Investment Property Priorities - Location, Location, Yield !

[Martin Skinner]

By Martin Skinner

Right the snow's over everybody and it's time to get this show back on the road!

Unfortunately it's likely to be quite a long and bumpy road so I thought I'd kick the years blog off with a priority Top 3. Hopefully it'll help keep things focussed on the journey towards financial stability.



Priority numbers 1 & 2 are "Location, Location ..."
I did have a bunch of great articles with lots of lovely tables and charts demonstrating the likely future variances in house price inflation between key regions however partly as a result of being pleasantly distracted by all the new social networking sites and events (and of course the snow) I've managed to misplace them. Still with traditional forecasting having been all but discredited perhaps we shouldn't rely too much on them anyway. Therefore I'll just share my opinions with you and you can comment if you agree/disagree. If you happen to have the tables/charts to hand then please feel free to post them too.

It seems certain to me that the North/South divide is going to widen in the years ahead as 1) investors prioritise properties in the safest, scarcest locations and 2) the [new] government is forced to reign in its spending.

Northern regions are more reliant on the state than southern regions and they will suffer more as a result. Demographics were forgotten somewhat during the boom and financial engineering was often prioritised over fundamental property investment criteria like location and future supply & demand. Sadly many investors found that agents, property clubs and developers forecasts for rental income and re-sale values evaporated and have been left sitting on flats that in some cases could take a decade or more to get back to where they were estimated to be at their peak. And that's assuming the local populace doesn't move to the south in search of better pay (or just any old job). The same can of course be said for many foreign destinations - let's not get into Spain or Dubai here.

The good news for those that have holdings there is that Prime West London is pretty much back where it was in 2007. Cash rich investors have continued to fight over flats and houses in Mayfair, Knightsbridge and Notting Hill throughout the turmoil. Once again the old adage Location, Location, Location has rung true and I believe it will keep ringing loudly for at least 5 years. Investing in the best location you can afford will continue to pay dividends.



Priority number 3 is Yield
Many buy-to-let investors (and others) have managed to hang on to their portfolios despite significant negative equity because interest rates have been reduced so dramatically. In most cases residential property investors have in fact benefitted from significant improvements in their monthly margins as rents have only dipped about 15% overall - as compared with about 50% on commercial property - and they're now beginning to drag themselves back up.

This means income arbitrage is back on the menu. If you can only get 0.5% interest from the Bank of England or a c4% dividend yield on equities then property starts to interesting above that level.

But what about rising interest rates for those looking to use leverage or with debt already in place? The debate will continue to rage on this in the months and years ahead I'm sure (hasn't it always?) however it's clear that they will have to rise at some point and it therefore makes sense to build in some margin for error on the yield. This can be a little difficult if you're borrowing 50% or more and following the golden location, location, rules because yields on Prime Central London properties can be as low as 3 or 4% gross.

So my tip, and I doubt the big fund managers will like this one, is to stay prime and consider more management intensive residential uses such as student accommodation, young professional accommodation and short-let hostels etc. If you were offered the choice between a long lease on a bank in a regional city centre at a yield of 5% or a flat with a 9.5% gross yield (7% net) in Central London what would you choose?



If you fancy learning more about student & young professional accommodation why not come along to our event on the 11th February where we'll reveal many of the secrets to successfully investing?

Andrew Goodwin senior economic advisor to the Ernst & Young Item Club wrote the best article I've read this week.
___________________________________________
Martin Skinner

[Vanessa]

Hi Martin,

Great blog and I agree with your thoughts.

I would add "create a USP" to your list. Tenants have a lot of choice and they know it. They are looking for the best their money can afford, and they want a deal!

In order to avoid the void, and keep your property fully occupied, I think it helps a lot to make it stand out from the crowd. Create a "purple cow" as Seth Godin would say!

In this post How to Be The Last Landlord Standing there was a great discussion of how to survive these challenging times which readers might find insightful.

There is also A Guide to Landlords on how to survive the credit crunch.

[Martin Skinner]

Thanks Vanessa,

I couldn't agree more and love the purple cow approach.

Does anyone else have an investment Top 3 for 2010?



:) Martin

[Nick Parkin]

Martin,

Great article. The normal National profile is that where London goes the South follows, and then the North follows last. Are you predicting an actual divergence of the markets?

[John Corey]

Martin & others,

1. I am not from the UK so I am not sure I get the North/South divide? What is the source of the divide? Clearly it is not weather or better views or anything else that is specific to location. There are plenty of good locations or bad locations in both.

