So you want to buy an investment property, you have dreams of becoming a professional landlord and living off the income! You have spent hours watching ‘professional investors’ on TikTok and Insta, so you’re ready to go!
Well before you start, think about this. Literally millions of people want to become a professional landlord, less actually do it and far less do it successfully. The reason for this is simple, it is because most people who go on this journey thinking about all the wonderful things which could happen. However, very few think about what could go wrong! Sure, you will hear horror stories about nightmare tenants or issues with cladding and while these things do happen the reality is that they aren’t anywhere near as common as people would have you believe.
By far the biggest mistake in property investment is that they pay too much money when they buy! As a would be property investor, you need to think about it like this.
‘You can purchase a very average property and it can generate a strong yield and have fantastic long-term growth, simply by getting the right price. However, if you pay too much for a fantastic property, it is not possible to create the same return.’
If you want to buy an investment property before you sign on the dotted line, make sure you can answer these three questions:
- How does the value and rent compare to the local property market?
- What will be my net return after tax?
- Have I got the best price possible?
If you cannot answer these questions, guess what – you have not done your homework and you are setting yourself up to FAIL!
How does the value and rent compare to the local property market?
It is impossible to do a good deal when you purchase an investment property, unless you know what a good deal looks like! Not only are you going to seek accurate market data, but you will also need accurate information on tax and other regulatory information.
Quality of the information
You cannot make effective investment decisions without having the right information. If you make assumptions or decisions based on inaccurate or misleading information, then you are setting yourself up for failure. That would be an expensive lesson in real estate investment!
Importantly, you will need to ensure that you are obtaining high-quality data. One of the biggest problems you will have is that there is a lot of information available. If you are serious about investing and building your knowledge base, you may well find you have to pay for market information. As an investor this is information which you should be willing to pay for; the reality is that collecting this data can be expensive, but you should not be unwilling to pay for some of it. The cost of the information may be quite small relative to the impact it has.
What market data to track?
So, what information do you need to track? Well, the reality is, the more the better. The key is not to get information overload, but to understand what the information is telling you. Just remember, you are only really trying to understand:
- What point in the cycle is the market in?
- What is the reality of pricing?
- How is the market changing?
So what information do you need, well this is what you need to know.
Demographic and general economic information
Demographic and general economic information will help you to determine the point in the market cycle you are in. Changes in demographics are among the most influential factors in rental growth and property value growth. This information will include:
- Location demographics: Average age, income levels, local school quality and ratings, migration patterns, and population growth all have an impact on a real estate market’s economic characteristics. Major demographic shifts can have a large impact on real estate trends for several decades.
- Crime rate: Safety is a key issue for all tenants. People want to live in a location that feels safe and secure, with low crime rates and strong levels of local policing. Criminality of whatever type will have a significant impact on tenant demand and rental growth.
- Local economic growth: Busy retail areas and high streets are good signs of active local economies. New employers are also great at improving growth expectations in a location. Economic growth tends to snowball, so the more growth that takes place, the more investment it will attract.
- Local amenity: What types of local amenities are in the area? Local retail, high streets, and commercial areas together with schools, banks, and local food and groceries shops are all important in underpinning local communities.
- Population growth: Typically, population growth is a result of other favourable factors, such as a low unemployment rate, an affordable cost of living, entrepreneurship, and access to a wide range of industries, to name but a few. If people are moving to an area, the number of potential buyers and tenants goes up.
Numerous government agencies and private research groups produce economic data. While some of this information can be quite heavy going, you will want to follow high-level economic indicators. These provide a great high-level overview of the strength of national and local economies.
- Consumer Price Index (CPI): The CPI is a measure of the rate at which consumer goods are increasing (i.e., the inflation rate). It is calculated by tracking the price movements of a basket of goods and services used by an average household in the country. The CPI is a good measure of how much inflation is taking place in a given location, and a good indicator of general economic growth.
- Consumer confidence survey: Consumer confidence surveys survey random groups of individuals and ask them a series of questions about their general feelings on a range of broad economic measures, such as consumer spending and growth expectations. The basis of these surveys is that the more confident consumers feel about the current economic situation, the more they are likely to spend, and therefore the more the economy is likely to grow in the future.
- Unemployment statistics: The unemployment rate is a good indicator of the general health of the economy. It is assessed by government bodies and typically counts those people who are both not in work, and actively seeking employment. These measures can change between countries. Generally speaking, in most developed economies an unemployment rate at or around 5% is considered ‘full’ employment.
- Household debt: Household debt is defined as the combined debt of all the people in a household, including consumer debt and mortgages. A significant rise in debt has historically coincided with economic issues.
As well as tracking demographic and economic data, you will also need to track housing data.
