For many people, property is the source of their wealth. They spend their entire lives working hard to pay off their mortgage in the hope that one day, they will be able to live rent-free.
It sounds like a dream. And for many, it is. But it can also be a great way to provide your family with a better life, without having to constantly scrimp and save.
The trick is to find a good property investment – a type of accommodation that will provide substantial returns over the long-term.
Here’s what you need to remember before you buy any real estate.
Location Is More Important Than Anything
Why is it that you can buy a mansion for £500,000 in some parts of the country, but only a one-bedroom studio in another? It all comes down to location.
Buying a property in the middle of a big city will always cost more because demand is higher. People want the convenience of living close to central areas so that they can get to work quicker. They don’t want to have to take the tube or the bus if they can help it.
Similarly, the demand for locations outside of cities is usually considerably lower. Here, you tend to get “more house for your money.”
When investing in property, you don’t care about the level of demand right now. You care about where it is likely to go in the future. The holy grail of real estate investing is finding a location in an area that is on the cusp of booming and then riding the wave. When rents in the surrounding area go up, it means that you can push yours up too, increasing the return on your original investment.
Get The Property Valued Correctly
The sticker price of property rarely reflects its true value. Both sellers and their agents are incentivised to raise the price as much as they can. The current owner wants to increase their wealth, and estate agents want to benefit from higher commissions.
When approaching a property from an investment perspective, you’ll want to make sure that the valuation corresponds to the income potential of the property.
Look at how much rent similar properties nearby can sustain. Then work out how much return you can make in twelve months and divide that by the asking price. Ideally, you want a ratio of over 12 per cent to make it worth the effort of investing. If it’s lower than about 7 per cent, you’re better off investing your cash elsewhere (unless you expect house price appreciation).
Choose Highly Profitable Housing Arrangements
Not all housing arrangements are equally profitable. Return on detached homes, for instance, tends to be quite low, whereas the money you get back from an HMO tends to be much higher.
Many investors begin their journey by purchasing a maisonette. These small properties are inexpensive to buy upfront but offer massive returns over the long-term.
Don’t Rely On Leverage
Property investors love leverage because it allows them to generate higher and higher cash flow. But you shouldn’t confuse money coming in with real wealth if you’re currently in debt.
The reason for this is simple. When you lever up, you don’t actually own the assets – the lender does. And so if you fail to keep up your repayments, they could repossess your properties and take your tenants.
Let’s say that you borrow money to purchase four properties that you then rent out. When times are good, the money you receive from tenants covers the interest payments on the loans.
But what happens if your tenants can’t afford to pay, say, because of the pandemic? Well, in that case, you suddenly find that you’re having to pay the mortgage out of savings. Plus, what happens if the value of a property goes down? Again, you’re in trouble because the bank might call you on the loan.
Leverage, therefore, is something that you should use sparingly. The best approach is to invest your rental payments into paying off the mortgage early. That way, you can build deeper wealth that isn’t so dependent on borrowing large quantities of other people’s money.
Deduct Your Expenses
When it comes to renting out your property to tenants, you’re able to deduct your expenses, except mortgage interest payments. So, for instance, if you make improvements to the property, you can count this as a capital expense and deduct it from your taxable income.
Similarly, if you pay a property management company or a maid, you can also count these as expenses that eat into your profits.
Your Credit Score Matters
For most people, a healthy credit score is important. But, for property investors, it’s critical. The better your credit score, the better the terms you’ll get on your mortgages.
Ideally, you want to have a score of over 800 to secure the cheapest rates. You can increase your chance of accessing these by paying down your existing debt, limiting your requests for new lines of credit, and paying all your bills on time.
Weirdly, many property investors begin their careers by doing things that improve their credit score. For them, it’s all part of the job. To be successful in property investing, you have to be able to borrow at low interest rates. If you can’t then it is much harder to make any money.
Trends Could Change
For the last twenty years, property prices have shot up. Mainly, this happened because of government policy. Low interest rates meant that sellers can put their prices up because borrowers can afford to pay for them. If interest rates were higher, mortgages would become more expensive, and fewer people could support them.
When investing in a property, consider the trends in the local area. Get a sense of which way the wind is blowing. Look at things like flipping activities, foreclosures and new constructions. And take note of the kind of businesses setting up in the area. That’s often indicative of how a place will flourish (or not) in the future.
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