What I suspect causes the 'divide' is the differences in employment. The old industries vs. the newer service economy. People want to live where they can find work and house prices are dependent on people earning an income to buy the houses. Find a community with declining employment and you will find falling house prices.

London is a bit of a wild card as some of its purpose or reason to be is beyond employment. London is a world city where many wealthy want to live because of the non-work attractions. Granted the focus on taxing the rich, the shift in the non-dorm status and other things might reduce London's desirability slightly.

2. Martin - you said that one should focus on yield? Can I challenge this slightly? I feel that too many UK investors look at the gross yield at the time of purchase rather than focus on the cashflow or net yield. If someone buys a place that has 10% gross yield and it looses money (negative cashflow) the 'superior yield' is really a false positive.

I would like to see a shift towards net yield or Net Operating Income (NOI - US term widely used in the commercial sector). What the property can produce in income after expenses before any debt service is the simple way to put it. When you buy for net yield you are focused on buying an income stream after expenses. Like a bond that pays out X%. A way to compare different assets classes to see what they can produce after running costs.

Looking forward to the event on the 11th.

John Corey
Follow me on Twitter-> www.twitter.com/john_corey
www.ChelseaPrivateEquity.com/blog

[Nick Dare]

John - I assume you use IRR to compare investments across asset classes?

I'd add the need to factor in the value of your time if your investment requires a more active role.

REI saidI would like to see a shift towards net yield or Net Operating Income (NOI - US term widely used in the commercial sector). What the property can produce in income after expenses before any debt service is the simple way to put it. When you buy for net yield you are focused on buying an income stream after expenses. Like a bond that pays out X%. A way to compare different assets classes to see what they can produce after running costs.

Looking forward to the event on the 11th.

John Corey
Follow me on Twitter-> www.twitter.com/john_corey
www.ChelseaPrivateEquity.com/blog

[Nick Dare]

Martin,

I generally agree but would add the following:

- The likes of Land Sec are moving up the risk curve. Having been net vendors of investment assets, they are now re-starting spec developments. My personal view is now is a risky time to be buying prime vanilla residential investments - what happens when the world wakes up to the overvaluation of the Euro, base rates hit 5% and overseas buyers disappear? For those with the appetite and ability, my view is now is the time to be looking to development, not pure investment.

- Local knowledge can trump the benefit of prime locations every time. I know of plenty of property people in deepest Somerset / Devon outperforming 99% of prime London investments through use of local contacts and knowledge.

- IF and I know it's a big if, the next government gets round to properly supporting the concept of a build to rent asset class and pathfinder schemes take off, some Northern markets might produce surprisingly robust returns.

My 3 priorities for 2010 are:

1. Joint Ventures - as you will have seen in the last Property Week's editorial, they asked the question why PE / high net worths / prop cos and investors don't get together to benefit from the sale of distressed assets. More relevant to this forum, why don't individuals here get together with land owners and share planning costs / risk etc?

2. Be nice to bankers! Leverage your contacts / relationships and not just to beg for development finance. The likes of Lloyds Banking Gp are starting to dispose of HBoS liabilities and I know of 35%+ write downs. Some are small portfolios and if you get on well with your bank manager, you might get to hear about them.

3. Be opportunity led / look for mispriced assets. Tomorrow sees me off to S. Wales, not somewhere I normally go to but there is the possibility of acquiring a site at a 55% write down.

[Lois Mondo]

Hi All,
Thanks for jolting us back onto the saddles.We were all getting rather rusty. Great blog Martin and interesting views Venessa and John.There is so much to learn and consider if one is to succeed.

I live in a semi-rural town in Essex where very little changes and we probably don't get the benefits of being closer to London as property prices were hardly affected by the crunch. And going into student and young people's accommodation segment would be quite a challenge, but one would have to go further afield to a bigger University city.

Lois mondo.

[Martin Skinner]

Hi Nick,

I didn't spot the severity of the 07/08 crash - I'll be the first to admit I was expecting a soft landing for the Resi market (though I blame Lehman for proving me wrong).- so I don't intend to get up on a high horse and say for sure this is going to happen. "Events, dear boy, events" (Harold Macmillan).

Having said that, personally I do think there is going to be a considerable divergence in house price movements between London and the South East (plus some parts of the South West) and the Northern regions of the UK - so much so that I think we'll have rising prices in the South while we have falling prices in the North.

On the whole supply has been stymied by the disruption in the construction and house building sectors so prices are likely to rise steadily over the next 5 years. However this will vary in line with demand and London and the South East clearly has the biggest Supply/Demand imbalance both now and looking forwards.

