Thinking of becoming a property investor? I’m going to start by telling you an all too familiar story……….
It’s early 2005. Mr Investor has a steady job, in his early 40’s and due to the value of his house storming up so rapidly, has a bucket load of equity. He drives an okay car but has a desire to make some serious £££££££. Seeing property prices shooting up rapidly and believing the amount of equity in his property is due to his wise choices, he begins researching how to be a property investor!
He speak to a mortgage broker. He opts to buy a £150k flat giving £750 pcm income. He’s got £50k in savings and can get a £100k BTL mortgage. He finds a flat straight away. The market is booming so he has to move quick and snaps something up. Easy peasy. Flat rented out. His mortgage is £400 pcm. Superb. It really was that easy.
Say his costs of new build flat are £100 pcm ish. He’s clearing £250 pcm for doing nothing.
Estate agent is back on the phone to him. Same type of flat. Is a good deal. Spread the risk with two properties he’s told. He speaks to his mortgage broker. Broker can remortgage his house and raise another £25k to put down as a deposit and he’ll easy get another BTL mortgage. No questions asked. Boom, deal done.
So Mr Investor has an added £250k debt. His investment properties are worth £300k and he’s got £50k savings in. His mortgage payments are roughly £1k a month. His rental income is £1500 pcm. He’s making money. And it’s easy.
6 months on and people are going a bit divvy for property now. His flats have gone up in value 10% according to the estate agent on the phone. Agent has something for him. Builders offering incentives so he hasn’t got to put any money in to the deal. How can he say no? He buys another 5 properties with 10% built in deposits.
His property portfolio is now worth over £1million. His debt is high but payments are just about covered on the new properties by the rent and with values going up he can’t lose.
He sees the value of his portfolio jump by 10% the next year. He’s made over £100k in equity in a year! His job was £35k. Wow!
Mr Investor is now seeing £££££. He buys another 5 in the same way as the last 5. He now owns 12 properties. He refinances his first two to 90% to get money out to pay for a new Aston Martin and get another three flats.
It’s now mid 2007 and Mr Investor has 15 investment flats. The value is about £2.5million in total and his debt is £2.2million. He has worked for just over two years and made £300k in equity. He is loving life. His portfolio is making him about £1200 pcm clear but he has all that equity.
October 2007 comes. Prices drop. Market panics. Nobody is buying. He’s still covered on his mortgages so no panic.
Prices continue to creep down. Mr Investor has little or no equity left in any of his properties. He does have the £1200 positive cash flow on his mortgages. He was on two year fixed rates and as they drop off on to the now very low standard variable rates of many lenders, it frees up more cash so he’s now bringing in around £1600 pcm.
2009, Mr Investor begins to panic and try and offload the properties that aren’t making him so much money. He’s still having to find cash to keep his property in good nick every time a tenant leaves. More agent fees. He tries to cut agent out. Finds rogue tenants. Cash flow now killed by one non paying tenant. He’s barely scraping a living.
Looks to remortgage own house to help but lenders won’t touch him. Understandably.
More of his mortgages drop on to the standard variable rate of lender. That’s like going from 5% to 0.5%. He’s back cash flow positive. All his mortgages are interest only and his equity has ran out.
He hasn’t managed to sell a single one of his properties for the money he needs.
Skip to 2012 and with interest rates very low but prices for two-bedroom flats even lower (In Dorset), Mr Investor is now in serious negative equity. He is cash flow positive due to low interest rates but he’s stuck. He can’t do anything as no company will touch him for a mortgage. He’s £200k in negative equity and he has no way of making that back through rental income.
When rates go up, which they will, Mr Investor will go bust. The cost of finance will be too high.
Mr Investor will lose his own home and all 15 properties that he’s purchased.
My three rules for buying investment property are:
1. Always be cash flow positive and with a healthy margin.
2. Equity is not dead money, it’s a safety net. And you’ll get better deals on finance.
3. Banks are not your friends. They always want paying.
Absolutely nothing wrong with buying investment property. But Mr Investor actually only had enough money to buy two investment properties. That’s it. Maybe only one. If he had kept the two good properties. When rates dropped he could have ploughed loads off the mortgages. He’s be in a really good position.
Playing safe is not necessarily always the best option. I’m naturally a risk taker. But if you always follow the rule of “If it seems too good to be true, it probably is.” you won’t go too far wrong.