Your Life in Property - Chapter 5

Long term Rentals

The most common type of investment, servicing the area of greatest demand. Typically, your tenants in this sector will be based and employed near your investment and have expectation to occupy the property for 6 months or more. The variability due to local market conditions tends to centre around if property is typically offered on a furnished [a more migrant population] or unfurnished basis and the typical residence times for each tenant. Both factors demand close inspection as they will affect your cashflow and also the stability of the investment. Let's take a few examples.

Long Term Tenant in UK

The tenant market in the UK, much like markets in most of the developed world, service tenants that for whatever reason are unable to purchase property. The purchase of property and the general appetite for owner-occupation in this market is high and is often achieved by those in work and a stable location. Therefore, typical tenants will be students, young professionals, migrant workers and people "between" houses due to a job move, divorce and the like. Whilst owner-occupation is on the decline in UK and has been for 5 years or so, these tenants are the mainstay of the market and will continue to be so. Consequences of this are that the average residence time is between 7-13 months in the UK, depending on location and many units are offered on a furnished basis. So what does this mean for the investor? Well, in terms of cashflow, any units offered on a furnished basis clearly take more time and effort to get right. A 10% allowance on the gross rental is made by the taxman for running such investments, and it is likely to cost around this in reality. Therefore, as pointed out in Chapter 4, the rental income needs to be reduced as a consequence. Additionally, the shorter residence time will inevitably lead to some unplanned voids albeit these may be short in active tenant markets. Finding new tenants and to move previous tenants out also comes with a cost. All in all, around 1-2 months' rent should be expected to be lost each time through vacancy and management input required to find new tenants and conduct the move. With residence times perhaps just short of 1 year, this reduces the effective yield further by 10-20% per year. You will have your own figures to work with here, but make sure you apply them, and don't gloss over.

Nuances within this market could be letting of property to sharers [so called Higher Multiple Occupancy or HMO in UK] and rentals to tenants within houses. The HMO structure has been a real growth area in the UK, and where tenant demand dictates, it can be a very successful model. The watchword here is effective management. The property will inevitably take increased wear and tear through the tenancy, dispute can occur between tenants and it can be difficult to keep control of the occupants as they come and go. I have 2 HMO properties in UK and have found them to be higher yielding than a standard let, perhaps by 3-4%. The increased workload and maintenance has in truth eradicated most of this uplift, so are they worth it? If you are able to manage the units without undue stress, I would say a resounding "yes". Getting the rents to a much higher level makes the properties more attractive to investors and so increases their capital values when they are eventually unloaded. Just don't underestimate the work!

Finally within this section, there is the rental to tenants in houses, typically families. This can be a very lucrative market, if the purchase prices are right in the first place. At one end of the market, you could be renting a 2 or 3 bed terrace to a family that are unable to access the mortgage market. If well-referenced, they could be very good tenants and their stability gives a stable return. On top of this, the longer occupation time should, though not always, result in the tenants really looking after your home. Some of the best rental stories I have heard fall into this category. The tenants and landlords have a great working relationship, and often managers in between become unnecessary. At the other end of the market, affluent migrant workers who do not want the bother of going through a house purchase can be found when the location is right. These tenants could be paying £2,000 or more each month, and expect a quality property in return. Tenancies in affluent parts of UK have this feature, but it is so often the case that the purchase price of a property in the area results in a paltry yield of 3-5%. In addition, the demands of the high-paying tenants can be high, and this can reduce the apparent yield yet further. It is hard to get this end of the market into cashflow positive territory, although extensive research could unearth what is perhaps the best find in the industry. Let me explain. In Aberdeen, as you know from previous chapters, I was looking for property that yielded around 12%. This usually meant me hunting in the less-favoured areas of town and taking lower-paying tenants to make it work. In 2005, I stumbled across something of a sweet-spot in the market, but ignored it as it was "off brief". What an idiot. The properties in question were newly-built 4 bedroom, 3 story town houses in an increasingly popular part of town. Demand was below supply at the time and prices had been reduced from £250,000 and could be had if you bought 3 houses together at a price of £200,000. The really interesting bit is that wages are very high in the area and characterised by a high proportion of wealthy migrant workers servicing the oil sector. Rents of £2,000 pcm where achievable. The holy grail of 12% being achieved in a very low maintenance unit. So why did I not buy? My consideration was that this part of the market was fragile and dependant heavily on one part of the economy. If I lost a tenant, my yield turned to zero and I had a big mortgage to service. It was too risky in my mind, from a cashflow perspective. Do I regret not buying? Yes I do. Properties of this sort really must come up very rarely, as a series of circumstances needs to be in place for it to occur. I feel in retrospect I was correct in assuming the voids were an issue and cash flow may not have been as good as the tried and tested 1 bedroom flat market. But from a capital gain perspective, these units by their very nature are a ticking time bomb for growth. 5 years on, after the biggest crash in prices in the UK for a generation, the units are prices at £420,000 even today. The lack of a few months' rent due to voids along the way seems and is irrelevant for once. Hindsight you might say. But it is a trick that will work time and again should the yields and purchase price be in place anywhere again. I will learn from this mistake.

