Cooling starts – 3pm

Picking up from the last chapter – the speculator has out-bid the professional. So all that remain are the speculative investors and the owner-occupiers. These types of purchasers have very different agendas. The speculative investor is looking to make money and the owner-occupier is looking for somewhere to live. Bearing in mind that the speculative investor is essentially a novice, their buying choices will largely be drawn on their own experiences with property. This will be likely limited to purchases that they have made for themselves to live in. In effect the speculative investor has the same buying requirements as the owner-occupier as they are the same being but with different agendas! The speculative investor will buy on emotion rather than fundamentals just the same as the owner-occupier. So they will be lured into the same property developer traps as the normal owner-occupier falls into. Common errors made by speculative investors are:

• A higher purchase price will be paid by a speculative investor for a property that conforms to their higher décor standards, disregarding the prospective tenant’s lower décor standards. The standard of décor that is required for rental properties will be overestimated with the belief that the tenant will pay for this higher standard and that the tenant will maintain it.
• A bias towards private up-market areas as the speculative investor feels ‘safe’ in these areas. A speculative investor will be typically earning above the average UK salary and will expect their tenants to be ‘young professionals’. What they fail to understand is that the young professional sector are either looking to buy themselves, and may very well be a competitor for the type of properties the speculative investor is looking at, or they will have assistance from parents in the buying process. Soon private developments become a fierce bidding ground with only one winner – the property developer!

• Properties that require refurbishment look like the only type of properties that the owner-occupier can afford due to their ‘perceived’ undesirability. Unfortunately only the opposite is true! Speculative investors look at the past historical growth and consider these type of properties another goldmine. They assume that after refurbishment they can make a nice tidy profit and have the opportunity to display their interior design skills for all to see. Again the speculative investor overestimates the sale price and underestimates the repair work and bids higher than the owner-occupier.
• Assuming that a tenant will be grateful and less fussy when deciding on whether to rent a property. Box rooms will be tolerated by the owner-occupiers but not by a tenant who may have to sleep in this box room! There is an arrogance element to the speculative investor assuming the tenant will be grateful for the high finish of the property even though the property is under-sized.

So as these two types of purchaser walk into the estate agents the red carpet is definitely not rolled out! The estate agent would have seen at least 20 of you already and to be honest is fed up with them saying either ‘I’m looking for a property to buy to rent out’ or ‘I’m looking for a property to get me on the property ladder’ – change the record! You, as a professional investor, look around at their display of properties on the wall, you see a property that looks cheap, but damn, it says ‘under offer’. You look further around and you see that all the properties on the wall are under offer or sold. You ask the estate agent what she’s got under £100k and she hands you one sheet. It’s a studio flat, requiring upgrading and it’s on a lease of less than 50 years! Any property that looks mildly interesting is above £150k and yielding less than 6.5%. You leave, leaving the speculative investor and the owner-occupier to battle it out.

3pm – 6pm

So what causes an owner-occupier to outbid a speculative investor? An owner-occupier will buy a property based on what they can afford, a speculative investor will pay whatever covers their estimated expenses. Whoever is higher will win. Look at this example:

Advertised property price	£100,000
Rental value p.a.	£7,000

The speculative investor

If the rental value is £7,000 then their mortgage company will allow them £7,000/130% = £5,384. This is because any buy to let mortgage company will lend only if the rent is 130% or greater than the mortgage payments. The investor can now use the rent to pay the mortgage and benefit from the expected capital growth that they estimate at no cost to themselves – essentially money for nothing! So at current borrowing rates of 5% the amount the speculative investor can go to is:

The owner-occupier

The typical purchaser for this type of property, looking to live in it, is earning £20,000. Their buying power will be their level of deposit and the mortgage they can raise. Based on a £10,000 deposit and four times lending the owner-occupier could stretch to:

So we can see that the speculative investor wins and thus will outbid the owner-occupier and push the price beyond £90,000 into the hands of the speculator. So the speculator will get the property between £90,000 and £100,000. Then you are left with just the speculator battling it out with other speculators and thus pushing the price to £107,680. What the speculative investor has not factored in is:

• void periods
• tenant default
• interest rate rises
• repairs
• exit strategy.

