Reasons to invest in Buy-to-let properties
Investing for the future is not as easy today as it once was. In recent times some pensions, endowments and share-holdings have turned out to be disappointing and, in some cases, disastrous.
In the long-run property has proved to be a safe and profitable option for many investors.
These are the key reasons for investing in property:
Potential Use of Leverage
Property lets you use other people’s money to increase the value of an asset. By splitting your own capital over several properties, you are using the tenants’ rents to pay for the resulting interest, while at the same time gaining the full capital appreciation of all of those properties.
Appreciation of Assets
There are very few businesses which have assets that grow in value, year after year. In most businesses, the capital assets depreciate, (go down), in value over subsequent years. This means that, at the same time as your investment is generating cash flow every month, the underlying asset (the property itself), is going up in value, adding to your personal net worth. Investment property is probably the only business which is available to everyone, where there is the possibility of both current income and long term capital appreciation.
Tax Savings
Although neither buildings nor land can be used for depreciation purposes in the UK, (only ‘Fixtures and Fittings’ can), there are useful tax concessions such as ‘Roll-Over Tax Relief and Taper Relief’, which can be applied to buy-to-let properties.
Easy Sales Revenue
For almost all businesses, finding customers is the biggest challenge they have to face when establishing a customer base in order to generate the cash flow to support the business.
In a portfolio of ten properties, rented out at £500 per month, the Sales Revenue will be £60,000 and over a period of five years, this will have generated £300,000. In very few other businesses, can one person generate that kind of revenue without a sales team and still work part time.
Profit is Inflation-Proofed
As inflation goes up, so does the cost of living and with it (whether it is selling price or rents), the cost of real estate. This means that as you build your property investment business, your profits are inflation hedged, because the value of your properties will rise with the tide of inflation.
Long Term Capital Appreciation
One of the best things about property is that it exists in an imperfect market. There is no absolute determinant of value. Personal circumstances, market conditions and individual skill and expertise have a significant effect on the price and terms with which you can acquire a property.
Even professional valuers can only claim plus or minus ten per cent accuracy; that is, a twenty per cent variation. Others in real estate say this is nearer to plus, or minus, twenty per cent, in practice. In truth, the value of a property is the amount for which a buyer is prepared to write a cheque.
Value does not exist independently of the owner’s context. This makes property one of the fastest ways to build wealth.
Minimal Investment Supervision Needed
Property is one of the easiest businesses to run without having to put in too much of your own time. By organising your portfolio effectively, you can arrange activities in such a way that it will take only a few hours per day, or less, to supervise.
Generates Income from Cash Flow
The biggest benefit of property is cash flow. There are four types:
1) Monthly cash flow.
That is cash that flows into the business, less the cash that flows out, over a given period. [Note; this is not the same as profit. For example, depreciation does not appear on a cash flow statement, whilst it does on a profit and loss statement.]
Generally if the cash flow is positive, then the project will be profitable.
2) ‘Up front cash flow’ comes from upfront payments your tenants provide for their tenancy.
3) The third type of cash flow is ‘re-financing cash flow’ which comes when you take your property that has gone up in value and tap into the equity by refinancing it to withdraw money. This type of cash flow is tax free since it is a ‘loan’ and not actual profit; better still it can be spent and it can be invested.
The key to using this type of cash flow is to make sure that the property still comfortably rents out, at more than the real cost of maintaining it, including the new mortgage costs of the refinance. You therefore have a cash flow buffer, should the rental market cool.
The very best reason to refinance is to invest the capital into another property. This way you get the profits from two properties, instead of the one you had before.
4) ‘Back-end cash flow’ comes when you sell a property. We generally urge investors to take a long term view and sell infrequently. However, there is nothing wrong with reviewing portfolio holdings. Indeed it should be done on regular basis; selling some investments, which allow you to go on and acquire even more properties and improve the overall profitability of the portfolio, is to be recommended.
An extremely useful tool in this context is ‘Pareto Analysis’, sometimes known as the ‘80/20 Rule’. The 80/20 Principle is a simple and effective tool, which anyone can use, to great effect. If you want to improve performance, it can help you focus on to those areas where your impact will be greatest. ‘80/20 Thinking’ will get you out of the habit of going along with the majority.
You will also need to develop a means for cash flow analysis, as a prospective buyer and a holder of property. This usually means tracking cash flow and vacancy rates, both for the property you own and the market in general. Remember that cash flow is the amount of money left over when operating expenses and loan payments are deducted from rental income, expressed on a time scale. The ideal tool for this activity is a spreadsheet.
Cash flow is not the same as profit, especially profit for tax purposes. To calculate profit for tax, you exclude principle payments, but you include depreciation, where appropriate.
When the net cash flow is negative, the outlook may appear bleak. However, to make the analysis fair, the tax benefits also need to be calculated, because there might be an after-tax positive cash flow.