The power of leverage
Financing is essential for property investments. It is true regardless of whether you have 50 000 or 500 000 000 to invest in property. It is very rare that anyone ever invest in property using exclusively their own cash. By using both your own money and borrowed money you can leverage your investments and get a lot higher return than you can ever get using just your own money. If you want to be truly successful when you invest in property you need to leverage your investment.
Lets look at a couple of examples to see how leveraging your property investments can increase your returns on investment. In these examples we will assume that you have GBP 200 000 to invest in property.
Lets start by looking at scenario A.
In this scenario you only use your own money and find a property that you can afford. You spend all of your GBP 200 000 on the purchase. The house contains two apartments that both rents for 800 a month. Your total income will be 1600 a month or 17200 a year. We will assume that you have to spend 5000 a year on upkeep. This leaves you with a profit of 12 200 a year. That gives you a 6.1% yearly return on your money not counting increased property value. Property values are hard to predict and it is better to make an investment plan that is not relying on the property value going up.
Now lets look at scenario B
In this scenario you talk to the bank and get a loan to leverage your property investment. The bank allows you to borrow up to 80% of purchase price which allows you to leverage your investment by a factor of 5. Instead of purchasing a property for 200 000 you can now purchase property for 1 000 000. The bank will charge you an interest rate of 4%.
You end up spending all of the 1 000 000 on one property. This property has 10 rental apartments that just like in our first scenario rents for 800 a month. All 10 units have tenants. This gives you an income of 8 000 a month or 96 000 a year. This property is 5 times bigger so you will have to spend 5 times more on upkeep 25 000. You also have a 800 000 bank loan. The interest rate will cost you 32 000 (800 000 * 0.04) annually . Your total expenses will be 32 000 + 25 000 = 57 000. If you deduct this from your 96 000 and you will be left with 39 000.
In this scenario you will get 19.5% return on your investment of 200 000.
We will still ignore the increase in property value. It is however important to know that any increase in property value will in this scenario increase your net worth a lot more. 5 times more to exact. A 10% increase in property value on 200 000 is worth 20 000. a 10% increase in 1 000 000 is worth 100 000.
The return on investment is like you can see a lot better when you leveraged your investment. A part of the return will go towards paying down your loan but that will still increase your net worth. If you are lucky enough for your property to increase in value the effect of the leverage will increase even further as shown in the example above. A 10% increase in value is enough to give you a 50% return on investment.
It is however important to remember that the higher you leverage yourself the higher the risk will be. It is therefore important not to over leverage yourself. The leverage will not only increase the benefit of increased property values, It will also increase the loss suffered from decreasing property values.
Now that you know the value of leveraging your property purchase it is time to look into how to finance them.
Property investments are usually associated with large sums of money. You will therefore most likely need to talk to a bank. Really large property investments are sometimes financed through the the issuing of bonds. However if your investment is large enough to be financed that way you are unlikely to read this guide and we will therefore not consider this option.
If you plan on making property investments a regular part of your investment portfolio it is important to build a good relationship with your bank. Shopping around among different banks can often be a good strategy to get the lowest interest when you buy your first property or when you are buying a house for yourself. However as a property investor it is more important to have a good relationship with the bank and have a ready access to credit than it is to minimize your interest rate, especially you think it might be hard getting loan. This doesn’t mean that your should pay a rate above the market rate. It just means that you shouldn’t do anything to shave another 10th of a percent of your loan rate. It is more important to have the credit to acquire a new property than it is to minimize your interest rates. Do not get greedy. Allow the bank to earn a little extra if that allows you to earn a lot extra. By creating and maintaining a personal professional relationship with your bank and your loan manager you can over time get a lot better loans that you otherwise would. The bank will allow you to borrow more if they know that you honor your obligations. This will allow them to look at more than just the numbers when they decide whether to give you a loan or not.
If you do not already have a relationship with a bank you have to build one. Getting the loan will be mainly about providing the bank with the right numbers to show them that you can pay the loan payments. What the loan manager think about you when you meet will also be an important part of the deal. You should therefore always dress and act as the investor you want to be, not the investor you are now. Looking like a million pounds will make it easier to borrow a million pounds. Always be polite to the bank staff and provide all documents they ask for promptly and politely.
Make sure that you are well prepared before you talk to the bank. Make a detailed investment plan that shows that you have planned the investment well and that you have the skill necessary to successfully invest in the property market. Show that you have considered all expenses and that you have planned for contingencies in case things do not go your way. All this will dramatically increase your chances of getting the loan you want.
Visit Lana-pengar.org to read more about bank loans and how to make a budget plan.
What to do if you cant get a bank loan
It is not unusually that aspiring property investor gets turned down for a loan the first time they try. This should not make you give up. Instead you should see it as a learning experience. Keep studying the market. Learn as much as you can about investing and renovating properties. Learn how to write a professional investment plan. Make sure that you keep saving money while you are doing all that.
Once you find a new investment property you can go back to the bank and hopefully this time you will get a loan. By showing up a second time more skilled with a more professional plan you can show the loan managers that you are serious about your investments. Make sure that the second plan addresses the concerns the bank had the first time. To be able to do this it is important that you listen to the bank the first time and the reasons they had for not giving you the loan. Sometimes they do not say the reason straight out but it is usually easy to deduct from what they do say. Maybe your second project need to be a little less ambitious than the first or maybe you need to invest in another area where the rental market is good.
The key thing is to not give up until you are able to get a loan. In a worst case scenario you have to buy your first property without a loan to be able to secure loans in the future.
When you need a little extra cash at the end
A special situation that can arise when you are remodeling a house to rent or flip is that you run out of money at the end of the renovation after you maxed out the loan the bank want to give you. Ideally you should have a contingency fund for situations like this but that is unfortunately not always possible. In these situation you might have to use credit cards or other high interest lines of credits to finish the construction. These types of credits should generally be avoided but it is better to use them and be able to finish construction than it is to stop construction. If you stop construction you will have a lot of money tied down in a property that you can not rent or sell. It is better to use the expensive loan to be able to liquidate or start earning income from the property. Always pay of these expensive debts as quickly as you can once the renovation is done. The total cost of using these credits will remain rather low if you repay the debt quickly.