The only thing that can push the price beyond the £107,680 mark is other owner-occupiers increasing their buying power by teaming up or by the individual seeking high income-multiple lenders. So in this example if you had two owner-occupiers deciding to live together and buy, both on the same salary and deposit, then their combined buying power would be:

This assumes a 2.75 times joint salary which is standard within the mortgage market.

So now the property’s value has risen to what a couple would be willing to pay for it. This couple could quite comfortably afford it even with expected interest rate rises as this is the home that they have chosen and their borrowing has been underwritten to be no more than 2.75 times joint salary.

So we can see there is a point when even the speculative investor drops out and is outbid by the owner-occupier accepting a lower standard property. Even speculative investors who are holding now sell out to owner-occupiers as the speculative investors are losing money on a monthly basis (due to rents not covering the mortgage and other expenses) even though they are gaining on capital growth.

If it had been an individual seeking a high income-multiple lender then their buying power could have been:

4.93 times individual salary being the highest income multiple I could find in the mortgage market as of today. This still outbids the speculative investor.

Looking at it as a sweeping hand of the clock:

Strategies within a cooling spot

The professional investor has dropped out of the market at this point. So if you consider yourself as a professional then the strategy is not to buy. If you want to make money in a cooling spot then you have no option but to buy and then sell. In other words you have to property trade. Now I am no expert on property trading and there is a good reason for this – I’ve never done it! It’s a risky game to play. I believe in the old mantra that property is a ‘long term investment’. A lot of money can be made but also can be lost. If you get your figures wrong and the market turns then you can get really stung.

However, considering it is the only strategy we have within a cooling spot, we’d best look at it in further detail. To make a profit from buying a property then subsequently selling it, the property has to experience capital appreciation. Capital appreciation can be amassed by one of two ways:

• Identifying properties with foresight.
• Identifying properties with potential.

1. Identifying properties with foresight

This is what people think they’re good at – speculating. You need to be extremely clever to do this as it requires an analysis of all the variables in the property market and make a prediction based on what is already out in the public domain.

The typical properties that perform well in a rising market are:

• Unique properties that are scarce such as detached houses in London, four bed properties where there’s a glut of three bed properties, or riverside properties.
• The more exclusive end of the market such as gated developments, prestigious addresses and better located properties in prime locations.
• Properties in a well serviced area with good schools, train stations, leisure facilities and shopping malls.
• New build properties.
• Areas under regeneration.

The estimated returns from the above type of investments is difficult to gauge. This is because:

• 1.You do not have all the information to hand to be able to analyse and quantify the extra growth likely to be experienced based on all these desirable extras.
• 2.You are asking private individuals what they think these extras are worth. If the property is sufficiently unique then this could be absolutely any figure! Try thinking along the lines of what would Michael Jackson pay for a house in London with a fully equipped theme park in the back garden????

To try and quantify these extras you need to take in to account the qualitative factors and try to put a value to these.

Take for example a five bed detached home in Camden in London. How many properties like this are there for sale in Camden – lets say eight? Out of those, how many people want or need to sell? Let me tell you – very few! How many people are actively looking for a house with a garden in Camden? Abolutely loads! So for rare and highly desired properties it’s a seller’s market.

Now if you can sit on your money you can literally drive prices up. It’s up to you when you sell and for how much unless you are forced to sell for reasons out of your control. Its called ‘Name your price!’ You name the price and they have to pay it – and usually they do. This is why the property prices at the exclusive end of the London market, and prestigious homes located in the home counties but commutable to London, have gone through the roof. Rises of up to 50% in one year have been seen for homes in London at the £5m mark. That means some people have bought a property for £5m and then had it valued at £10m! Nice work when you can get it.

If you want to speculate on what to speculate on then look at commute times. It seems that leisure time is getting more and more important and saving five minutes on a commute is deemed to be very attractive. If you can find something that little bit closer to the city then you could get an above average gain over the next coming years compared to a property outside of the city.

2. Identifying properties with potential

Now if you want to make money the hard way and do something to a property then you can always get your DIY tool box out. I try to stay away from this but that’s because I am lazy! However there are people who make a living out of this and have even got a TV series out of it, like Sarah Beeney, so I have to include it in this book!

