trouble when the mortgage company find out.

In the end, the guy realised that he had fallen for a scam but not before he had paid out a couple of thousand of pounds in ‘introduction fees’ and the like to the company.

Mortgage companies will not take kindly to potential purchasers attempting to manipulate figures in order to swindle them out of money. In the case of the company above, the plan is to mortgage the property at the absolute top end of what it might be worth, but to purchase at significantly less. This means that the purchaser ends up with a lump sum of surplus cash over and above the purchase price. The mortgagor (the party that is borrowing the money) will still be repaying the whole sum through the monthly payments; however the mortgage company will be excessively financially exposed to risk. No one could realistically expect a bank to take on all the risk in someone else’s property venture. Mortgages are subject to conditions that ensure the bank minimises its risk as much as possible. They are not charities, and they will not allow a prospective property entrepreneur to indulge in attempting to build a property business without facing risk. If banks were to leave themselves open to such risk on a regular basis, they wouldn’t be in business for long.

© Copyright Gordon Brown and licensed for reuse under this Creative Commons Licence

My point in this article is that I always (rightly or wrongly) assume that everyone involved in the property field is a professional and unquestionably honest. That’s why organisations such as The Royal Institute of Chartered Surveyors, the Law Society and The National Association of Estate Agents exist. They ensure that their members adhere to high minimum standards of practice. I’m not saying for a minute that all private companies offering a service that doesn’t fall into the professional categories above will rip you off. However, the old expression “if it seems too good to be true, then it probably is” will serve to remind you to be on your guard. It wasn’t until I read the forum post mentioned above that I looked round the web and saw far too many similar companies doing the same as the one above. They just want to sell expensive property investment courses to aspiring (but naive) entrepreneurs. It makes me sad to think that the profession that I take very seriously might be associated with these shysters.

Please, remember these principles:

Property sale values are recorded within the process of purchase and registered with the Land Registry. You will not get away with obtaining a mortgage for more than the property is bought for unless it’s one of those fabled 110% mortgages.
You really should not have to go to seminars to learn about property development and investment. All you need to do is study this website (!), do your homework properly and enter the field carefully. If you go to a seminar, there is an extremely good chance that they will try to sell you something.
If it were really possible to purchase a property legally without using any of your own money, everyone would be doing it. Property is expensive, this serves a purpose by (in economics terms) making ‘barriers to enter’ the field. If everyone could buy property without using their own money, can you imagine what property values would do? The hard fact of it is, purchasing property requires capital. It’s what makes the whole process work properly; The bank wants to minimise risk so that they stay in business, and the property entrepreneur should be embracing a small amount of risk because this is what produces the return for him.

Jun 1st, 2011

Risk Management in Property Investment & Development

Let’s be clear on this, investing in or developing property represents an element of risk to a greater or lesser degree.

Most prospective property developers and investors realise this but some subsequently procrastinate over taking positive steps to progress their venture. Perceived risk can include:

Getting a property project only partially complete before running out of cash.
Experiencing a problem during build of such scale that the contingency fund does not cover it.
Finishing the build and not being able to sell or let the property in order to recoup costs.
The property build/conversion will cost so much that the developer with experience substantial financial hardship in order to get it finished.

All these concerns can be effectively managed and guarded against prior to the start of the project. This is where a particular approach is vital; these risks should not put anyone off engaging in a property development or investment project.

© Copyright Jeremy Bolwell and licensed for reuse under this Creative Commons Licence

Risk is the ‘price’ of the return from a venture. It’s been said that ‘the higher the risk, the greater the reward’; however this seems (to me anyway) to be a contradiction in terms. If risk is high, then there is no guarantee of reward at all. People generally have very differing views on the amount of risk they are comfortable to adopt. However, if a developer is looking to borrow in order to fund the purchase and renovation/conversion of a property, then the mortgage provider will be very keen to see the project organised as low a risk as possible. This includes the developer putting around 50% (for first-time developers) of their own money into it.

So in conclusion, it’s important to minimise risk wherever possible. And to be honest, property is one of the lower-risk methods of investment and capital building. It’s not THE lowest, but there are far riskier investments available to those with the appetite.

