Property Investment: Expectations vs. Reality

29 Jun 2021

Think you know the basics of property investment? Think again.

Here are four common mistakes people make when starting out.

Expectation: You need to buy a property that you would be willing to live in yourself.

Reality: You need to focus on the fundamentals and where you can make some money.

If you’re purchasing a buy-to-let investment, you won’t live there. Counterintuitively, often the best places to invest are not necessarily the nicest places. These are the areas undergoing regeneration and improvements to infrastructure, which will drive up value.

It can be difficult to decide to invest in areas that perhaps you yourself wouldn’t want to live in. But ultimately, you’re looking to the future and what it will be like then. When looking at some of the less-desirable areas that IP Global has invested in over the years, there’s no question that they have performed the best in terms of price growth. So, it is essential that you try to focus solely on the numbers and remember that this is purely an investment decision rather than a place you might end up living in.

 

Expectation: It is better to buy in cash rather than to take out a loan.

Reality: Taking out a loan can increase your returns exponentially.

Many people are scared of the word ‘debt’. Regarding property investment, however, debt can increase your returns exponentially. Investors who take advantage of banks willing to structure loans at cheap rates are the ones who become truly wealthy building up leveraged property portfolios. Take a look at this example:

Investor A buys an apartment in cash worth £250,000.

  • Assume average appreciation of 5% p.a. for 6 years
  • Apartment is now worth £325,000 (30% increase = £75,000)
  • Rental income is £1,000 per month, resulting in £12,000 (4.8%) p.a. or £72,000 over 6 years.

Total Profit = £147,000

Return on Investment is 58.8%

Investor B invests in an apartment worth £250,000 but takes out a 70% mortgage. The split is therefore £75k : £175k Equity to Mortgage.

  • Assume the same average appreciation of 5% p.a. for 6 years
  • Apartment rents out at 4.8% yield while the mortgage interest rate is at 4%
  • Apartment is now worth £325,000 (30% increase = £75,000)
  • Rent covers mortgage = Cash flow neutral

Total Profit = £75,000

Return on Investment is 100%

 

Expectation: Yields are everything.

Reality: Your primary target can, and should be, a combination of both capital growth and cashflow.

Your rental yield is simply the annual rental return, calculated as a percentage of the property’s purchase price. Prime locations with high levels of demand and resultingly higher property prices will tend to have lower yields, compared to other less central locations. Yield is therefore often a reflection of risk, and lower-yielding prime markets are typically more secure.

However, there are other key factors to consider that make for a solid property investment. For example, a location experiencing strong population and economic growth, combined with an undersupplied housing market make a compelling case for investment.  Also, choosing a location with a low vacancy rate will ensure there’s no oversupply of rental properties on the market, this will keep void periods to a minimum and support rental growth.

So, at the end of the day, if you’re in it for the long run and your primary focus is capital growth while being relatively risk-averse, choose a property in an established high-demand location. However, if your focus is cashflow in the short term, yield plays a much greater role in your investment decision.

 

Expectation: You need a substantial amount of equity upfront to invest in property.

Reality: There are ways to structure your investment plan so that you need less capital upfront.

Depending on the percentage of your investment you can get mortgaged (typically around 70%), you can drastically reduce the amount of equity to go ahead with your investment through joint-ownership. You have the option to invest with up to four people, which can reduce your equity required to as low as 5% of the property value.

If you’d like to find out about more property investment myths debunked, check out out our guide, 10 Crucial Truths About Property Investment.

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