With a residential property you can either:

• a)Refurbish it.
• b)Extend the property.
• c)Convert the loft.

a) Refurbish it

There is real synergy to be created if you get this right. Synergy means the sum is greater than the parts, or some people like to say 2+2 = 5. Let me explain.

John buys a house for £200,000. Spends £10,000 refurbishing it and sells immediately for £250,000. So he makes £250,000 – (£200,000 +£10,000) = £40,000. So in this example:

£40k has appeared like magic from seemingly nowhere. The reason for this £40k appearing is due to:

• John saving time for the buyer. Part of this £40,000 represents time and hassle taken out of the buyer’s equation. If the buyer saw the property for £200,000 it would not be attractive as they could neither do the work nor project manage it.
• John having £10,000 to refurbish it in the first place. Having the money to refurbish a property cuts most buyers out. The usual people who have an extra £10,000 in the bank on top of the deposit to buy the property are property investors like me, not private individuals. This makes the property more difficult to buy and hence these investors bid the price down.
• John is an expert. The cost to refurbish a property for a developer is VERY different to the cost achievable by a private individual. This is because developers know where to shop, what not to do and how to make things look better than what they cost. This is because it is their livelihood and they need to know these tricks and tips. These all result in making the property appear more valuable than what they have put in. Its called ‘adding value’.

I said above I don’t really get involved in refurbishments, however this is not strictly true. I do but only when I am forced to. This is when either the property

• a)is so cheap that I can’t say no
• b)the property gets vandalised by the tenant or kids on the street
• c)and when I do, I do the bare minimum.

Now there are loads of books on how to add value to a property by making it look pretty and this ain’t one of them! The market is flooded with amateur DIYers who have given up their day jobs to pursue this activity. What is actually happening is that properties requiring work actually go for more than properties that don’t require any work at all! If you are going to enter this market ensure you do not underestimate your costs and overestimate your selling price. Have a look at this example:

There’s a property for sale for £100,000 that would be worth £150,000 if it was refurbished under current market conditions. The cost of the refurbishment is estimated at £10,000 and will take two months. I would adopt this forecasted profit and loss:

Selling price (90% of anticipated selling price) = 90% × £150,000	£135,000
Estate agents’ fees 1% +VAT	(£1,586)
Net proceeds	£133,413
Costs:
Purchase price	£100,000
Refurbishment (150% × estimated costs)	£15,000
Loan repayments (six months’ interest)	£2,500
Total costs	(£117,500)
Anticipated profit	£15,913

So prudently it will take you six months to make £15,913. Annualised its £31,826. Now is this worth your time? If you left a £10,000 p.a. job then maybe this project would have been worthwhile. If you left a £70,000 p.a job then maybe not.

b) Extend the property

Extending a property is a guaranteed way to increase its value. However, this is not a guarantee that you will add any value. You could actually spend £10,000 and only add value of only £8,000. I have created a way of avoiding such a hiccup.

It’s all to do with the ratio of land to buildings cost. If you build on prime land then you win, if not you lose!

So what is prime land? Well it’s all to do with the rebuild cost of the property. You can get this from the original survey you had carried out when you bought it originally. If the survey was carried out a while ago then allow for price inflation of around 2.5% for each year on the rebuild cost.

To decide if the land is prime you simply calculate the following ratio:

If the ratio is greater than 1 then it’s prime. If its less than 1 then it’s not prime.

So if Jack has a property that is currently worth £100,000 and the rebuild cost is £60,000 then the current market value rebuild ratio is:

which is greater than 1, hence Jack should extend.

If Jill also has a property worth £100,000 and it has a rebuild cost of £120,000 then the ratio is:

which is less than 1, hence Jill should not extend.

You should use this ratio as a multiplier to determine how much value will be added to the property. So in the above examples if they both decided to spend £30,000 on a downstairs extension then their properties, as a rule of thumb, increase by:

So Jack makes £50,000 – £30,000 = £20,000 profit as a result of the extension, Jill makes £25,000 – £30,000 = £5,000 loss as a result of the extension.