To address the points above in turn:

1. Running out of cash mid-project.

This element of risk is managed by careful planning of the project. Many novice developers run low on cash, but it’s almost always because the budget has not been organised properly. The principles of running a financially viable project are:

Purchasing the property at a good price. It takes time to select the right property; it must fulfil many criteria – purchase price being one of the most important. If you are purchasing at an auction and the bid goes above your maximum level, you MUST resist the temptation to continue bidding. In my experience, if one opportunity has come along, then the chances are that another is not far behind. Once in a lifetime chances are just not that common. It’s far better to purchase a property at a good price and sell at an average one, rather than buying at an average price and hoping to sell at an exceptional one.

Agreeing a fixed-price contract with the builder. This is insisted on in many cases when obtaining development finance. It should be possible to agree stages of build with the contractor, where you pay a proportion at the end of a stage before moving on to the next. The agreement is likely to specify what is not covered in a fixed-price agreement. This might be substantial ground work or structural alterations. This is all in the negotiation.

Sourcing materials shrewdly. This might fall into the principle above, but if you intend to do it yourself, approach it as a business and not a personal ‘statement’. Buying the property and approaching the building work with your head, not your heart helps so much in this. Keep in your mind that the aim is to get the property let or sold and move on to the next.

2. Blowing the contingency fund on an unforeseen problem.

A contingency fund is an excellent idea. This is usually around 10% of the whole project budget. A fund of this amount will actually be a condition of borrowing with many companies (you’ll have to produce proof of the amount in a bank account).

So if a whole project budget is £240,000 for example, a contingency of £24,000 should be available in addition.

If the principles above are followed, there really should not be any reason for unforeseen problems to require more than 10% of the budget to rectify. Ground, structural and roof problems are usually the most expensive to sort out, but almost all of these can be taken into consideration if a good survey is carried out prior to purchase. Excessive build/conversion costs are another one of the criteria that should be considered before purchasing the property.

In some cases, problems do arise that there really was no way of knowing about before the project is bought. In this case, a degree of imagination is sometimes called for to resolve it without blowing that contingency fund. The most expensive and challenging problems are things like disused wells or buried objects. However these are rare.

3. Not being able to sell or let the property at the end of the building phase.

This is a problem that has affected many aspiring property developers over the past 4 years. As mortgage companies suddenly tightened their criteria for lending, the amount of buyers across the market as a whole reduced to such an extent that demand came to an abrupt halt.

This might be regarded as the greatest of all the risks involved in a property venture. It is theoretically possible to have a property advertised for sale for an indefinite period of time; and this scares the life out of many prospective developers.

Property is widely regarded as being highly ‘illiquid’. This means that the value cannot easily be released. The opposite end of the scale is cash; this is obviously a ready source of capital that can be used easily. Because of the nature of property’s lack of liquidity, it has certain characteristics such as a degree of stability of value (due to the fact that it is a tangible item, unlike for example – company shares). Unfortunately because of this shortcoming, capital can be ‘wrapped up’ in a property with little way of extracting it.

The way this problem is managed, is again by proper financial management. To reuse my quotation from above…. far better to purchase a property at a good price and sell at an average one, rather than buying at an average price and hoping to sell at an exceptional one. You must remember this! In many cases, the reason why properties stay on the market for so long is because they are overpriced for resale. Sticking to a rigid budget dramatically reduces this risk because there is less chance of financial overstretch. You should certainly make sure that you have planned for the property to be complete yet vacant for around 6 months after the build.

4. Experiencing financial hardship in order to complete the build.

Clearly, this is a variation on the perceived risks already mentioned. Most successful private developers have sufficient ‘surplus’ income to cope with the increased monthly outlay to cover another mortgage.

Some amount of flexibility will be needed to cover unforeseen problems, but the contingency fund will be in place to cover them.

There are not really many valid reasons why novice developers should find themselves enduring financial hardship to get their project completed.

To conclude, sensible and realistic budgeting should go a very long way to managing the anticipated risks involved. However as I’ve mentioned already, property development and investment is risky; if it wasn’t, there would be no money to be made in it.

