Property investment can take many forms. In basic terms, it is the purchase of a property or shares in a property with the aim of making a monetary return. Typically, investment properties are new developments, often still being built, or properties in need of significant renovation. Such properties are chosen based on their potential for enhancement and the subsequent profit that can be made through rental or resale.
Types of Investment Property
Any property can be considered as an investment property. Houses, flats, commercial office space, warehouses and even empty plots of land can all be purchased with the intent of developing them to make a significant return on the purchase price. The property investment market is full of diverse opportunities. There are many routes into the lucrative business of property investment, all of which hold distinct advantages and disadvantages for potential investors depending on their individual situation.
Types of Return
Returns are made on investment properties either through renting them out (as residential or commercial lettings) or selling the property on at a higher price that it was originally purchased for. In many cases, both forms of return may be made on a single property. By renting the property out, a regular monthly income is generated. This can be used to pay the monthly instalments on the mortgage (if applicable), put towards other investments, or simply seen as an additional income for the investor. Making a return through the letting of a property is generally a long-term endeavour. Typically, the value of the property increases during the time that it is being let, in accordance with inflation and rising prices throughout the market. A large profit can often be made through the eventual resale of the property at the end of the letting period. Alternatively, many investors choose to make a quick profit by simply purchasing a property, renovating it so that its value is increased and immediately selling it on for a profit. This is a much more short-term form of investment. Often the profit generated through the resale will be used in the purchase and renovation of one or more further properties, each time aiming to increase the amount of the return on resale.
Types of Investment
There are two main types of investment: direct investment and indirect investment.
Direct investment is simply the purchase of a property, either as a cash buyer or with the aid of a mortgage. In this case, the investor owns the property outright and has full control over how the property is developed and the use it is put to to generate a return (i.e. sale or rental). The investor is responsible for the renovation, upkeep and management of the property. In cases where the developed property is let out, the investor will be the landlord, meaning they have legal duties towards the tenants. This can involve a great deal of responsibility.
Indirect investment is through a property fund. Property funds are a kind of collective investment. Several investors pay into a fund and the money is pooled to allow for the purchase and development of various properties or the purchase of shares in a property company. A similar distinction can be drawn between the types of investment made by property funds as by individuals. If they invest directly, it means that actual properties are purchased as assets, using the pooled money. If they instead invest indirectly, the combined funds of investors are put towards the purchase of shares in property companies. In either case, what the investor actually gets for their money is shares and these typically cannot be cashed in for a lengthy specified period, normally seven to ten years.
Comparing Direct and Indirect Investment
With a direct investment, you are in control. You are responsible for all the decisions pertaining to the choice of property, negotiation of purchase price, and any renovation or re modelling that is required to increase the value once the property has been bought. This means three things:
- There may be a lot of work involved. Not only will you have to oversee the purchase, securing a mortgage, instructing a conveyancing solicitor, commissioning a survey and filling out all the required documents, as well as paying out for all the costs involved in this process, but you may also have to have a lot of hands on involvement in the redevelopment or refurbishment of the property. This may be half the draw for some people, particularly if they have experience working as a builder or contractor and have many contacts within the industry. However, for those that view the property solely as a monetary investment and have little time or resources to put into the development, indirect investment may be the better option.
- You are responsible for the sale or letting of the property once it has been renovated. Again, you will need to contact estate agents and solicitors, fronting any costs involved. With a simple resale, your responsibility is minimal. However, if letting the property there will be many things you need to consider with regards to your legal obligations as a landlord. You will be charged with upkeep and maintenance of the property, as well as establishing legal contracts or tenancy agreements. You may need to purchase landlord’s insurance to ensure you are covered should the tenants ever make a claim against you or should anyone suffer injury when doing maintenance work on the property. This can be a significant extra cost.
- You take all the risk. If you are unable to sell the property within the anticipated time frame, or the property stands empty for a period, you will have to find the money to meet mortgage repayments and any other associated costs. Likewise, if there is a significant drop in market prices, you may be unable to sell the property on for a profit, despite having made (and paid for) significant renovations.
The main benefit that draws people to direct investments is that the investor gets 100% of the profit and this is often significantly more than what would be earned through indirect investment. If, for example, you invested R200 000 as a deposit on a mortgage and bought a property worth R2 000 000, should the market value of the property rise by 10% you stand to make a profit of R200,000. If you had invested the R200 000 in shares through a property fund, the same 10% rise in market value would only net you R20 000 profit.