This ratio is only an indication and should not be used as an exact estimating tool. This is because there is a lot more to an extension, such as choice of materials, style and design and so on. However, if the ratio is greater than 2 then it should be taken as a big green light to EXTEND! This is because whatever you spend you will approximately get twice back.

c) Convert the loft

This is the cheapest way to get an extra bedroom. For some reason in this country we determine the worth of a property largely on the number of bedrooms rather than the arbitrary measure of square footage. You must use this anomaly to your advantage. To calculate whether you should or should not convert the loft use the multiplier above but multiply it by 3. Let me show you using the same example above:

These are both Jack and Jill’s loft multipliers. So if Jack and Jill both spend £5,000 on a loft conversion then they can expect an uplift in the values of their homes by:

So Jack and Jill can expect to profit from their loft conversion to the tune of £20,000 and £7,500 respectively.

The buyers in a cooling spot

There is no point in selling when your property is currently in a hotspot. This is because there is still room for the price to grow and it’s currently profitable thus its not costing you to hold. It becomes worth selling only when the property becomes unprofitable but the price is still growing. The highest point in the market can only ever exist within a Cooling Spot. This is because the property price has risen to the point that it is unprofitable but it is still on a trend upwards. A professional investor drops out of buying in this market and only the owner-occupiers and novice investors remain.

You will be able to sell within this market as it exists as there will be owner-occupiers who will not be concerned about the profitability of a property as they wish to live in it rather than rent it out. There are also speculative investors out there who are banking on the property price to keep on growing and the novice investor who doesn’t do their sums right. These buyers are able to buy your property at an inflated price above the real price because:

Owner-occupier
Self-certified borrowing	Self-certified borrowing means that you can self-certify your income. You do not need to prove your income. All you need to do is state your income.
	This has led to people lying about what they earn even though they can afford the mortgage. This means they bypass the restriction of income multiples of around 4 times genuine salary and get borrowings of 4 times fictitious salary.
	This pushes up the prices paid above the normal fundamental prices and creates a bubble.
High income multiple lending	Some lenders are offering in excess of 4 times salary. I have seen 6 times salary for certain types of working individuals, such as trainee doctors and solicitors.
	This can cause a bubble element to property prices as these types of borrowers can outbid the normal 4 times salary buyer. It then becomes a battle between these professional salaried workers with only one winner – the vendor!
Consumer debt	Due to the banks seeming willing to lend to absolutely anyone for virtually anything, everyone seems to have a deposit. This has increased the number of buyers and hence pushed demand for property higher. Higher demand means higher prices which are achievable due to borrowing a bigger deposit which is usually not stress tested for affordability.
Novice investor and speculative investor
Buy to let	Due to the buy to let mortgage also operating under the current variable base rate the same problem occurs here. Instead of demanding a 2% loading over the long term rate they demand a 2% loading over the current variable base rate. This means you get novice investors buying at 6% yields and below, hence superceding the first time buyers highest price.
	Due to the poor performance of the stock market in recent years the property market has attracted the traditional stock market investor. Here the investor will aim for capital growth and so will be happy to take a less than 2% loading. The speculative investor will make the estimation that the growth experienced in the past will happen in the future over the short term. The speculative investor’s bid then supercedes the first-time buyer’s bid hence a bubble element will exist.

It is these types of buyers that do cause the bubble in the property market – so use them to your advantage! To find out about where all the hotspots, cooling spots, coldspots and warmspots are in the UK then visit www.propertyhotspots.net. (This site also has a national yield and capital growth index for over 330 areas in the UK.)

Awareness table
Ratio of earnings to property value	The industry standard is around 4 to 4.25. So keep track of average salaries in an area and their size relative to property prices in that area. Look at typical first-time buyer properties and typical first-time buyer salaries in differing industries.
Lending multiples	Its around 4 to 4.25 as said earlier but it used to be 3! So it has crept up over time which therefore changes the fundamental price of a property.
Number of first-time buyers	The market starts with first-time buyers. If there is a lack of these then prices have to fall as they are not taking the bait. Investors will step in but only to a certain degree. The market requires first-time home owners in order to rise the property ladder, otherwise second-time property prices will fall dramatically.