In the north where the state is responsible for so much of the economy. I read an article the other day where local employers were complaining there was no way the private sector could compete for quality staff with the pay and perks on offer from local government (how crazy is that?). This will surely have to change and it will come as a big shock to employees.

Immigration and demographics should also play a major role - people generally prefer to move to London and the South East where the wages are higher and there are already more jobs on offer.



:) Martin



Nick Parkin said:

Martin,

Great article. The normal National profile is that where London goes the South follows, and then the North follows last. Are you predicting an actual divergence of the markets?

[Martin Skinner]

Hi John,

Thanks for your reply - very sensible, progressive thoughts !
I totally concur employment is one of the most significant drivers & I think employment prospects will diverge significantly between the North & South in the next few years.

In terms of London yes spot on it is a World City and as such it's local markets are generally some way ahead of the rest of the UK and overall much more resilient. I see a steady stream of wealthy foreigners still streaming into London for the lifestyle, schools etc despite the tax rises and some brokers/fund managers moving out.
Dumb tax tho' I should add, really dumb (negative impact on tax take and headline tax take isn't the right message to foreign co's/workers).

Yield-wise yes I prefer to work off Net Yield too (just couldn't help mentioning the gross as well) and have assumed a c15% management fee & higher maintenance plus utility costs etc.
Just out of interest do you have any HMO's/Student/Young Professional-lets in the UK or their nearest equivalent multi-family real estate in the US? If so, what's been your experience?


:) Martin

REI said:

Martin & others,



What I suspect causes the 'divide' is the differences in employment. The old industries vs. the newer service economy. People want to live where they can find work and house prices are dependent on people earning an income to buy the houses. Find a community with declining employment and you will find falling house prices.

London is a bit of a wild card as some of its purpose or reason to be is beyond employment. London is a world city where many wealthy want to live because of the non-work attractions. Granted the focus on taxing the rich, the shift in the non-dorm status and other things might reduce London's desirability slightly.

2. Martin - you said that one should focus on yield? Can I challenge this slightly? I feel that too many UK investors look at the gross yield at the time of purchase rather than focus on the cashflow or net yield. If someone buys a place that has 10% gross yield and it looses money (negative cashflow) the 'superior yield' is really a false positive.

I would like to see a shift towards net yield or Net Operating Income (NOI - US term widely used in the commercial sector). What the property can produce in income after expenses before any debt service is the simple way to put it. When you buy for net yield you are focused on buying an income stream after expenses. Like a bond that pays out X%. A way to compare different assets classes to see what they can produce after running costs.

Looking forward to the event on the 11th.

John Corey

[Martin Skinner]

Hi Nick (Dare this time)

Thanks for the reply - the breadth and depth of your knowledge is always very impressive !

Very good point on the value of the investors time, it can be a frustrating task holding tenant sharers hands and this should not be forgotten. I personally believe the extra income is worth it especially until you get to about 10 properties and have plenty of cash. At that stage you may want to consider outsourcing the lot or single-letting some/all to reduce the hassle. The figures I'm working including costing in outsourcing the lot by the way - of course outsourcing brings its own risks and you should still keep a fairly close eye on the properties.

Personally I think we're still in an investment market (mostly) rather than a development market because margins are not high enough on most dev sites yet to compensate for the extra risk (and there's so little build finance around) but of course there are opportunities for both - and a contrarian approach can bring superb returns if you know what you're doing (which you clearly do).

Local knowledge trumps - yes, agreed, I'm also an advocate of sticking close to your home so you can control the management/maintenance if you need to and you have a better chance of being sure it's a great deal. I'm still very wary outside London, the South East and selected parts of the South West.

I must say I'm not sure about Wales (even at 55% off for a site) and I know an article in Property Week suggested PRS Pathfinder could drive up returns outside London but that seems like an outside bet to me - I question the returns btw as opposed to the PRS which I think Bob Kerslake (combined with the attraction of the Resi market overall) will happen. If anything I think the extra supply will drive down prices in regional/Northern locations over the medium term. What do you think?

Joint Venture's as you've described I agree are a superb model and you're absolutely right it should be rolled out (progress will probably finally be made in this area in the public sector). Speculative development makes a lot more sense if the land is put in for a profit share and the other party puts in the build cost for their profit share (the combined risk of losing new money on a site is greatly reduced).

Great comments, thanks all ! And please keep your top 3's coming !!