Indirect investment takes the pressure off. In this scenario, all the investor must do is pay in the money, sit back and (hopefully) watch the share value increase. However, the investor lacks control over the decisions made as to what is done with the money and may not stand to make as substantial a profit as through direct investment. They also will likely not be able to access the money and withdraw from the scheme until a specified time has passed. This is usually a relatively long time, typically seven to ten years.
There are many things to take into consideration before making a property investment. Be sure that you look at all the options and choose the best kind of investment to suit your situation.
Assessing Your Finances for Property Investments
It is important to properly assess your finances before entering any sort of investment. The only reason to purchase an investment property is to generate a return. If you are not completely aware of every aspect of your financial situation, it is difficult to assess the potential of any investment to issue a profit. Without taking the time to make a careful and detailed analysis of your finances, you could end up in deep trouble, even losing money on an investment.
The first thing to consider is what existing funds you have available. Work out the balance of any savings and debts you have. If possible, pay off debt early and leave yourself with only a positive figure. This may take a significant chunk out of your savings, but it will make your position more secure. Work out your discretionary income. This is the amount left over after paying taxes and deducting the cost of personal survival items such as food, rent and utilities. Lenders will want to know the amount of monthly discretionary income you receive when assessing mortgage or loan applications. Mortgage lenders do not just look at the gross or net salary of applicant but consider all regular outgoings and any outstanding debts to ensure that borrowers have a realistic likelihood of being able to meet scheduled repayments. Working out the total amount of savings you have put away and your discretionary income will tell you how much you can realistically afford to contribute to the investment both as initial capital and in terms of monthly payments that may have to be covered while a property is being renovated or marketed. Using this information, you can work out a budget based on your earnings, savings and any mortgage that is likely to be obtainable.
How Much Will Your Investment Really Cost
Calculating the cost of an investment means considering much more than just the purchase price of the property. There will also be fees payable to conveyancing solicitors and estate agents, Stamp Duty Land Tax, Capital Gains Tax, Income Tax, the cost of hiring a management company, any costs involved in renovating or furnishing the property, Land registry fees and various other amounts associated with property sales and purchases. All these costs must be added together to give you the total cost of an investment. Only if the total cost falls within your budget should you consider going ahead with the investment finance.
Cushioning Your Investment
If the worst-case scenario becomes real and your investment fails – how much of cushion do you have? It is always wise for investors to ensure they have an amount set aside in case their investment falls into difficulty. There are always holding costs associated with a property between the time that it is bought and its subsequent rental or sale. These costs include mortgage payments, utility bills, council tax and maintenance costs. Similar expenses will be incurred by the investor during any period that a buy-to-let property stands vacant. It is always wise to ensure you have an amount set aside to cover these costs, not only during the time you expect to hold the property (e.g. whilst it is being renovated or marketed), but also for an extra six months – just in case there are delays and the property stands empty longer than expected. The consequences of not being able to meet these costs are dire; not only do you stand to lose the property and anything else put up as security against a mortgage or loan, but there will be substantial damage done to you credit rating if you default on a mortgage. This will make it impossible to obtain funding for future investments.
Your Ability to Secure Finance
Before you can invest in property, it is likely that you will need to obtain funding in the form of a mortgage or home loan. Your ability to secure this funding and how much you can get will depend on several factors, but all the costs mentioned above will be considered. The first and most important thing you will need is a deposit. At the height of the property boom, mortgage lenders were known to 100% or even 110% mortgages, which required no deposit from the borrower. However, with the economic crash came stricter regulations and much greater caution being exercised by lenders across the board. In the current economic climate, a typical deposit required for a mortgage is between 10% and 25% of the purchase price of the property. The extend of your savings will largely determine the size of the mortgage available to you, as these will be used as your deposit. However, mortgage lenders will also need to know your discretionary income, to ensure that you will be able to make repayments. They may also require a business plan detailing all the costs involved in the investment, your plans and the timescale for making a return on the property, and any contingency plans and finances you have in place if things go wrong. The more detailed information you can provide, the more secure the lender will feel in making a mortgage offer. You will also need a good credit rating.
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