Long term Tenancy – German market

Most markets in the developed world bear close resemblance to the UK story outlined above, but I will introduce the features of the German market as these are sufficiently different.

Due to lower rates of owner occupation across the country, typically between 15-45%, the tenant market is turned on its head compared to that of the UK and many countries across the world. What we find in Germany, and some other markets around the world of low owner occupation rates, are longer length of the typical tenancy, tenants covering the spectrum of the population and a market typified by institutional investors purchasing on bulk. So what does a typical tenancy in this market look like? As a contrast to the shorter tenancy periods in the UK, tenants in this market can be students, migrant workers, professionals, families and even retired workers. The average tenancy is more like 5 years, with some tenants staying for 30 years or more not being uncommon. Now that is stable! Tenants consequently treat the rental as their home and unfurnished property, even down to the provision of kitchen and other fixtures down to the tenant. In addition, depending on the part of the country in question and the state of market, units can be bought as a multiple so the whole apartment block or a number of apartment blocks. Investments are bought on a far more commercial basis and priced for investors, based on yield. When I first entered this market in 2005/ 2006, I found it all a little too good to be true. Not only were the features above in place, and management of a complete block of 20 apartments more straightforward than the management of a single apartment in UK, the ancillary costs of running the property were calculated in a far more transparent way. Effectively, all the side costs associated with the running of the investment such as: House management, buildings insurance, ground tax, boiler and lift maintenance, etc were effectively paid outwith the rental yield of the property by the tenant, directly to the management company. There really are few deductions being the collection of rent [around 5% of net rent] which need to be factored in. Still all sounds too good to be true? Well, it is not a gift. The useful due diligence in terms of property condition and location as in previous chapters needs to be conducted, as well as effective management in the next chapter. I have met many investors who have entered the German market based on low capital values alone and who have either lost their shirt or at best temporarily misplaced it. I remember well the meeting with an investor from the UK who came to our offices in Leipzig with a Lidl carried bag full of keys from a "development" in a small town in East Germany. He had bought 120 units for around 5,000 Euros each at an auction in London. There of course was a reason the seller needed to take the property to auction in another country! There were around 10 units rented when he bought them, and the costs needed to get the others in a rentable condition was around 30,000 Euro per unit. He was cashflow negative from day 1 and there was no way out for him, apart from take his Lidl carrier bag back to London and see if he could "pass the parcel" with the problem. A sad case. But overall, the German market offers a real opportunity for an investor to access the market quickly, invest in a significant number of units and get managed in a truly arms-length manner. With yields of 8-12% not untypical, it is a marker which demands further research.

