Location, location, location is just as relevant for landlords

One question I am often asked by would-be investors is this: where should I buy my first rental property?

Because I can only draw upon my own experience, the answer I give is ‘as close to your own doorstep as possible’. It’s where almost all landlords start. Why? Because managing houses close by is a lot less of a headache than crossing cities and travelling motorways to do so. Preparing a new property or getting your trusted contractors to solve a tenant issue is always more difficult when there is more tarmac than necessary between you and it.

When I used to work in finance with rental property as my secondary interest, once a month or so I’d drive by my rentals on the way to the office just to check them out. I took great comfort (and still do) knowing that I controlled my own pension fund and could actually touch it anytime I wished, with very little effort.

True, you may have heard of a greater yield to be had 30 or 40 miles away. But factor in the time and fuel expenses of having to travel back and forth, as well as finding good people to repair issues quickly, and your additional gains could be frittered away in higher servicing costs.

No time to waste

Half of my own rental properties are within three miles of my home. It’s just easier, trust me. Many would-be investors get so bogged down with the question of location that they never get started at all. I’ll meet someone six months after they approached me for location advice, and I’ll ask them where they bought in the end. Often, the answer is ‘I still haven’t decided’.

(While writing this article a tenant called me to report a power outage. The problem couldn’t be solved over the telephone. A quick 20-minute round trip to the property discovered they hadn’t properly inserted their electricity top-up card. Problem solved. Happy tenant. ￡75 electrician’s call-out fee avoided. Back to the keyboard).

If you’re serious about property investment, do anything to avoid unnecessary procrastination such as mentioned above. A property could have been found, purchased, appreciated by ￡30k or more, and generated ￡1,500 of cash flow in that same time (assuming the conveyancing took 3 months). What a waste of time and money for a fledgling landlord.

Know ‘your’ area

For the sake of argument, let’s say we agree on the question of location. A landlord or developer with their finger on the pulse will know at all times what properties are available nearby, how long they’ve been on the market, what price they will likely sell for and what they’ll attract in terms of rent. They’ll know it in their head.

Rightmove is a property investor’s best friend and must be in a permanent state of ‘on’ in your pocket. Always remember to search with ‘Include Sold STC’ (subject to contract) selected, to gauge the movers and shakers. Don’t be fooled though; if it’s sold STC, the price you see isn’t necessarily what was paid. What you can see is the asking price. The purchase price won’t become public knowledge until post-completion unless you know the selling agent well and they trust you with such info. Check out Rightmove sold prices, and the rental prices for similar properties in the area before you make offers. Make sure the yield stacks up (minimum 5% but you should aim for up to 7% if possible).

Avoid competition

If there are lots of similar properties available for rent in any given area, avoid it. You don’t need competition. There are plenty of other options in the opposite direction. You’ll end up reducing your rent (and with it your yield) to win a tenant and that’s an unacceptable compromise. Renting out your property should be as easy as selling candy to a kid. You’re in this for a passive income so don’t stress yourself out competing with others.

That said, you’ll be surprised at the opportunities that exist close to your own doorstep. Unlike any other business I’ve been involved with, I rarely bump into competitors and despite what the media will have you believe, there are always many more properties available than anyone could ever hope to afford. And think about this: if you were to purchase every property and piece of land within 3 miles of your home then you would be well on your way to becoming one of Britain’s most prominent private landlords.

Be alert

Currently, in my target area, there are twelve properties for sale that meet my requirements for a worthwhile rental property - I’m not in the market at this moment in time as I am awaiting completion on a couple of recent purchases. But the property market is in a state of constant flux, so I watch them all and keep a keen eye on their progress.

If my new purchases drop soon, and I can renovate and rent them quickly, I’ll be heading back to that list looking for the weakest, most succulent opportunity that’s fallen to the back of the pack. If a target property persists in escaping you despite your best efforts to secure it, don’t be tempted to overpay and don’t panic, because just like buses, another one will be along 5 minutes later.

This sort of behaviour may sound a tad predatorial to the layman, but it’s absolutely necessary if you’re going to maximise the usage of your capital and gains. And that folks is the aim of the property game. You need to know almost exactly what any target property can be bought and rented out to work out the yield.

Do the math

Yield as a percentage, defined as: (Annual rental income / Purchase price) x 100 is your friend, but to make a good friend of it, you have to take the time to understand it thoroughly. If you increase the rent as the years go by (which you must), the yield will slowly rise as a direct result. You may decide to refinance and withdraw some equity at the end of a fixed mortgage term, which will reduce the yield. This is fine so long as the drawn down equity is being used to finance a deposit on a new property, and not a new Range Rover.

While we’re merrily digressing into the subject matter of portfolio metrics, my personal favourite is Return On Capital Employed (ROCE). If it’s the yield that provides the guidance to pull them in, then ROCE cleans them and fries them. It’s how you drill down to assess the return on the cash you’ve actually had to put into a property.

I simply take the expected annual first year’s profit after costs such as insurance and maintenance and I divide it by the sum of what I’ve paid out in cash - the deposit, stamp duty, legal, refurbishment and tenant-find costs. The ROCE provides a true metric of the annual return on my defrayed funds. I always aim for 12%. Add to this annual capital growth of around 5% on the entire value of the property (10% in the last year), and you have the kind of returns at which even the most seasoned of investors would raise an eyebrow.

Don’t overdo it

It’s difficult when you start out, but as your portfolio grows try to stay around 60% LTV across the board, including any future refinancing. That’s the total percentage of borrowings versus the total portfolio value. This demonstrates financial restraint and good governance when you apply for your next mortgage. Although they won’t tell you, mortgage companies will love you for it. Lenders want to know that your portfolio can withstand a market downturn. Stay within this hallowed parameter and they will happily continue to feed your growing addiction to buying property long into the future.

Transversely, should you fall a persistent victim to the marketing of high LTV mortgage products, then not only will your margins suffer immeasurably but you will also taste the nasty end of the stick if the market upends itself. Higher LTV mortgages mean you’re borrowing more money at a higher rate – a double whammy. Lenders at the riskier end of the yield curve have a nasty habit of running for the hills at the merest hint of a downturn, even if it’s only temporary.

They’ll focus on de-risking their book, by revisiting their most risky clients (high LTV, missed payments) and use your head as a stepping stone to keep theirs above the waterline. You may end up having to sell properties at a depressed price to pay down excessive debt. Not good. Remember that BTL mortgages are unregulated products so you won’t have the protections afforded to a residential customer. Mortgage lenders are businesses that exist to make a profit and protect their own interests, not yours.

Time is money, so go ahead and check out the market in your immediate surroundings. Trust me, there’s no greater place to start.