by Rob Dix
Gross yield is the annual rental income generated by an asset, divided by the price of acquiring it – so a property that brings in £10,000 per year in rent and cost you £100,000 to buy gives a gross yield of 10%. (On your calculator, that’s 10,000 divided by 100,000. The result is 0.1, which expressed as a percentage is 10%.)
It clearly doesn’t reflect the real results you’ll get from an investment, because it doesn’t take into account the costs you’ll incur. As a result, saying “I got a gross yield of 10%” isn’t enough to know whether that’s a good thing or not – but because it’s so simple to calculate, it’s a handy rough-and-ready way to quickly compare properties that are likely to have similar costs associated with them.
(When I calculate gross yield, I like to include any major refurbishment costs in the “price of acquiring” part of the equation. After all, it’s a bit misleading to calculate figures on the basis of buying a property for £70,000 if it’s such a wreck that you immediately need to spend £30,000 doing it up.)
Net yield is the annual rental profit (rather than income) generated by an asset, divided by the price of acquiring it.
So if the property cost you £100,000, the annual rent is £10,000, and you have costs (including mortgage costs, management fees and maintenance) of £5,000, that’s a net yield of 5%.
As this calculation takes costs into account, it’s more useful than gross yield in situations where you can reliably estimate what your expenses will be. When different people talk about “net yield” you can never be totally sure which expenses they’ve accounted for – the big ones are obvious, but you could get down to the cost of shoe leather when walking over to inspect the property if you wanted to. It doesn’t particularly matter: the calculations you make are only for yourself, so it’s important just to be consistent with what you include so you’re always comparing like with like.
Gross and net yield have their uses, but neither of them captures the entire investment equation. What we really need is a calculation that takes everything into account – and which we can use not just to compare different properties, but also to compare our return from a property investment to the returns we could get if we invested in a different asset class entirely.
That calculation is Return on investment (ROI) – calculated as the annual rental profit divided by the money you put in. If you buy wholly in cash, the money you put in is the same as the cost of acquiring the asset, so your ROI and net yield will be identical. But if you use a mortgage, your ROI will be higher than your net yield.
For example, our hypothetical property cost £100,000 and generates a £5,000 annual profit, giving a net yield of 5%. But say that you only put in £20,000 in cash, with the rest of the purchase price being funded by a mortgage. Your ROI is therefore £5,000 profit divided by £20,000 cash invested, which equals 25%.
You’d be forgiven for asking,“What’s a good ROI?”. Unfortunately, that’s an almost impossible question to answer. But let me try.
It’s easy to say what a bad ROI is: a negative one, meaning you’re losing money. Beyond that, it’s completely personal. For example, an ROI of 2% sounds rubbish to me – I could practically get that in a savings account without going to all the effort of buying a property. But to someone who’s convinced that local property prices are about to rocket and they’ll make a killing on the capital growth, “not making a loss” might be good enough in the meantime.
At the other end of the scale, some investors target ROIs of 25% or more – far beyond what I aim for. That’s because they’ve got a strategy that’s geared towards sweating their assets hard, perhaps by buying cheap houses and renting them out by the room. They know from experience that it’s possible to achieve those returns with the model they follow, so they’re not going to settle for less.
I’m exceptionally hesitant to even put a range on it: on the one hand I don’t want to hold you back by giving you low expectations, and on the other I don’t want you to avoid buying something that would have matched your goals perfectly because you’re trying to hit the bottom of an arbitrary range. You should also be mistrustful of the numbers that other people quote (especially if they’re trying to sell you something), because it’s often hard to be sure what they’re including. For example, the exact same property might give an ROI of 12% if you’re self-managing, 8% if you’re factoring in an agent’s fees, or 5% if you’ve also put in more of your own cash because you want a smaller mortgage.
But I know you won’t let me get away without giving you an actual number, so fine: with my own investment I look for an ROI of at least 10%, although I often get far higher and will be tempted slightly lower if there are other positive reasons to buy. Does that tell you anything? Not really, so I encourage you to completely disregard that single data point and focus on what you can achieve and need to achieve in order to hit your goals.
Chapter 1
Save hard, take it easy,
retire well
Aim: Build a healthy income stream over 20 years without working too hard.
In a nutshell: Invest enough to buy one high-yielding property every 18 months, then increase the pace as rental income compounds.
Upfront capital required: Moderate
Effort involved: Low initially, moderate as portfolio grows
Ongoing investment required: High
Payoff: Long term
For this first strategy, we’ll take the most basic form of property investment possible: saving up hard, and using those savings to buy properties. As time goes on you add each property’s rental income to your savings, allowing you to pick up the pace.
You’re not going to get rich off the income from one property, so this isn’t a lot of use if you’re desperate to quit your job right now (don’t worry if that’s you – we’ve got strategies to cover that later). Instead, this would work nicely if you’re in your 30s or 40s, have a job that you enjoy, but don’t fancy the idea of working until you’re in your 60s or beyond.