Commercial Tenancy

From the outset here, I will confess to a limited experience in this market. Having invested in only a few smaller units myself and only having introduced a limited number of investors to such property. This is perhaps a blindspot, due to the huge sector which it represents. The reason behind my lack of exposure to commercial property probably lies to the significant difference in this kind of asset and the manner in which it is purchased and managed. Commercial property ranges from a small shop or office unit below a residential block right the way through to supermarket complexes and large industrial spaces. What they all have in common is that the risk of the investment lays not only in the occupied state of the unit but also in the ongoing success and viability of the business that occupies it. Determining this risk is clearly a crucial part of the due diligence process that residential investment does not involve, with macro-economics being more the factor there. That said, commercial investments can be a very transparent offer and come with long-standing tenants in place. Additionally, it is typical for contracts running between 5-20 years to be in place, giving some security of tenure with maintenance issues being taken care for by the tenant. Much like the economy itself, the appetite for commercial investments can be very volatile, and property suffer greater falls [and experience faster increases] than residential property. For example, commercial property in most of the developed world has recently seen drops of around 40% or more, whilst the economy is is decline. Purchasing commercial property therefore in the current phase of the cycle could prove very rewarding if the tenant in place remains viable. Yields in strong markets can be around 6%, whilst more risky investments can bring 10-12% net yield. Against the current backdrop of low interest rates, and knowing that the running costs of a commercial investment can be very low, it could be a tempting market to enter. From my limited experience, I would tackle such an investment based on the viability of the incumbent tenant's balance sheet and attempt to buy a type of premise in a location that would support a swift re-tenancy should the incumbent leave for whatever reason.

Short Term Accommodation

Okay, back to an area I have more experience in, so hopefully I can provide a few more thoughts for you.

Have you ever watched "A Place in the Sun" or flicked through a property magazine in a dentist's waiting room and found the allure of owning a second home almost irresistible?

Seems a great way of using some of that spare cash you have and putting it to good use, not doing much in the bank after all. And the promised cherry on the cake is letting the property out when you are not using it for your own short breaks. The fag-packet calculation reveals that you could buy the property and rent it to guests who will essentially pay for the mortgage [if you take one] and all the running costs. Hey presto, a free holiday house. You pat yourself on the back for being so clever, go into the dentist's chair and think on it some more. On reflection, it seems too good to be true. Why doesn't everyone get up to this wheeze? Let's take a look at the fag packet in more detail, using the usual boring metrics our regulars will be used to.

Location

As usual, the daddy when it comes to criteria in evaluating the viability of a purchase of any property, in this case a second home purchase. But rather than using the usual tools to determine demand from long-term tenants, we are looking for the short term market [let's agree that to be 3 months or less]. Different ways of tackling this one. Here's some ideas, all internet-based so you can keep your buttocks firmly where they are right now:

• Research a number of travel sites to determine where people are going for short breaks. This will give some ideas mainly about the leisure market.
• Look at fast growing regions where the employment base could be very transient [and therefore unwilling to go for long-term accommodation]. This could include sectors such as off-shore energy [short stays onshore], near film studios where only temporary accommodation is sought or more typical seasonally-based activity.
• Try and find areas where business people come and go a lot. These could be near convention centres, universities or research areas and just an area undergoing a lot of development.

The internet really can save so much time in research. When I was researching the viability of a UK short term property, I found the Travelodge website very useful for example. Travelodge operate all over the UK, and have small hotels which service short stays for the range of clients. What was very useful was to see which Travelodge's were the cheapest [check out Grantham or Dundee, for example] and where the dearest were [London, Edinburgh, Aberdeen rank high]. In fact, the Travelodge in Aberdeen really stood out. Due to the oil industry, and a thriving economy, rooms were fully booked right out to 3 months, and then the maximum £70 per night for the rest of the year. Dundee, only 60 miles south, had rooms available year-round for £19 or so. This really was a good first indicator of the viability of short term accommodation. Closer investigation on the ground showed that Aberdeen didn't have enough beds in the city, but property prices were on a par with nearby Dundee. Short term accommodation really took off in the city a few years ago, local property owners eventually catching on.

And really, this is what this section is all about. Any fool can tell you that the capital cities such as London, Paris and Berlin have a lot of demand for short-term accommodation. But how much do you have to pay for the property in the first place? This is clearly key. Property in London or Paris is often around 5,000 – 10,000 Euro per sqm. In Berlin, central property can be had for 1.000 Eur – 2.000 Eur per sqm. That's a bit different! And whilst long term rents usually have some correlation to the price of a property [the rental yield], the price paid by a short-termer is often more closely related to the price of hotels in the city. Now that is interesting....