May 13th, 2011

Property Development Finance

Many aspiring Property Developers procrastinate over their plans because they believe they will not get finance to fund their project. This is clearly an extremely important point, because as I’ve written in many posts, even if you can afford to, it does not make good business sense to use 100% equity (capital that is not borrowed) in a venture. One of the main advantages of working in property is that because it is a tangible asset (i.e. not a paper asset) it can be borrowed against.

In the current economic climate, you might be mistaken for believing that it would be impossible for you to get a mortgage based around a property that needs substantial work to put it into a marketable condition. This is not necessarily the case. The vast majority of mortgage providers will be sceptical when you mention ‘property development’. This is because the sum that the developer borrows is secured against the property itself. This is why mortgage debt is the cheapest of all loaned cash; the bank/building society massively reduces its risk by ensuring that it has a legal ‘charge’ over the property in the event of a default of mortgage payment. Essentially meaning it can sell the property to settle your debt if it needs to. If the property were to be repossessed in an uninhabitable state, the banks chances of recouping its loss would be severely compromised.

Another likely scenario is that the mortgage provider might only release a very small proportion of the total amount being borrowed for land/property purchase, and only release the remainder when the project is completed. This obviously means that the developer has to fund the individual build stages out of his own pocket. This can be catered for when you are an established, experienced professional developer. However a novice is likely to be financially stretched.

The alternative to this is to have each payment released at each (pre-agreed) stage. This is a fairly common approach because it’s an established way of only paying interest on what is being borrowed. These payments will however, be released in arrears; meaning that the individual stages must be covered by the developer, but the funds to pay costs and fees will be released in arrears at each stage boundary.

At this point, I’d like to take the opportunity of pointing readers in the direction of my posts on Financial Leverage in Property Investment and Development, and carrying out a Property Development Appraisal. This is so that you are aware of how to calculate how much you need to borrow and why it’s not a good idea to use all your own cash.

Be aware however, specific conditions still apply. Mortgage lenders are now more than ever, quite risk averse. All the usual conditions of obtaining a mortgage approval still apply:

You should definitely not be overstretching yourself too far. This is (arguably) one of the causation factors for the recession, too many people borrowing beyond their means to buy more and more expensive properties. This is currently the most common reason for rejection of mortgage applications. You simply have to be creditworthy.
You must have a good proportion of equity to invest. This is now usually around 10% minimum with the most generous of lenders on an owner-occupier mortgage (this level of gearing would not even be considered for a development project). A realistic figure for a property developer is around 50%-60% of the GDV. An alternative to this would be if you already own the land or pre-development property yourself.

In common with all professional developers, the novice must accept that full compliance with lenders conditions for each individual project is vital. It’s not like a conventional owner-occupier mortgage, where you simply pay the instalment each month and the provider more-or-less leaves you alone. Developing for profit is almost a joint venture with the bank. They must be absolutely 100% happy that you know what you’re getting into, or at the very least employing an experienced professional who does.

Apr 10th, 2011

Borrowing to fund a property development

Financial leverage is basically the practice of using borrowed money to supplement equity (non-borrowed money). In the field of private property development and investment, this is often done at a ratio of between around 20%-50% equity, the remainder being borrowed in the form of a mortgage.

The term ‘gearing’ is closely related to this subject. Gearing is the particular ratio of debt to equity. The proportion of debt is expressed as a percentage of the equity. So if a property is geared at a ratio of 65%, this means that the amount of capital borrowed to purchase the property is 65% of the total investment. In the world of finance, if a particular company is geared at 65%, then it would be regarded as high risk. However, private property investors might have to borrow up to 3 times the equity level. This would not be regarded as risky in the same way as corporations, but you should always acknowledge the risk factor in any investment. The return on your investment is the payback for accepting this risk.

A certain amount of financial leverage is not only (for the majority of people) inevitable, but it is also desirable. This is because of 2 reasons:

It enables a speculator to increase his holding several times over. It makes more financial sense to place 25% of your total investment into each of 4 properties, rather than placing 100% of it into a single one. This enables investment diversification (which helps minimise risk) and maximises potential future returns.
Purchasing a property using 100% equity is the most expensive way to run a development or investment company. This is because tax is payable on a company’s NET profits. If the vast majority of your return is regarded on paper as profit then you must pay tax on it. Mortgage repayments are regarded as liabilities and will subsequently reduce tax liabilities.