At this stage in life it’s common to have a demanding job and a young family, so you may want a strategy that doesn’t involve putting in a lot of time or acquiring all sorts of specialist knowledge. This first strategy fits the bill nicely, but to compensate for the lack of time and skill needed, you will need to put in a fair bit of cash.
How much cash? Well, in the example I’m going to run you through below, you’ll need to invest £25,000 to buy each property. If that sounds like a lot to save up… well, it is – if you wanted to buy one every 18 months, it’s £1,388 per month. If you have a post-tax salary of £66,000, that’s a quarter of your income.
If saving that much is impossible, you can tweak the variables by buying cheaper properties or waiting longer between purchases – but however you crack it, it’s still a relatively capital-intensive strategy. In its favour though, it’s incredibly safe and simple.
Let’s get on to an example then – and assume that we’ve already saved up £25,000 to start off with.
Example
For the purposes of this example, we’re going to use a three-bedroom terraced house in Eccles, Greater Manchester – just west of Salford.
Here’s a link: propgk.uk/eccles-buy
As you can see, it sold at an asking price £80,000 and it looks like it doesn’t need any work doing other than a bit of a clear-out. To keep things simple, I’m going to assume that the asking price of £80,000 is a fair reflection of its true market value. (In reality you’d never make this assumption, and we’ll see later in the book how to calculate what a property’s true market value is.)
In terms of the purchase then, the figures look like this:
Deposit: £20,000 (25% of £80,000 purchase price)
Purchase fees (solicitor, survey, etc.): £1,500
Stamp duty: £2,400 (for all examples, I’m using the new “investor” rates of 3% higher than the normal thresholds – which came into effect in April 2016)
Refurbishment (just safety certificates and any odds
and ends): £1,000
That’s the £25,000 of savings neatly spent (with £100 left over for a celebratory dinner when it goes through). Now, what about income?
In that area, someone claiming housing benefit who was entitled to a three-bedroom house would be given £577 per month. There are some areas (often those where property prices are cheapest) where you’ll struggle to find tenants who aren’t claiming housing benefit – but I’ve picked an area where you’d be able to find private tenants, possibly at a higher rent. Here’s one nearby being marketed to private tenants at £595: propgk.uk/eccles-rent.
Nevertheless, £577 puts a handy “floor” under the rent, and to play it safe that’s the number we’ll use in calculating our returns.
Out of that £577, we need to account for the following monthly expenses:
Mortgage (£60,000 borrowed on an interest-only basis at 5% interest): £250
Buildings insurance: £20
Management fee at 10%: £57.70
Allowance for repairs at 10%: £57.70
That leaves us with a monthly profit of £191.75.
(Everyone has their own opinions about how much to allow for repairs, and of course you might self-manage and not have that cost to account for. You won’t necessarily agree with my numbers, but the main thing is that I’m going to keep them consistent throughout the book so we’re always comparing like with like.)
Before calculating the annual profit, I’m going to allow for the property being empty for two weeks per year. For a house like this, which is likely to let to a family reasonably long term, I think that’s fair enough: it could be a month-long changeover every two years on average, for example.
After building that into the figures, we end up with an annual profit of £2,212.47. Based on the £25,000 we put in, that represents an ROI of 8.8%.
That’s the first purchase out of the way, and there’s nothing left to do: all we’ve done is pop onto Rightmove, bought a property at the asking price, done the bare minimum of refurbishment and handed it straight to a letting agent. Job done, and in rolls the rental income!
At its simplest, we can just repeat this exercise every 18 months. Do it for 15 years in a row, and we’ve got a rental income (ignoring tax) of £22,000. After 30 years, we’ve got £44,000.
In fact, we can actually buy more properties as time goes on – because in addition to our investment, we’ve got the rent stacking up in our bank account. And while £2,200 in annual profit doesn’t sound like much, it adds up quickly.
If we ignore tax again for a minute, we’d be saving up an additional £2,200 in Year 1, £3,300 in Year 2, £4,400 in Year 3, and so on. By Year 6, we’re able to buy two properties: one with the regular investment, and one with the accumulated years of rental income. By Year 15, we’re able to buy two properties every year.
(It’s worth noting that I’ve been talking in “today’s money”, but in reality there would be inflation to contend with. House prices, wages and rents will increase significantly over a decade or more, and this could be good or bad for your plans depending on by how much, and when, each of them grows. There are just too many variables to talk about it sensibly, so we’ll stick to today’s figures – while recognising the need to re-evaluate our strategy as time goes on and things change.)
In reality, tax will slow this pace down – although as we’ll see when we come to the “Tax and accounting” section, your tax liability during the acquisition phase could well be lower than you think. Tax or no tax, once the snowball reaches a certain size, the momentum is hugely powerful: while at first it looks like it’s going to take 30 years to accumulate 20 properties, by re-investing the profits it should be possible to get there in closer to 20 years.
