Property Investment International - Newsletters
PII Newsletter May 2010 - Cashflow, voids & patience
Dear Investor,
This month we focus a little less on property markets and more on the practical issues and considerations of owning property.
Cashflow – just how important is it?
The mistake many people have made over the last few years is investing on the assumption that property prices will go up indefinitely. Yes it’s true that generally the most money is made on the capital growth between what you bought the property at and sold it at (or in some cases refinanced at). However, you can get into an awful lot of trouble if you prices don’t go up (or even go down) and you have negative cashflow.
A more basic question is why would you buy an investment that loses you money every month? It’s very difficult for most people to predict the future course of a property market or economy and thus you have to go into the investment so that it makes sense from day one – particularly with property which is not very liquid compared to shares.
Unfortunately, many people have bought at what were already high market prices in the hope that prices will continue to increase. Often little research was done, the pictures looked nice and the sharp salesman on commission answered all questions so convincingly that large sums of money were handed over with less thought than choosing weekly groceries in the local supermarket. The only thing saving people right now is the low interest rate environment.
If you lose just 100 (eg euros/pounds/dollars) a month (ie 1,200 /yr) on a property how many of these such properties can you buy before the average person goes bankrupt? Not many I suspect. If the figure is 500 /mth or more then this could be a serious worry.
On the other hand if you make eg 100 /mth then, all things being equal, you should be able to buy as many as you can get your hands on. Then even if prices don’t go up (or even go down) you can still pay the mortgage and sleep safely at night.
As well as looking at the cashflow from a property you also have to do a “sensitivity analysis”. How sensitive is the property and/or your portfolio to changes in incomes and costs? For example, if rents were to drop 10% and interest rates increased by 1% (eg from 5 to 6%) how would this affect your cashflow on your property / property portfolio – can you still afford to pay the mortgage? What if you have a tenant that doesn’t pay the rent for months, or you have a large void period or an older property that requires a raft of repairs? Can you portfolio handle such scenarios? And if not what can you do to reduce such risks?
Always protect the downside and the upside will take care of itself. Before making money you have to make sure you don’t lose it first.
I would caution anyone who plans to buy a property for the long term that has negative cashflow. The only exception to this might be if you can buy something at a good price and sell it on relatively quickly at a higher price, but this is a slightly different trading/investment strategy.
Is it better to buy a property with a 5% yield in a high growth market than a property with a 10% yield in a low growth market?
Well the answer partly depends on the current level and direction of interest rates. If mortgage rates are around the same level or higher than a typical rental yield you cannot reasonably expect much more further growth as very quickly it becomes far cheaper to rent than to buy a property and thus relative demand will naturally start to drop.
The real number to look at is what is the margin between current mortgage rates and current rental yields. If interest rates are 10% and mortgage rates are 5% the chances are demand for such properties will increases and along with it prices. If that same property increased in price by 33% it would still yield 7.5% and probably still attractive for a buyer if mortgage rates are 5%. On the other hand if mortgage rates and rental yields are 5% how many investors are likely to be tempted to buy when the property would struggle to breakeven once associated costs are factored in?
As well as looking at the margin between current mortgage rates and current rental yields you also have to take a view on their likely direction. If inflation is running high then interest rates could quickly increase and if there is too much building taking place rentals could well drop, so even if you do have a 5% margin between mortgage rates and rental yields this could very well disappear. Conversely if rentals are on the rise and interest rates are likely to fall perhaps buying with little current margin might be attractive.
Naturally there are a whole host of factors to consider when investing in a property market, however, as a general rule of thumb always try to invest in properties that are likely to have a sustainably high rental return relative to long term mortgage rates.
Voids – the cashflow killer
Having your property empty without a tenant can have a huge affect on your overall rental yield. The question is, if you have an empty property on the market, how long do you wait before reducing the rent and if so by how much?
For every month a property is empty it eats into your overall rental return by 8.3%. Furthermore, as the owner of the property (eg if it’s an apartment) you are still responsible for paying the monthly bills until you get a tenant in. Typically the bills can add around another 30% on top of the rents, which pushes the figure of 8.3% to over 10% - ie if you expect a 5% net yield, then with a 1 month void period this will be reduced to 4.5% assuming you rent it at the same amount per month that is was initially advertised for.