:) Martin

Nick Dare said:

Martin,

I generally agree but would add the following:

- The likes of Land Sec are moving up the risk curve. Having been net vendors of investment assets, they are now re-starting spec developments. My personal view is now is a risky time to be buying prime vanilla residential investments - what happens when the world wakes up to the overvaluation of the Euro, base rates hit 5% and overseas buyers disappear? For those with the appetite and ability, my view is now is the time to be looking to development, not pure investment.

- Local knowledge can trump the benefit of prime locations every time. I know of plenty of property people in deepest Somerset / Devon outperforming 99% of prime London investments through use of local contacts and knowledge.

- IF and I know it's a big if, the next government gets round to properly supporting the concept of a build to rent asset class and pathfinder schemes take off, some Northern markets might produce surprisingly robust returns.

My 3 priorities for 2010 are:

1. Joint Ventures - as you will have seen in the last Property Week's editorial, they asked the question why PE / high net worths / prop cos and investors don't get together to benefit from the sale of distressed assets. More relevant to this forum, why don't individuals here get together with land owners and share planning costs / risk etc?

2. Be nice to bankers! Leverage your contacts / relationships and not just to beg for development finance. The likes of Lloyds Banking Gp are starting to dispose of HBoS liabilities and I know of 35%+ write downs. Some are small portfolios and if you get on well with your bank manager, you might get to hear about them.

3. Be opportunity led / look for mispriced assets. Tomorrow sees me off to S. Wales, not somewhere I normally go to but there is the possibility of acquiring a site at a 55% write down.

[Ian Tuckley]

Hi Martin,

As I am only a novice investor and somewhat out of my depth when it comes to income arbitrage and pathfinder schemes but I am very happy to see that you advocate, from your lofty vantage point, that which I am implementing at local level already.

This year, I will be mostly buying(or LO) max 5 bed houses to HMO within 2miles of the local UNI with the USP of good quality, furnished accommodation. Not rocket science and certainly not a new idea but the cash flow and net yield are very positive! Yes, it is more intensive but then that's my job and with yield at least double (my time deducted) that of normal tenancy, it's only part time. I will hopefully be able to enjoy life abit more this year which is what it's all about, I'm sure you'll agree.

Question; if I'm doing this, so will lots of others and so will this eventually cause over supply?

I might well be attending your event in February,

many thanks

Ian

[Nick Parkin]

Martin,

It's very refreshing to hear someone saying "I got it wrong", it's a sign that they know what they are talking about! Good business isn't about knowing that A is going to happen, it's about knowing what you will do in every case when one of A, or B, C happens.

The jury is still out for my predictions for the slump, but it looks as if I may be wrong too - at least in the short term. A saying from investing that always makes me smile is "A Long Term Strategy is a short term play that didn't work out!".

I've benefited from the London effect, but I didn't think it would happened. 10+ years ago I was concerned that the Internet revolution would mean that everyone went to Shetland to live, so I diversified. As it turns out it seems the internet has driven everyone into Cities where the best Broadband and people are, and there is only me out here in the countryside running a business on remote.

If you get the choice between being skillful or lucky I always say - pick lucky. It works for me.

Kind Regards,

Nick

Renting Flats in London
Follow on Twitter






Martin Skinner said:

Hi Nick,

I didn't spot the severity of the 07/08 crash - I'll be the first to admit I was expecting a soft landing for the Resi market (though I blame Lehman for proving me wrong).- so I don't intend to get up on a high horse and say for sure this is going to happen. "Events, dear boy, events" (Harold Macmillan).

Having said that, personally I do think there is going to be a considerable divergence in house price movements between London and the South East (plus some parts of the South West) and the Northern regions of the UK - so much so that I think we'll have rising prices in the South while we have falling prices in the North.

On the whole supply has been stymied by the disruption in the construction and house building sectors so prices are likely to rise steadily over the next 5 years. However this will vary in line with demand and London and the South East clearly has the biggest Supply/Demand imbalance both now and looking forwards.

In the north where the state is responsible for so much of the economy. I read an article the other day where local employers were complaining there was no way the private sector could compete for quality staff with the pay and perks on offer from local government (how crazy is that?). This will surely have to change and it will come as a big shock to employees.

Immigration and demographics should also play a major role - people generally prefer to move to London and the South East where the wages are higher and there are already more jobs on offer.



:) Martin



Nick Parkin said:

Martin,

Great article. The normal National profile is that where London goes the South follows, and then the North follows last. Are you predicting an actual divergence of the markets?