Finally, a bit of competitor analysis in the market could be useful. Is there someone else in the area you are looking at doing just what you want to do? Perhaps they will chat things over with you. If not, their availability calendar on their website [check it for a few weeks] will show demand fairly well.

Maintenance and Running

The property will of course take more of a pounding from short-termers. That's just a fact. You will also have to provide everything within the apartment or house, as appropriate to the market. This will often mean towels, toiletries, IT and internet etc etc. Lots of overheads you don't get with long-termers, but of course you will make some use of all these lovely facilities when you stay at the property.

In terms of running of the property, the level of client expectation [usually related to what they are paying!] needs to be considered. Obviously, you are going to present the property spotlessly clean and having a good cleaning team on board that will work when you are not in town. But how are your guests going to access the property, especially out of hours. Will a key box suffice outside the property, or should clients be met? Things to consider. How will the clients expect to pay? Do you offer credit card payment [expensive] or are your guests happy paying cash, or better in advance by PayPal?

And what about marketing? Of course the internet will be the most useful way for you to start, before you build a word-of-mouth following. Research will tell you if the market is competitive enough to need to market through portals [such as Expedia] or you are in a niche location that you can service well from your own internet site, perhaps with links from local service providers such as exhibition halls and the like. A whole article is needed on the marketing of the property really, but suffice to say it is here that the investment, if bought in the right location, will live or die.

Fractional Ownership

We should cover this type of property, not so much because it is a sector that can produce income but because it is often sold as such. Quite simply, fractional ownership means you buy a share in the use in a property either by a fractional entry on the deeds or by some agreement under a lease. It sounds a lot like timeshare, and in practice it bears a close resemblance. The advantage of fractional ownership is that the cost of entry are that much lower and can be achievable without the need to take up finance. You can therefore assert that fractional ownership only becomes popular towards the end of a property cycle when capital values are out of the reach of buyers and banks have pulled back on lending levels. Perhaps it is a good indicator that it really is not time to buy into the market.

Where the scheme could work, is in achieving the purchase, albeit shared of a size of property that you could not otherwise afford. Your level of share will obviously dictate the amount of usage you are permitted. Ok, so as an alternative to renting a holiday villa there could be something to say for the scheme. As an income-producing venture, the topic of this little book, it is unlikely to meet even the loosest of business plans. Just weigh the realistic income that can be produced during your permitted time against the high running costs and maintenance that will be required. It would be good to see some records of similar property in the area and the cashflow actually produced. Once you have a handle on the actual cashflow, put this into

context with the total cash you are putting in and come up with a rental yield. If it stacks up, then perhaps look into the scheme further. It is unlikely you will find reliable rental yields in this sector, and the chance of offloading the property to others at a profit is a real gamble.

Property for Development

As opposed to making profit on the regular income from a property rental, the basis of this book, profit can of course be made through developing property and selling at an uplifted value. Countless TV programmes and newspaper articles have been dedicated to this topic in the boom decade of 1997-2007, covering a topic that was once the preserve of professional builders.

So is there any sense to enter this market right now, post-property boom in most markets? Well, it is a risk unlike the income model we have covered so far. How can you be sure you can achieve an uplift in value and find a ready buyer in good time? Is finance availability for such projects in place? What skills, over and above competitor professionals, do you bring to the party?

