There is an awful lot of comment in the popular press about the state of the worldwide property market but how can you make long term gains with limited risk? Is it really as easy as people might have you believe?
One of the truest phrases ever uttered about the property market is the fact that the best gains are made on a long term basis, even though there will be highs and lows during the intervening period. There are so many major economies around the world linked to the property market that governments literally cannot afford property to continue falling in value on a long term basis.
Setting up your own property portfolio
The best property investor are the ones that are not in a rush to build up their portfolios, the ones who will take only calculated gambles rather than high risk ones which could literally ruin an investors existing portfolio or their whole financial footing.
While your first investment into the market is likely to be a concern, this will soon recede as long as you have a firm base. If your first property is built on debt, you struggle with your repayments and markets collapse, you could literally be finished before you even started!
It is essential to start slowly, ensure that you are fully funded and able to service your debts out of existing income – whether this is personal income until you are able to arrange a lease on the property or rental income if there is a tenant available from day one. Once your first property starts to pick up in value and your continue to pay down any finance attached to it then you will start to see your equity in the home rise, i.e. your net profit after all debts are paid off. So what then?
This is where it starts to get very interesting if for example you bought a house for £100,000 and saw it rise to £200,000 over time. If you have paid off say £20,000 of your mortgage capital then you have £120,000 equity in the property (£200,000 – £100,000 + £20,000) which is in reality money which you could readily liquidate but at the expense of any future rise in the value of the property. However, the £120,000 equity which you have in the property could be used as collateral to cover a new mortgage on a new property then as that property hopefully increases in value you can do the same again and use the equity on the second property as collateral for a mortgage on anther property. It may sound easy in principle, which it is, but it is not that easy in practice.
A perfect world
In a perfect world you would be able to keep using equity in your newer properties as collateral for the next property. If everything went to plan then not only should you be able to obtain a better rate on your finance by using another property as collateral but as time goes by the equity in your older properties should grow as you pay down the debt and (hopefully) property markets continue to edge higher, leaving more breathing space for your finances.
Life does not always go to plan!
There are many things which could go wrong when setting up your own property portfolio, the most devastating would be a fall in house prices when you are just starting out and only have a small number of properties in your investment portfolio.
Imagine the scenario, your first £100,000 home is now worth £200,000 and with the £20,000 you have already paid back on your mortgage you have £120,000 to play with. You buy a property worth say £100,000 using the highest mortgage you could obtain (around 80% of the free equity in your first property) and use the rent for the two homes to cover your mortgage payments. If the market were to fall by 20% then you would be in serious trouble, the £200,000 property would only be worth £160,000 which less your £80,000 outstanding mortgage would leave equity of just £80,000 which would not cover the £100,000 mortgage you took out on the second home.
However, while this might affect the interest rate on your mortgage as it is not 100% covered anymore you would not really hit the buffers until you actually start missing payments and are forced to sell not only the second property but perhaps take out a loan or sell the first property as well. This would see £20,000 in equity taken off your first property to cover the outstanding balance left on your £100,000 or a loan taken out against your first property for the excess £20,000 required.
Slowly does it
The greater the amount of equity available in your property the more cushion you should have against property market fluctuations and the chance that tenants don’t pay or you are forced to sell one or more homes to cover debts. In the early days, when some people may be tempted to push themselves onwards and upwards, it can really backfire and cause major problems.
It is easy to forget that even though you are using equity in existing properties to finance the future investments you will also be paying down the mortgage on each property at the same time, which will see the outstanding total mortgage finance fall and the equity figure continue to move upwards – although movements in general property markets will also affect the value of your property and the equity figure.
In truth we are looking at a buy to let property portfolio, something which has been very much in the news of late after the demise of leading buy to let market operator the Bradford and Bingley. The trick about being successful in the buy to let sector is protecting your rental income which is invaluable in paying off your outstanding mortgage and ensuring you have enough of a buffer against the equity in your properties and outstanding mortgage payments
It all sounds very easy, and to some extent it is, but your need to take you time, not rush and ensure that you do not over extend yourself. The more say you have over your investment transactions the better because when the banks become involved you may not always be able to realise the capital that you had hoped.