Tips to ensure your property investment is a success
Last week, a new property investor called us in a pretty anxious state. He was about to buy his first rental property but was getting cold feet. It is a natural fear: whenever you do something for the first time, you step into the unknown. It doesn’t matter that millions of others have done the selfsame thing before you (in this case, invest in buy-to-let property) – it’s your first time, and that’s frightening.
We all overcome such fears on an almost daily basis: a first date; the first time we drive; the first day in a new job, the list is endless.
Irrational fear can be recurring
Sometimes the fear is a recurrent nightmare. Jade Jones cried harder than she had ever done before her semi-final Taekwondo bout in the recent Rio Olympics. “I started crying before the semi-final because I was just so nervous and felt so much pressure,” said Jones, the now two-time Olympic gold medalist.
Often, what drives us through our fears is stubbornness, determination, and perhaps a desire to prove others wrong. In property investment, you need more than these base qualities. You need questions that qualify the decision you’re taking and the huge sum you’re about to invest. Get it wrong, and it will cost you more than merely coming in silver position.
In this post I’ll look at seven questions, the beginner property investor must ask before making their investment. And not only beginners, either: these are questions that seasoned investors ask before committing to any new buy-to-let opportunity.
1. What are my financial goals?
When you begin with your overall objective in mind, you’ll take a long-term view. You’ll start thinking about the amount of passive income you want your buy-to-let property to generate in ten or twenty years. You’ll ask questions like:
You’ll be better placed to decide how much capital you need to commit to taking a step closer to your financial goals. You’ll also be able to create shorter-term goals that marry with your long-term ambitions, and you can make sure your investment property fits these.
2. Will this buy-to-let property get me closer to my financial goals?
With your long-term and short-term ambitions set, you can start to create a property investment profile. What I mean by this is, what is the ideal property to buy?
With this knowledge, you’ll be able to drill down from the big picture level to the detailed view pretty quickly. It will save you time and unnecessary effort. You’ll start taking notice of the numbers more, as well as the property fundamentals that underpin the perceived investment potential.
See our investment blog, “Property research – your guarantee to success as a property investor” for further information on this.
3. What will my cash flow look like in the first two years?
Plenty of different factors can change the property market. A change of government, an increase or decrease in interest rates, a large company moving into an area, and new infrastructure build are just a sprinkling of things that can affect property prices and rental income.
We recommend calculating your cash flow numbers on a two-year basis and revisit these every year. When considering costs, remember to include the following:
- Mortgage costs
- Property management fees
- Maintenance and repairs
You should also make an allowance for void periods. You can do a back-of-an-envelope calculation as a first estimate, but you’ll need to assess more accurately before proceeding.
4. What if the property moves into negative cash flow?
Ideally, your property will produce a positive cash flow (where your rental income is more than your ongoing costs). If it doesn’t, this isn’t necessarily a sign that it’s a bad investment (in fact, some investors purposely invest in negative cash flow properties and create substantial wealth – read the investment blog “How negative cash flow could make you a wealthy property investor” for more insight).
For most investors, a buy-to-let property investment strategy is based upon positive cash flow, but you should be prepared for it to accidently move into a cash flow negative position. Like I said earlier, lots can happen to temporarily disrupt cash flow. The first step is to build up a cash reserve that will enable you to make up any shortfall in income.
5. What can I do if things get tricky?
Every now and again something happens that severely disrupts the market. If your cash reserve is strong enough, you are likely to be in a position to weather the storm.
The last time such a severe shock happened was in 2008 when the Global Financial Crisis caused companies to collapse and sent shock waves through the property market. Poorly positioned property investors saw previously thriving property portfolios collapse. Those who had researched their investments diligently before investing and then used positive cash flow to build up a cash reserve came through relatively unscathed and saw the value of their investments rise shortly afterwards.
Prepare for the unexpected by expecting it – build up a cash reserve and know the strategies to use when your property accidently goes cash flow negative.
6. How will I make money on this buy-to-let investment?
If your property is in constant negative cash flow, the only way for you to make money is on any appreciation in value. Of course, properties should rise in price, but there is no guarantee. In this case, your investment controls you.
By investing for positive cash flow (and being prepared for periods of negative cash flow) you control your investment.
7. Should I have an independent review of the property fundamentals and my due diligence?
Finally, before making that investment, have an independent assessment of its potential. Verify all the details, including:
- Rental potential
- Property management fees
- Landlords insurance costs
- Stamp duty
- Mortgage interest payments
- Local property fundamentals that will underpin your investment in the long term
This final step, the independent verification, should give you the ultimate confidence to proceed. It’s like learning to drive: before you go solo, a test confirms your ability on the roads.