Tired of low bank rates?
IF YOU ARE HOLDING CASH IN A BANK AND DESPAIR AT THE MISERLY RATES BEING PAID TO YOU - PLEASE READ THIS....THERE IS A 'BETTER WAY'
Do you need to make your cash work really hard for you?
Are you tired of ‘miserly’ bank interest rates?
Over the years I have constantly been asked by people who are cash rich, how they can make the best use of that cash in property.
Up until recently, they enjoyed decent returns on their cash even if they just left it in a basic high street savings account.
How things have changed!
This is illustrated to me by the massive increase in numbers of people who now approach me for advice regarding making their money work much much harder by placing it in property.
My answer has always been the same, as I know through experience that cash wisely invested in property will always outstrip cash in the bank. This applies even when bank rates are excessively generous.
Why is this?
Simply because with property we enjoy the phenomenon of ‘leverage’
What is leverage?
Forgive me if you are aware of this phenomenon already. Leverage, in this context, is the leverage of using other peoples money to finance our aspirations. In other words, borrowing the lion’s share of the purchase price of a property from a bank - in order to fund a deal.
Banks really do like property as an asset secured against a loan. Even now!
How do I know that?
Simply because they are happy to provide finance for properties that they know are a safe bet in the short and long term.
Try asking your bank manager for £1000,000 to back a ‘sure-fire’ winner at Epsom in the 2.30, or to buy a portfolio of FTSE 100 shares – and don’t hold your breath waiting for a positive reply!
On the other hand, present an investment opportunity with rental potential breakdown to your bank, and don’t be surprised if they are prepared to lend you 75% of what it is being bought for!
You see, even in tough economic times, banks are not stupid. They are still lending money for investment properties.
When it comes to buying a property for investment purposes you will find that the bank’s decision to lend or not isn’t based on the borrowers income either.
The really important question for the bank is ‘is this a viable investment deal?’
How do you think some canny investors have acquired portfolios of hundreds of properties over time?
If the decision to loan them the money was based on their income alone (as it is with a residential purchase – in properties where you live), then not many people could possibly build such ‘empires’ for themselves!
Each property is considered to ‘stand alone’ – and in effect, someone with say 50 properties can be said to have 50 separate stand-alone businesses. In fact, that is a good way to view a property empire.
Example
Assume
You want to buy a house worth 100k
You will need 25% deposit (25k)
The bank will lend you 75% (75k)
Monthly mortgage at 5% interest only will be £312
Market rent (going rate) is £520 per month
So, as long as the rental potential for the property in question is assessed by the bank at £390 per month (125% of the mortgage of £312), then you loan will more than likely be granted.
If the property in question rented out at say £520 per month, then, after the tenant kindly paying off the mortgage for you of £390 per month, you would be left with a gross profit of £130 – or £1560 annually.
If you had to put £25,000 of your own cash into this deal (25% of the purchase price of £100,000)
Your return would be £1560 from £25,000
Or 6.24%
Now, whilst 6.24% return is much better than any savings account currently, and also the fact that you will have an investment property that will rise over time (they always do over the medium to long term), for me – this is simply not good enough.
Why is it not good enough?
Because of two reasons.....
- You would be paying too much for the house
- You wouldn’t be making enough monthly profit after he rent has been paid
Let’s look at both comments
I always shudder when I hear of some enthusiastic newcomer to ‘property investment’ who has paid full market value for a house. In this current climate you should be, and I will show you how to do this consistently, be paying around 65% of a property’s value! Even in ‘normal times’ - when property is rising, slowly but surely,you should never pay more than 80% of a property’s true worth.
By paying less for a house, you therefore need to borrow less, and you therefore also need less of your own money as a deposit too!
Simple......
Makes sense I hope? Also, it means because your monthly mortgage will be less, yet, because the the rent on the house in question will be the same, then your monthly gross profit will be more too!
Lets compare 2 scenarios using the assumptions on the property we looked at before (above)
We know that by buying at 100k
We need to borrow 75k
We need to put down a 25k deposit
Our monthly gross profit after the mortgage is paid is £130
If, however, we buy the house for 65k..the following happens
We need to borrow 48.75k (75%) Mortgage £203 monthly
We need to put down 16.25k (25%)
Our monthly gross profit will be £317 (versus £130 previously!)
The annual gross profit will be £3804
Your return would be £3804 on an investment of 16.25k
= 23.4%
As opposed to a return of 6.24% on the conventional example that you saw previously!
In other words, your money is working almost 4 times harder in the ‘unconventional’ approach.
Speaks for itself I think?
However, hopefully you haven’t missed the really mind-blowing bit here?
You see, not only have you made a fantastic return on your money by being unconventional and refusing to buy houses at ‘sticker prices’, but……
You will have created a cool £35,000 wealth for yourself at a stroke!
It’s simple…if the house is really worth 100k, then, by buying it at 65k – you have increased your wealth at 35k - at a stroke!
This is the way that creative property professionals function.
There is a saying in this business that ‘you make your money when you buy’.
Its certainly true if you buy property this way!
I actually know though that not only do you make your money when you buy, but you also make a second profit when you sell.
Think about it….
You buy a house worth 100k for 65k and ten years later you sell it for say 163k (based on just a modest 5% compound increase per year).
Your total profit is 98k!
As opposed to 63k had you paid the full price of 100k!
Examples of making 100k cash in the bank work for you...
If we use the second ‘unconventional approach’ to portfolio building, we see that the deposit needed for a 65k purchase of a 100k property is 16.25k (25% of 65k)
Therefore with 100k at your disposal, you could buy 6 properties and have a little change over too!
By paying ‘sticker (retail) price (100k each) you could only buy 4 properties! (4 lots of £25,000 deposits)
However by negotiating big discounts from market value you could....
Buy 6 properties x 16.25k deposit each = 97.5k total
Your gross annual yield of £3804 per property
X 6 properties = £22,824 - for investing 97.5k of your cash
Or, as previously
23.4% ANNUAL RETURN
Oh, and don’t forget the 6 lots of £35,000 you will have creatively negotiated!
£210,000 on top of this annual yield!
To summarise, that’s a gross yield of £22,824
Plus £210,000 negotiated equity
For 97.5k invested!
Plus..your opportunity for capital growth over the coming years on top of all of this!
If you don’t think that this beats the miserly returns cash in the bank gives you now then I will be staggered!
Hopefully this has made you think a little about the power of using a combination of your own cash – which is probably doing nothing for you presently – coupled with the notion of borrowing the Lion’s share of the amount needed from willing lenders.
Presently, banks are willing to lend you £3 for every £1 you are prepared to invest yourself for investment properties (75%/25%).
When the market ‘bottoms out’ and prices start to stabilise, then rise again – this will probably, as it used to be increase to them lending almost £6 for every £1 you are prepared to invest (85%/15%).
Incidentally, when this happens it will be a sure sign of the housing market starting to prosper again – the downside being for investors that the bargains that abound now, in 2009 will no longer be available in the same quantities.
Having said that, there will still be bargains – there always are.
I should know, I found just as many deals in the 2001 – 2006 period (when the property market was booming) as I ever did at any other time.....