Property is quite unique as an investment as it enables speculators to borrow higher levels against the property value. This is because it offers a tangible investment. Even if the property remains unoccupied or unsold for an extended period of time, the lender will always have (at the very least) the land value to guard against the loss of their capital. Even if the building upon the land is destroyed somehow, the land will always have some value. Most other investments do not offer this.

An example of why financial gearing increases returns is as follows:

An investor purchases a property at a price of £100,000. Equity is £35,000, and £65,000 is borrowed.

Investment capital £100,000

Less loan £65,000

Property owners equity £35,000

Rent for initial 5 years £8,000 per annum

Less loan interest £5,200 per annum

Net income to property owner £2,800 per annum

Return on Property Investor’s equity £2,800 ÷£35,000 = 8%

So the property investor achieves a return of 8% per year for the first 5 years. However it is in the subsequent years where the advantages of leverage become clearer.

Reviewed rent for next 5 year term £10,000 per annum

Less loan interest £5,200 per annum

Net income to property owner £4,800 per annum

Return on Property Investor’s equity £4,800÷£35,000 = 13.71%

Subsequent terms will reflect even greater returns in comparison to the level of equity placed into the investment. This investment would be a 65% gearing.

It is highly unlikely that an investment of only £35,000 could produce a return of 13.71% and more if invested in stocks. Prior to the recession, Hedge Fund Managers spoke of producing returns of up to 40% per annum. However, a minimum investment is required (far in excess of our example value of £35,000) and the investment risk would be regarded as far higher than that of property. Many hedge funds have gone out of business post recession, taking their invested capital with them. Remember though, property is a tangible investment and it is difficult to foresee a situation where it would ever be worthless.

Nov 28th, 2010

Property Investment Market Research

I do not profess to be an expert on business, but one thing I certainly do know is that the vast majority of first-time business starters do not put their plans together the right way.

Many, many business start-ups have failed because the founders try to establish the business in this order:

Decide what they can produce.
Get the item/service to market.
Decide who they will sell it to.

The reason this approach fails so often is that they aren’t producing the item or service to any particular ‘market’. There is a good chance that whoever they attempt to sell to isn’t actually looking for the product anyway.

A far better approach to establishing a business is to:

Research a market or field to understand it and the people immersed within it.
Learn exactly what shortcomings are evident.
Source a solution to that ‘problem’.

A property venture that makes money for you (let’s face it, why else would you be considering it?) is a business in the conventional sense; and the second business model above is very appropriate as a base. It will prove to be an expensive mistake if you buy a development or investment property, get work carried out and then think about whom to sell it to. Countless TV property programmes quote the novice developer as wishing to appeal to ‘young professionals’. This is all very well if the property is the right type and in the right area, however it will not work for the centre of a university district (for example).

It is so important to be extremely fussy when looking for a potential property that fits your requirements. In the case of professional developers, many plots of land will be under careful scrutiny so that the precise one is eventually chosen that will produce his expected return. To apply the business model above is very appropriate because the property will be your ‘product’ taken to market.

All areas will have particular needs in respect of accommodation. They are also highly likely to have accommodation that just will not sell or let. The letting agent is the absolute best person you could speak to when considering the type of property that you are going to purchase as an investment. If you are intending to develop the property, then speak to an estate agent in a similar way. The agent will have access to potential clients that have pestered him for a property to rent or buy in a certain area (this could be narrowed down to a particular road). He will no doubt be on the phone to these people on a very regular basis to provide an update on availability. Therefore, if you do purchase the ‘perfect’ property that offers exactly what these purchasers or tenants want, you are almost guaranteed to sell or let and achieve a good price.

In contrast, the agent will also have an extremely good idea of the properties that just will not move. These are the ones that appear in the paper every week with gradually declining prices or rents. The agent will know exactly which property you should not buy.

The venture must be approached in exactly the right way if it is to succeed. Several geographical areas can be considered, with the intention of purchasing a property in one of them. However, the property type is very likely to differ considerably across the range of areas. Your considerations might look like these examples:

Area A could ‘carry’ more reasonably priced single-person’s accommodation. Therefore the purchase of a large house that stands a good chance of obtaining consent for conversion into flats would be a shrewd move.
Area B is more upmarket and fairly ‘suburban’. It would support more 2 bedroom, generously proportioned flats because the agent regularly receives serious enquiries after them. Therefore, it might be sensible to consider a newly-built block of three storeys with upmarket, well-sized flats.
Area C is completely suburban with quiet roads but close to 2 good schools. In this situation, a plot that could accommodate 2 or 3 new detached houses would be an excellent move.

