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January 4 - January 12, 2021
You’ve done your research and you’ve estimated the net operating profit to be £5,000 per year. If we require a capitalisation rate of 5% p.a. from an investment of this type, then we would be prepared to pay £5,000 p.a. ÷ 0.05 = £100,000 for this property. In valuation parlance, this process capitalises the net operating profit of £5,000 p.a. to produce a capital value for the property. The multiple we used is 1 ÷ 0.05 = 20 times.
The investor may seek a higher cap rate on a property they consider riskier than this or a lower cap rate where the growth potential is even higher.
returns we can get on other types of investments.
full universe of potential investments, including stocks and shares, bonds, other types of property,
One common reference point we can use is the current “risk-free” rate. In a UK context, this is often taken to be the yield you can get on long-term government bonds. It’s based on the assumption that the UK government is unlikely to default on its debt. So, the yield on a long-term UK government bond sets a baseline for the return we could earn without taking any risk. At the time of writing, the yield on a 20-year fixed interest UK government bond is hovering just below 1.0% p.a. – an all-time low.
In the past, investors have sought a risk premium of 3% to 6% p.a. over the risk-free rate on residential property, depending on the perceived riskiness of the investment. In the current environment, that would give a cap rate of somewhere between 4% and 7% p.a. for use in our calculations.
Suppose I can borrow money at a cost of 3% p.a. If I borrow £100,000, the interest cost on my borrowing, assuming an interest only mortgage, would be £3,000 p.a. If I invest in a property which has a cap rate of 5% p.a., then I make £5,000 p.a. on the £100,000 of borrowed money invested.
Property Valuation Principles by David Isaac.
new carpets and a lick of paint.
we expect the refurb to be a light one,
3. The residual method of valuation
Property developers use this method to estimate the price they’re prepared to pay for a piece of land that they intend to develop. To do this, they estimate the final value of a completed development and subtract off the cost of the development and their profit margin to arrive at a residual land value.
contingency of 10% of the total estimated cost to guard against overruns.
The approach I like to use is to calculate the profit as a % of the cash tied up in the project. For example, say the cash you need to complete the development is £100,000.
Then I might require a profit of 20% of £100,000 which is £20,000 as my reward for undertaking this project.
You can also use sensitivity analysis to show how your profit might change as the key variables in your residual valuation change. For example, if you’re doing a flip, you could run the numbers assuming a +/- 10 per cent change in the development cost and +/- 5% in the final sale price.
You’ll be able to read all about more advanced valuation techniques like discounted cash flow modelling, how commercial property differs from residential property, and how to build the impact of inflation explicitly into your valuation and modelling.
Repayment mortgage
Interest only mortgage With an interest only mortgage, you pay just the interest on the borrowed money each month. At the end of the mortgage term, you still need to pay back the original amount borrowed. So, you’ll need a plan for how to pay this back at the end of the term. Most owner-occupiers take out repayment mortgages. Their thinking is that they want to have the mortgage paid off in full by the time they retire. So, they opt to pay this off gradually over time. This is the default for most property owners and it’s favoured by banks.
position. The investor then has the choice of whether to use the extra cash flow to overpay on the mortgage, thereby reducing their outstanding mortgage balance, or put it towards their next property purchase instead.
Payments on an interest only mortgage
Payments on a repayment mortgage
Suppose property prices had fallen by 10%, rather than increased. In the first case above, you would have lost only 10% of your investment, but in the second case you’d have lost 40% of your initial investment.
The key to riding out a dip in the market is to make sure you’re cash flow positive,
Most lenders insist that the rental income must be at least 125% of the mortgage payment,
Typical things lenders look at include the following: your non-property income whether you own your own home previous property experience where you live, e.g. in UK or abroad whether you’re buying through a limited company
In general, I tend to go for longer fixed rate mortgage products,
details of the current service charge and ground rent a copy of the tenancy agreement (if the property is tenanted) a copy of the lease agreement to check things like ground rent increases and/or your ability to sublet any fees that will be applied by the freeholder on subletting the property your rights around changes or repairs to the property
establish a “ballpark”
Research shows that people who are presented with extreme anchors unconsciously adjust their expectations in the direction of the opening number.
Let’s look at how it works. Set your target price (your goal) Set your first offer at 86% of your target price Calculate three raises (94%, 98% and 100% of your target) The final offer should use a non-rounded number On your final offer, throw in a non-monetary item
Ackerman’s original system works off incremental deductions of 0%, 5%, 10% and 20% from the final target price.
offer them £100 of John Lewis vouchers, a set of collectible gold coins, or perhaps a set of dining plates for their new home.
Voss also swears by using non-round numbers like £102,451 for your final offer.
In any property deal, there are a truck load of other things that can be used as bargaining chips. For example, there is the timeline for the move, the fixtures and fittings that are included, whether the property gets a clean beforehand,
Your lawyers will probably obsess over a range of smaller “deal risk” points. This will include things like which party pays for any under or overpayment of a service charge in a prior period when the seller was still the owner. You can add these into the mix too.
On one recent deal, we’d reached our limit on price, but we still weren’t quite at a deal. So, we decided to pivot to other terms. We knew the seller was a single guy who was selling his flat so that he could buy a larger house. The seller was a designer and he had great taste in furniture. The apartment itself was nicely furnished and we felt we could leave all his furniture in place and it would add value in the rental process. We decided to offer two things that we guessed he might value. - We offered the seller the choice of completion date. We said we were okay to complete on
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If you’ve ever watched 24, the hit US TV series starring Kiefer Sutherland, then you’ll know all about leverage.
Positive leverage This is your ability to provide things your counterpart wants. In a property negotiation, positive leverage could be a movement on price or on one of the non-monetary terms discussed above.
Negative leverage This is your ability to make your counterpart suffer.
Mild examples could include stalling for time when your counterpart is burning cash,
if you require your counterpart to register a title with the land registry when it’s not a formal requirement.
When I’m talking with agents, I’ll often use my ‘investment partner’ as the excuse for needing additional time
Your cat or your dog could be your partner, it really doesn’t matter.
buy you time to properly consider your next move.
You might also find that a little bit of cheekiness goes a long way.
A cheeky line like ‘I think we’re almost there, what else can the seller offer to get the deal over the line?’ can work wonders in sealing a deal. In the UK, we like a bit of cheekiness – why not use that sense of humour to help you unlock some value.
You have to know accounting. It’s the language of practical business life. –Charlie Munger
Capital This is a special type of liability of the business. It’s the amount that the owner has invested in the business to get the business up and running. The business owes this back to the owner. When a business is set up as a limited company, we sometimes call this the ‘owner’s equity’ instead of capital.
when the owner injects money into the business, this is a liability of the business that needs to be repaid.
