re investment : “Advanced Strategies for Property Investment for Landlords and Property Investors”
Any professional investor knows that part of a successful investment strategy is to balance the competing aspects of risk and reward. One of the big risks to any residential buy-to-let investor is that in essence their investment is very ‘lumpy’. That is to say it is a large investment in a single asset class, in a single location. This is great when times are good, but if times are bad for residential investment in that area then there is no way of avoiding poor returns
Is there a way around this for landlords?
The secret of good investment practice is a strategy that aims to spread an investor’s risks. This means holding a range of investments in different sectors. The theory being that when one investment is doing poorly others will be showing good returns and therefore overall the investors ‘pot’ will keep on growing.
For a buy-to-let property investor diversifying their investment portfolio may seem to be problematic if not impossible. A landlord and property investor does not always want to buy another residential investment property in another part of the country in order to diversify the geographical spread of their residential investment portfolio and thereby reduce their risks to a fall in residential property prices in one part of the country because of the very practical difficulties of having to remotely manage a buy-to-let investment property. Also by buying another residential investment property a landlord is buying an investment in the same asset class. This is not really diversifying an investor’s portfolio and therefore reducing the risk to the landlord of their investment performing badly.
What a landlord and property investor really needs to do is to use their residential property asset as an investment vehicle to finance a portfolio of diversified investments thereby providing a landlord with their own diversified investment pot.
Jim Smith’s 2 bed terrace house in York
Jim has a buy-to-let investment property in York worth £200,000.
The annual rental income is £12,000 which gives the residential investment property a gross yield of 6%. Therefore as it stands Jim is 100% invested in UK residential property and specifically in this case in the York housing market.
To finance this residential investment property Jim has taken out a £100,000 repayment buy-to-let mortgage over 25years on which he is paying 6%. This costs £644.30 per month in repayments on his buy-to-let investment mortgage. Repayment of the mortgage leaves Jim with a net income after paying his mortgage of £355.70 (in reality this will be eaten into by other expenses).
Jim therefore has equity of £100,000 in this residential investment property. Now say house prices fall over the next five years by 10%. This means the value of Jim’s property drops to £180,000 thereby reducing his equity to £80,000.
How can landlords reduce their investment risk
Jim is keen to reduce his risk of sustaining a fall in the value of his investments. This is best achieved by following a strategy of diversification. This is how it is done.
He increases his borrowing to £150,000 through a further advance of £50,000 on an interest only basis. Again the interest rate payable is 6%. This makes a total payment of £644.30 pm plus the interest only payments on the further advance of £250 pm. In total this amounts to £894.30 pm which is still covered by the £1000 rent. It is worth mentioning that rents are likely to rise over time whilst the repayment part of the mortgage will start to fall.
Here is the clever part. The £50,000 of the additional loan should then be invested in high yielding shares and funds. In the current climate it is easy to find funds & shares that pay dividends with a 6% yield.
By doing this Jim has immediately diversified his investment from 100% in UK residential to 80% residential: 20% shares & funds and according to Portfolio Theory immediately reduces his risk of sustaining an overall loss.
For example the share portfolio that Jim has invested in does reasonably well and rises by £20,000 or 40% over the 5 years. The result being that this cancels out the loss of equity sustained by his residential property.
The ‘win win’ scenario is obviously that both the values of his shares investments and his residential investment property continues to rise.
The risks to Jim of this investment strategy is that his share portfolio does badly; however careful stock selection and in sectors away from the UK should mean that if the UK economy goes into a slump other markets will be doing well.
The other risk of this strategy for Jim is that mortgage rates rise meaning his increased borrowing costs exceed his rent. Hawkeye can hedge against this by fixing the interest rate payable on all or part of his buy-to-let mortgage for the period.
This strategy is not for the faint hearted landlord. However, for landlords who are comfortable with managing their own financial affairs and want a way to reduce their exposure to the UK residential investment market it offers a solution to a real investment conundrum faced by landlords of how to reduce the risks of a landlord sustaining a loss as a result of a falling or stagnating residential investment market.
What a landlord needs to do is go beyond thinking just of their individual residential investment property as an investment but to see it as almost an investment vehicle with which to create a diversified selection of investments with which to achieve a landlord’s individual financial goals. By using the undoubted income generating capacity and excellent long-term capital appreciation prospects landlords can then create their own diversified specialist investment vehicle.