This is to show that many property types can be considered. It really does depend on the area and what is vital, is a flexible approach. The venture is a business and the properties should not be regarded as a blank canvas to experiment with indulgent interior designs. The aim is to produce a finished property that will have people fighting to rent or buy; and yes, this is perfectly possible in the current market provided you have done your homework.

Sep 13th, 2010

Interest Rates and how they Effect You

Interest rates are currently at an all-time low. This obviously makes it very cheap to borrow money in the form of a mortgage. However, many mortgagors (borrowers) do not fully understand the influence of mortgage interest rates on the payments they are obliged to make each month.

The Base Interest Rate in the UK is assessed every month by the Bank of England’s Monetary Policy Committee. Many factors are taken into consideration when deciding whether to reduce, maintain or increase it. One major influence is the rate of inflation or deflation. The interest rate is varied to regulate consumer demand; if the rate is increased then goods and services appear more expensive and subsequent demand reduces. This ultimately tends to ensure that price inflation is less likely. If the interest rate is reduced, then prices appear to be cheaper; this is used to stimulate consumer demand.

The other side to fluctuating interest rates is the effect they have on savers. If interest rates reduce, it might stimulate the retail aspect of the economy but investors will be less inclined to place their capital with the banks as the rate of interest the investors receive will be poor. Likewise if interest rates increase, savers will be more inclined to leave money in a savings account because of the more favourable return.

Another influence on interest rates is LIBOR (pronounced Lybor) which is an abbreviation for ‘London Inter-Bank Offered Rate’. This is the interest rate that banks use when they lend money to each other. This rate of interest is announced daily and is determined by the money markets in London. The behaviour of LIBOR can provide the banks with a useful indicator of a forthcoming interest rate change. If LIBOR is significantly above the bank base rate, then it can be a sign that the base rate will increase. If LIBOR is below bank base rate, it might be an indication that the markets feel that the base rate will decrease.

These changes in the Bank of England base rate directly effects borrowers. Mortgage providers (mortgagees) usually arrange Variable Rate loans at around 1%-2% above the base rate. If the base rate goes up, a mortgage is also likely to increase by the same rate. Although this is not ‘set in stone’; it is up to the mortgage provider to pass on reductions or increases.

A Fixed Rate mortgage is often used by landlords, as it is very easy to budget and plan for repayments into the future. Landlords that have access to this facility are often recommended to fix the rate for as long as possible e.g. If this term is 25 years; then that’s 25 years of mortgage repayments that will not change over time. Although in practice, it is highly unlikely you will find a mortgage provider that provides this for a period longer than about 5-10 years.

A Tracker Rate mortgage will closely shadow the base interest rate and stay around 2%-3% above the base interest rate. This allows the borrower to take advantage if the interest rates drop, though it will get expensive if the interest rate increases by a great deal.

On a typical repayment mortgage, the borrower pays a particular sum each month which covers a percentage of capital but is mostly made up of interest (though this ratio will change as the term of the mortgage progresses). So for example, if a total monthly mortgage payment is £1,000, this might comprise £750 in interest and the remaining £250 goes towards paying off the capital. The amount of interest paid depends upon the amount of the loan still outstanding and the interest rate applied to it. The capital portion of the repayment depends upon the amount borrowed and the term of years the mortgage is to be repaid back over (for example 20 years). So if a borrower makes overpayments, this reduces the capital aspect of the loan far quicker and therefore substantially shortens the mortgage term and therefore the total amount of the mortgage.

The following tables offer illustrations to compare the effect on monthly mortgage repayments when the interest rate varies. Far too many property speculators and conventional homeowners do not consider the effect that a substantial rise in interest rates would have.

These tables show the difference that a significant change in interest rates would have on mortgage repayments. Almost all mortgagors would experience difficulty to some degree if rates increased, however some element of flexibility should always be considered.

Aug 6th, 2010