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It's a topic that keeps coming up. X property will make Y yield. Now yield as a metric, served a purpose. A quick and simple way to assess one property against another. But if you are investing with a mortgage. It really doesn't cut the mustard. - and to be honest if you are doing anything other than standard BTL, I'd argue it's not much use anyway.
So what do I factor in before I buy a property? Well, everything.
I need to know what I am investing (how much will it cost me to buy the house and get it ready to let?):
I then need to know what operating profit it will make (how much money will I have left at the end of the year?) To do this I need to know my monthly costs:
And finally I need to know my income:
I can then deduct my costs from my income to tell me my annual profit. To work out how good the investment is, I then look at what the annual profit is as a % of my total original investment. This gives me a true view of the operating profit for any property.
There is one other factor that I look at, which is the potential for capital gains. but whereas predicting operating profit is educated forecasting, predicting capital growth is more like playing the lottery. It's hard to predict how one property will do against another over the long-term. So I'd only make this judgement call, if everything else is too close to call.
Generally this would be based on if their is something particularly unique/better about a property like off-road parking in a central city location.
In a post-section-24 world, using yield to assess a property is dangerous and it can actually mean that you could end up making a unexpected loss!
What do you think? Is there a better way? Does anyone judge a property purely on Capital Gains? If you are buying cash, is this detail irrelevant? Does anyone have a view on the minimum return they would accept?
I have never used potential capital gain as a way of assessing returns. I’ve always tried to use business fundamentals (ie yield as you show). It’s an approach that has probably cost me a lot of money as I’m sure I have missed out on the massive capital gains that we’ve had in the past few years.Having said that, I’m pessimistic about property values in the next 5 years (at least) so if I was investing now I’d still look at yield alone. And that includes factoring in s.24 changes to tax relief. And if that led to a loss-scenario forecast then I would either hold onto my money or invest it in something else
That's actually how I feel. I believe the majority of my profit has actually come from capital gains, but they aren't brilliant compared to other properties, as I have focused on yield/operating profit. The problem is, surviving/growing if cash-flow is poor. It's likely that gains on x2 properties will beat gains on just one - even the best one for capital gains. So it's better to grow, take the cashflow and hope you'll get some gains.
I guess the alternative is buying for gains and holding cash, to mitigate cash-flow issues. But, you end up with the same conundrum - unemployed capital getting poor returns and the returns not being as good as a high yield and lower capital gains approach.
Oh, and to avoid confusion for any other readers . In my original post I was talking about yield as the following measure: Rental income as a % of the property value.
You are correct I also describe a type of yield, but I prefer to call it operating profit, as the term has become synonymous with this metric and the simpler form can be very misleading - as per my explanation.
This is a good thread with some good logical advice.
The ultimate way to assess an investment is with a Discounted Cash Flow and look at the internal rate of return.
This brings the worth of the investment to the present day and can incorporate rental returns, projected rent increases and projected capital losses or growth (e.g property value changes), expenditure, etc.
This approach can be applied to any investment or development project.
Rural Practice Chartered Surveyor. Experienced in estate management, residential investments, planning and development and rights for utility apparatus. All comments are for casual information purposes only. If you wish to rely on any advice I have given please ensure you obtain independent specialist advice from a third party. No liability is accepted for comments made.
Spot-on Ben. Certainly, what I got taught in my finance modules. Only problem, is that I struggle with the maths. Hence my numpty-approach.
I think as a naturally cautious planner, I generally prefer to ignore capital gains - there is a danger that incorporating them leads to a heavy skewing. As I think they are far less predictable, I prefer them not to sway my decision too-much!
I agree, I find it tricky too but if you can get hold of a good spreadsheet with it all built in you just have to adjust the inputs.
Here is RICS guidance on DCF methods for property. It says commercial but the methods apply to all kinds of property.
I think also crucial to a property is how well you buy it too. yield and long term operating profit great and perhaps also extra accounting costs, higher BTL interest if in a ltd comp to avoid s24 however if you're buying something way below market value this has to influence purchase - call it capital gain at day one?
I'm more in the biz of BTS, however if dipped my toes into BTL, i'd sure want to be able to take my capital back out and use the same deposit to go again and buy another asap.
regards Andrew Peers - property investor / sourcer - 07912674181
Property Redress Scheme Number 011436 NLA member 174404
I think BMV deals are a rarity - you are essentially talking about breaking a market. -there are other threads on this. I also think that if you get one, it's rare to get enough equity, that it's useful in these big-deposit times.
What is more likely, is a deal which offers the opportunity to add-value, i.e a simple layout improvement that could make you some equity. For me, this is like natural capital gains - a bonus. It's a useful way to hedge against market issues and on occasion, is worthwhile to remortgage/recapitalise (but as soon as you get into these numbers I think you are more in the renovation market that the B2L)
I am with the Buffet in my approach: The best investment period is, forever.
Sure - a lot depends on your demographic too, if they all need to be right next door to each other in a small area, it's hard to find a well priced property regularly. The larger the area / range the more it opens up that possibility. If you buy well, it just gives options, you don't have to wait till cash flow gives you next deposit you can simply remortgage straight away and go again.
You don't have to major renovate / develop to make a margin, a simple refurb is often all thats needed. Helps to know many auctioneers and their staff, some receivers etc. but nothing beats lots of research on lots of properties - big numbers game going from circa 2-300 down to one that will make a good margin.
I generally don't buy BMV, I buy well, improve the property's value then sell at hopefully and normally a 15% net profit margin. You don't have to sell and often these margins are larger if not in London or good home counties as well as less work normally needed.