Let’s say you have your property on the market for 500 /mth + 150 for bills. Let’s look at some scenarios (which assume no other costs such as maintenance):
1. Property rented on day one you will receive 500 x 12 = 6,000 net income in year 1 (assuming the tenant pays the bills)
2. Property rented after one month at the same advertised rent you will receive (500 x 11) – (150 x 1) = 5,350 net income in year 1 (which is only 89% of scenario 1)
3. Property rented after two months at the same advertised rent you will receive (500 x 10) – (150 x 2) = 4,700 net income in year 1 (which is only 78% of scenario 1)
4. Property rented on day one but at a reduced rate of 450 (ie 10% less), you will receive 450 x 12 = 5,400 net income in year 1 (which is 90% of scenario 1)
5. A more typical scenario is that the property is advertised at 500, but stays empty for 1 month but then is reduced to 475 before actually being rented at 450 another month later. In this case you’d receive (450 x 10) – (150 x 2) = 4,200 net income in year 1 (ie only 70% of the level in scenario 1 and 78% of the level of scenario 4)
The true cost of a void period is likely to be even high when you average out the monthly cost of insurance, taxes, maintenance and other fees.
What the above scenarios aim to demonstrate is that its highly destructive to your returns to have a property sitting empty and the sooner you get a tenant in, even at a slightly reduced rent, the better.
In the UK which has a relatively good market if you price your property fairly your property should not stay empty more than one month, otherwise you are doing something wrong.
In the Czech Republic, for example, which has traditionally had a good rental market but is currently suffering from an oversupply of units on the market and falling rental prices it’s very important to be realistic and to monitor the prices and market feedback closely. Properties can often take more than one month to rent.
In Bulgaria where the market is swamped with cheap property tenants are extremely price sensitive and have so much choice they won’t bother even looking at a property if it’s not in the right area or has the right facilities. Properties in good area’s still have a good supply of tenants if priced correctly however properties in poor locations can take many months to rent no matter what the listed price.
Once you get a tenant in its often easier to adjust the rent upwards at the end of the first rental contract period (assuming market prices allow) than to try and get a fresh tenant at a high price from the start.
The exact strategy you employ to get the property rented will depend on the property itself relative to the market and which market you are trying to rent in. So there is no right answer. However, in no case should you over price your property and keep holding on in vain in hope of getting a tenant.
Sell now or wait?
Probably the most common question we’ve been asked over the last year is “is now a good time to sell my property” or variations thereof. Typical reasons for wanting to sell have been, for example, simply the need to raise money at home, get rid of a property that has negative monthly cashflow that is hard to support or to take advantage of a large gain in exchange rate between currencies.
In late 2008 and early 2009 we recommended many clients to sell up and get out before prices fell too far especially if they were nervous about the ability to get finance, cover rental short falls, too much hassle (don’t be afraid to change your management agent if so!), risk of losing their job etc. During this period we did a substantial number of resales via our Czech real estate agency brand.
Since then the market continued to worsen to a point today where prices will probably not fall much lower.
In today’s market sales are still possible but not at the prices of a couple of years ago.
If you really need to sell, then get in touch and we will help sell your property. Otherwise my advice is to hold for a little longer and wait for the market to pick up.
The economies in the Czech Republic and Poland are not in such a bad state and should pull through the crisis, supply of property is quite high but this should slowly get absorbed and building as all but stopped meaning in 1-2 years time the markets could well be a lot healthier.
Another large factor of whether to sell or not is the currency fluctuations. If you had bought in the Czech Republic 3 years ago when the GBP/CZK was 42 and sold today at GBP/CZK = 30 then you’d make a 40% profit when you bring the money home simply on the exchange rate change without even any property price appreciation. In Poland, where many people took our mortgages in Swiss Francs, you may find that your mortgage is still worth more than the value of the property in PLN (this problem is even more acute in Hungary).
In Bulgaria and Romania, for example, sales in these markets are likely to be difficult for some time to come (particularly if mortgage finance is not available in the market). Therefore the choice is somewhat simple either cash out now at whatever price you can get or hold for the foreseeable future.
If you want to sell your property or just want more detailed advice then get in touch.
Regards,
Simon Tweddle.
www.propertyinvestmentinternational.com