Many years ago I bought a small property as a weekend getaway. I hadn’t caught on to the income generating value of property at that stage and after realising not too many weekend getaways were happening, I decided to rent it out.
I wish I could say the property bug bit me then, but it didn’t and I missed out on many years of potentially building a lucrative property portfolio. Luckily that investment worked out well and I have come to realise property investing is an exciting, challenging and tangible way to build wealth and passive income streams.
The beauty of it is that there are many ways other than the conventional “buy and live in it” to get value from property;
- The Buy to Let approach which I accidently fell into. This is an ideal source of passive income, while also potentially resulting in capital growth over the long term;
- The Sell for a profit strategy. This doesn’t immediately appeal to me as it is a more hands on, higher risk property play and I have got to say I wouldn’t deal well with having to deal with builders, cost overruns and trying to find buyers;
- Indirect investment through funds: this is the hands free approach and can be done at different levels of risk and return in terms of the risk profile of the investor.
Which option to choose?
The easiest option for the beginner who wants to dip their toe into property is likely to be the fund approach. The disadvantage of this approach is you don’t get the same sense of achievement as you get with the tangible bricks and mortar strategy but you do avoid the administration and stress that comes with direct property investment.
Investing in property ties up your cash and it is extremely difficult and time intensive to exit. On top of this, in the UK there are onerous buy and sell costs; estate agent and surveyor fees, stamp duty, land tax, solicitor and conveyancing fees. Landlords are further heavily penalised by the taxman with an additional 3% added to the relevant stamp duty charge as well as the limitation of the deduction of mortgage interest. From 2020 mortgage interest will not be 100% deductible from rental income in the tax calculation. Instead you will receive a tax credit of 20% of your mortgage interest.
With either approach it is important to remember that both direct and indirect property investment are exposed to the risk of decreases in property prices and rental demand.
It is possible to mitigate these by:
- making sure you have not gone in over your head and taken on too much debt. Remember a rise in interest rates is likely to increase the cost of the mortgage.
- creating an emergency fund specifically for your property investments to cover void periods without tenants and the costs that arise from unexpected repairs and household catastrophes. Think burst pipes in winter!
- Not concentrating all your investments in property. Invest in a diversified portfolio which includes other asset classes as well.
What can go wrong
My first investment property foray thankfully worked out mostly by pure luck and not by design. Unfortunately I didn’t get as lucky when I bought my first apartment to live in, and I managed to make every rookie mistake in the book.
- I based my investment decision on continued future price appreciation. This is not a given and what is going up can equally reverse it’s trajectory and head down again. Unless you are planning on adding value by adding square metreage you cannot rely on this increase in the short or even medium term.
- I overleveraged by taking on too much debt. As mentioned earlier interest rates can rise and they did, substantially increasing from 17% to 22% over the space of a few months. The affordability of the mortgage repayment should be stressed at higher interest rates to confirm you could still afford to pay it. Also, property values decrease which could result in the amount you have borrowed being more than the value of the property.
- I did not consider all the metrics in my return calculation. A property that works because of leverage (looking at your return based on how much cash you have invested, usually your deposit, should equally work when looking at the return over the total property value. i.e. a property return of 1% over the value of the property should not become attractive because you managed to finance 80% of it in debt thereby increasing your return to 5%. Also careful consideration should be given to comparative returns for that specific property type in that specific area to make sure the price you are paying for the property is market related.. The moral of this story – do your research.
- I did not refurbish my apartment but I would have without a doubt underestimated the full cost of the refurbishment. Budget some “fat” for cost overruns especially in your initial property investments. As you build your portfolio you can base future estimates on your past experience.
- Again as this was intended to be my home this didn’t come into the equation, but clearly on my first investment property I did not have a clear strategy. Knowing whether you want immediate cashflow, long term capital appreciation or a combination of both helps to more effectively direct your search to the appropriate property.
- I did not get the right advice from the right advisors. I allowed myself to be led into a less than optimal mortgage which resulted in a stretched position financially.
- After the nightmare of my apartment purchase I was scared to try again and missed out on many good opportunities because I was waiting for the perfect property. All the resources I have researched and the mentors I followed highlight this as a mistake many new investors make; looking for the perfect A+ property and overlooking all the A- properties while on our hunt for the elusive unicorn.
Despite all the errors I have made, or because of them, I know that property investing done correctly can add a positive degree of diversification to your overall investment portfolio. Do your research, avoid the errors above, chose an approach that works for your asset building plan and get investing!
Automate your cashflows to direct your money towards creating these passive income streams. Grab the freebie to see how it can be done.