Despite the difficult markets currently, it is possible that you do have an advantage over the bigger builders. Your local knowledge may put you at an advantage, perhaps you know of a forthcoming infrastructure development in the area that has not hit the press as yet. Maybe you know the seller on a personal level and can negotiate a price without presenting it to the market. So perhaps there are angles you can take. Some basic pointers to give you the best chance of making in a profit in an assumed flat marketplace:

• Can you add value to the property in an easy way some how? This could be in a number of ways. For example, can the land that comes with the property be sold off separately and reduce the risk of the main project? Are you acquiring the property with a restriction on the lease for example that can be lifted post-purchase and can therefore add value? That could be a great way to make money without doing the work, if you are well-versed in local legals and planning rules.
• Can you extend the property in a cost-effective manner? Perhaps the property is a bungalow that can be readily extended in the attic. Maybe there is land sufficient to support a one or two story extension? I suppose the point here to make is that laying a brick in a poor part of town costs the same as laying a brick in the best part of town. The value of that laid brick could vary up 3 times or more in many locations. So the location of the site, as ever, is paramount.
• Are there some local infrastructure improvements to be made in the area, and will that benefit be obvious at the time you come to sell the property? You may have heard a rumour of a new train station or new school, but the trouble with rumours is that everyone else has probably heard it and it may come to nothing by the time your development is finished.
• Can the use of the property be easily converted towards a sector that values the property higher? For example, can an old commercial building be converted into residential use? If so, what are the difference in value per sqm for each sector in the area and is there enough of a margin to take the risk you will get permission. Alternatively, can a residential property be converted into smaller units, and sold at a higher level? Does the micro-location support this?

So, this route, particularly in a favourable sellers' market, could be a way of turning profit in a much quicker way than the alternative income model. But the risks and stakes are much higher. Really do your research, before turning up to what really is a casino-type wager. The more research you do, the more the odds will be in your favour.

Purchase of land for development or subsequent sale

The final sector we shall briefly look at is the purchase of land, without property on it. There is a lot of commonality between the approach here of course with that of development of property. Perhaps the big difference is the longer timescale it can take to realise the investment, land being very illiquid. The types of land that may be of interest to an investor could be:

• Land for farming, in a country that has low land values and good crop yields.
• Land that could have the use of it changed, such as approval for residential building.
• Land that could be leased to a high-paying tenant, such as a mobile phone aerial or TV.
• Land that can be leased as a commercial area whilst approval for a change of use is granted. A favourite one is buying a city centre patch of land, and renting out for long term car parking space to local residents or businesses. The yield can be higher than that of other property types, there is little maintenance and you could be sitting on a gold mine should permission to build be given.

Timing of land purchase is critical, even more so than built property. The fluctuation in price is far greater and aligned [albeit usually with a lag] to the general state of the economy.

Auctions

Again, a complete book could be written on this topic and a search of Amazon will prove this to be the case. I will add only my own experiences of auctions, having bought only 3 properties in such a way. What can be said for auctions which are concluded in a competitive manner [ie more than 1 person bidding] is that the true market value is being paid for the object. In a difficult market, the supply of property to auction may well exceed buyer demand and prices paid can be a lot lower than listed through agents. This relies on realistic reserve prices being set. Buying at auction in a buoyant market can result in paying over what is available in the open market, with buyers placing additional value on assured delivery. Not a good place to be! As a general rule of thumb, if bidding is competitive and closing prices continually reaching above the guide price, then perhaps you have wasted a day, and you should keep your hands in your pocket. On the other hand, an empty auction house, particularly near the end of the day can be a great place to pick up units as long as you have done basic due diligence on the object and have ready finance to close the deal.

Buying From Institutional Sellers

Unless you have a lot of money to spend, it will be difficult to get direct access to the best deals that institutional sellers offload. It is more typical that a specialist agent will be able to give you access, as they have a good working relationship with the seller and deal with them on a bulk basis.

Some real bargains exist here, and it is where I have bought a lot of property and will continue to do so. The "no free lunch" is the poor delivery of such objects and the wasted time chasing down 5-10 deals to achieve only 1 sale. Perhaps this is fine for property professionals who have the time and tools to undertake such a delivery route, but more difficult for private investors who have the burden of a day job.

Our company, ProVenture, assist clients to purchase such property and there are others in the various markets around the world. The point to discuss as an opening conversation with such agents is to gain facts on the delivery success they have enjoyed over the last 12 months or so, and to get a realistic picture of what to expect of delivery and price. Once you have this clear in your mind, then you will know if this is a route to market for you.

Next Chapter - People not Bricks = success