Macro housing data
Macro housing data is generally far easier to obtain than specific sales information, as large statistical groups generally publish it. It will include key housing metrics.
- Housing requirements: In most developed economies there is a shortage of housing in major cities. Many countries publish high-level statistics on what these are based on the overall level of supply and demand, together with expectations regarding new demand, including migration. There is good high-level data available in most countries about the volume of new housing that is required to meet demand every year.
- Housing starts and completions: These are also an important measure of future pricing and housing trends. How much housing is being built to meet future demand is a highly useful measure. If there is an undersupply of housing and no increase in new supply, then this indicates that pricing will likely stay the same or go up. Conversely, if there is an oversupply of housing and more supply is being delivered, then this will likely have a deflationary impact on house prices.
- New planning applications and approvals: There is a significant time lag between planning approval and the delivery of housing. So, new planning applications and approvals are a good leading indicator of supply constraints. However, just because planning approval is granted does not necessarily mean that the developer will build the property immediately.
What will be my net return after tax?
If you are buying an property for investment, then most likely you will be buying for a combination of the following:
- Capital Appreciation – so you can recycle your equity and use it to acquire other properties to build your portfolio
- Income – ultimately most people purchase investment property in order to generate income
How much of each of the above you are looking to generate will change over time as your investment objectives change. However, you need to be able to calculate how much of the financial returns you get to keep, versus how much is absorbed by taxes and other costs.
There are six key financial metrics you need to generate to determine which property best meets your investment objectives:
- Cash required: How much cash is required to purchase the investment?
- Net cash flow: How much cash will an investment generate after covering costs?
- Net income after tax: How much income is left after paying tax?
- Capital appreciation: How much capital appreciation will the investment generate?
- Available equity: How much available equity is your property generating which you can reinvest in other properties to grow your portfolio?
- Net return on cash if sold: How much net income does
As an investor you need to build financial models in order to generate these financial metrics.
Have I gotten the best price possible?
Finally, you need to understand have you negotiated the best price possible? What can you do to maximise your position in negotiations and get the best deal, and how can you drive portfolio performance?
You should accept that whatever happens, in buying off-plan you are taking a risk. How much is this risk worth? Well, it does not matter how much it is worth, it’s about how you leverage it. You leverage risk by reducing the developer’s risk and then seeking to be compensated for your own risk. How do you do this? By focusing on where their risk is.
• Buying point in the sales cycle: As an investor, your greatest advantage is that you can buy at any point in the sales cycle. And the developer’s risk is highest at two specific points in the sales cycle:
–At the very start of the sales campaign, when they need to sell the property to meet their pre-sales targets;
–Post-completion if they still have apartments and they need to sell them.
These are the two points in the sales cycle when you have the greatest negotiating leverage, so you should target these points in time.
• Developer type: Think about who you are buying a property from, and where their pain points are. A smaller developer like the example we used may be constantly under pressure to sell, so you may always have a lot of negotiating leverage. In contrast, a larger developer may not be worried about further sales if they have met their pre-sales targets. Therefore, you will probably only be able to maximise your position at the end of financial quarters or the end of the financial year in the latter case.
See if you can reduce the specification so you can get a better deal. Most tenants are unlikely to pay more for a higher specification, so why shell out the cash for it if you don’t have to?
Additionally, why buy a property if all the tenant amenities will add significant costs to the purchase price and your running costs?
Market access costs
You need to think about what you need to make a purchasing decision. How you need to consume information about a property will directly impact your additional costs in purchasing a property.
There is absolutely nothing wrong with buying a property via an exhibition or sales event. However, keep in mind that there is a cost involved in doing that. So, if you need to have a coffee table brochure, a full exhibition experience, and augmented reality to get your head around the property you will buy, there is a cost to that. As the consumer of that information, one way or another, you will need to pay for it.
An alternative way of thinking about it is this:
• Buy in a good market where there is a high level of protection for consumers
• Buy from a developer with a good track record of delivery
• Make sure the contract affords you enough flexibility.
A significant amount of cost is built into marketing budgets, so if you can find a way to digest and understand the property without all of the costs involved, you should share these savings with the developer.
Buying in Bulk
Do not underestimate the power of buying in bulk! Ideally, you should try to find ways to bring together groups of other buyers or friends to purchase with you. Bulk investors typically get discounts in the region of 10 – 20% off the market price.
Important notice: Proptech Pioneer and its associated companies seek to provide real estate investors with guides, information and tools, but we cannot guarantee this information to be accurate or perfect. You use the information at your own risk and accept no liability if you rely on this information. Proptech Pioneer is not a tax advisor, accountant conveyancer, lawyer, financial advisor or mortgage advisor. You should seek independent advice from independent professionals before making any investment decision.