dothesums blog

Having read Tony Levene’s article in the Guardian on line ‘Buy to Let investors fear they may be left homeless’ dated 22.03.08, is it any wonder that these landlords get everything they deserve? How can educated people be so consumed by greed that they deceive the banks and inflict higher loan charges on the rest of us.

For two, or three, years now we have been warning our clients that new build properties, city centre, or otherwise, are unlikely to be profitable.

Also, that purchases with no deposits are doubtful as an investment and dubious in law.

There are, and will continue to be good investments during the credit crunch, because prices will be softer.

Choose the post code areas with the highest forecast growth.

Check tenant demand in those areas.

Work out the combined net cash flow for each year and add to it the projected growth in the value of the property, to get the return on your investment.

That Mr.Morris is seeking redress from his valuers, when he bought without seeing the properties, is the same as the gambler who tried to sue his bookmaker for not exercising a duty of care, when he ran up gambling losses of over a million pounds. Delusional is the word that springs to mind. Where was his duty to himself? If you believe the salesman to establish property value and estimated likely rental income, without even seeing the property, then you only have yourself to blame. These two investors were motivated by greed and the prospect of easy money. It has been an expensive lesson for them, but in the end the real costs will fall on the rest of us.

I watched an otherwise excellent BBC2 programme last evening on the generation of wealth in the City and the operation of hedge funds.

The term ‘leverage’ was used many, many times and was not described very well.

Leverage is possibly the number one reason for buying an investment property, because it enables the investor to profit from the appreciation of an asset, bought with borrowed capital.

Suppose we buy a flat for £100,000. We have a deposit of twenty percent, £20,000 and secure a loan of £80,000.

The bank has an investment of £80k, we have invested £20k. Our investment is one fifth of the price of the asset, the ratio is 5:1.

Suppose in the following year the value of the flat rises by £10,000 to £110,000 and we decide to sell. Ignoring other costs just for the moment, we have made £10k on our original investment of £20k.

That is, we have increased our capital by 50%. At this point the bank does not come along and ask for their 80% share of the £10K. All of the £10k belongs to the owner. The bank makes its money on the interest on the loan.

So instead of increasing our capital by 10% as the value of the flat has done, we have actually increased it by 50% a ratio of 5:1. This is leveraging. This return comes with a cost though.

The cost is the interest on the loan. If we can then let the property at a rent which covers this interest plus other costs such as insurance, the tenant pays for the loan, in full or in part.

Leveraging is not confined to property. Any asset can be leveraged, companies, aircraft, even football clubs.