Lessons
This example shows us the power of using leverage in the form of a mortgage – which we can see by comparing this strategy to a couple of alternatives.
By the time we’d bought ten properties, we’d invested £250,000 and generated an income of £22,000 per year. If we’d saved up until we could buy properties in cash instead of using mortgages, we’d have only been able to buy two properties – which would give an income of £10,200. On the face of it, using leverage has doubled the returns – but it’s actually better than that. Firstly, buying instantly instead of saving up for extra years has brought in thousands of pounds of extra rental income. Also, if property prices go up by 10%, we’ve got ten properties to gain in value (for a total gain of £80,000) instead of two (a total gain of £16,000).
(Using leverage has its risks too, and those mortgages will need to be paid off at some point, but those concerns are less significant than you might think. We’ll talk about this a lot more in Part 2.)
Alternatively, if we’d invested that £250,000 in the stock market and later withdrawn it at a rate of 4% per year (a figure that many people claim is a “safe” withdrawal rate in retirement), we’d only end up with £10,000 per year.
This nicely demonstrates how powerful property investment can be, even if you do nothing special. Remember:
We’ve barely mentioned the potential for the properties to increase in value. The property I chose for the example is in a popular owner-occupier area, so should deliver at least some degree of capital growth over the long term. This gives you interesting options in terms of building your portfolio faster or planning your exit strategy… of which, much more later in the book.
The gross yield on the example property is relatively high at 8.6%, but it didn’t require any special knowledge or hours of hunting to find.
You’re paying the asking price rather than negotiating any kind of discount.
You’re not doing any kind of refurbishment that would add value.
There are no effort-intensive but higher cashflowing investments, like multi-lets.
There’s nothing clever at all, in fact. You just have to make one very standard purchase every 18 months, and nothing else.
There is, of course, one big assumption here: that you can afford to take large chunks of your earnings every year to finance the growth of your portfolio. For many people this isn’t realistic, which is why the next strategy won’t have this requirement. But the current strategy is a great “worst case” place to start, because it involves virtually no time or skill – so as your confidence increases, you can progress to other strategies that are less capital-intensive.
In the meantime though, many people find it totally possible to live on 75% of their income with enough discipline and commitment. In fact, when I first drafted this chapter, I based it off saving 50% of your income and had an even more aggressive timescale – because while it may sound impossible, some people manage to do it while still having most of the middle-class trappings (for an introduction to this idea, see propgk.uk/mr-money-mustache). Alternatively, you could start a business in your spare time to generate an extra £1,400 per month.
Whether you do it by cutting your spending or increasing your earnings (or a combination), it’s not exactly easy, but nor should it feel impossible – and the rewards are huge. Even if you hadn’t invested in property at all you’d still be doing better than almost everyone else by saving up that much cash – leveraged property investment just pours petrol on the fire.
In this model then, property isn’t a get-rich-quick scheme or a method of generating huge returns in itself – which would be impossible with just one, pretty average, acquisition every 18 months. The magic is in the stealthy approach of combining property investment with living a restrained financial life. It’s an approach that might leave you short on skiing holidays and Gucci handbags, but will have your colleagues scratching their heads when you triumphantly hand in your notice 20 years before they could hope to do so…
Chapter 2
"Recycle" your cash
Aim: Build an income stream while limiting the amount of capital you need to invest.
In a nutshell: Find properties that need refurbishing, do the work that will increase their value, and
refinance so you need less of your own cash to put into the next purchase.
Upfront capital required: Moderate
Effort involved: Moderate
Ongoing investment required: Low
Payoff: Medium term
After reading Strategy 1, you might be about to hurl this book down in disgust. “So you’re telling me that if I just invest a shedload of money every year for the next 20 years, I’ll be rich? I don’t need a book to tell me that!”
Well, it’s called property investment for a reason: you can’t expect to make money without putting at least some resources in. But never fear: there are ways to get results even with a smaller cash input. In return though, you’ll need to work a bit harder.
The strategy we’ll look at next is sometimes known as “recycling your cash”, because you reduce the amount of cash you need by taking one deposit and re-using it for multiple purchases. How? By refurbishing and refinancing.
Example
To keep things simple, let’s take the same type of house in the same area of Manchester where we bought for £80,000 as part of the previous strategy. But instead of paying £80,000, we find a house that’s near-identical other than being in pretty poor condition. We manage to negotiate buying that tired and unloved house for £55,000, then spend £10,000 bringing it back up to standard – thereby reinstating its “true” value of £80,000. Effectively we’re creating £15,000 of equity out of thin air, which is our reward for improving its condition.
You might think that if a property needs £10,000 spending on it in order to raise its value to £80,000, you’ll need to pay £70,000 for it. In fact, any investor would want some kind of “margin” as their reward for doing the work – otherwise they could just buy one that’s already in good condition and save a lot of effort. The question is how far below £70,000 you can secure the property for, because that determines the size of the margin you build in.