Understanding the difference in profit of the two investment types.
At Baron & Cabot a question which is raised daily is what type of investment an investor should look at when purchasing a property. Rightmove and Zoopla is filled with available completed properties and yet there are hundreds of off-plan investment properties being marketed daily via email and on any Google search.
Simply searching for an investment property will deliver thousands of options of already rented, completed properties, properties which you can take vacant and properties going through a build process.
A trained broker should work with you to understand your circumstances and needs to give you the best option, however understanding this yourself will allow you to be one step ahead.
Use these questions to help understand which way is most suitable for you.
1. Do you need rental income immediately?
We occasionally have clients who require immediate rental income to subsidise their salary or lack of salary. If the rental income you want to receive from a buy-to-let investment is needed quickly it makes sense that a completed property is going to be more suitable.
I had a client this week asking whether a mortgage was needed immediately for an off-plan investment. It is important to understand that the mortgage is only payable when a property is completed, although you are likely required to pay a proportion upfront on exchange of contracts.
Understand your finances first of all and whether the cash from rental is paramount to your living requirements.
2. How long is your strategy?
Ideally all investors who purchase a buy to let investment will be looking at a minimum of 5-year investment strategy.
In doing so it allows the buy-to-let investor to look at over all return on investment and not be restricted to quick year one capital growth, or immediate high yields.
A 5-year strategy allows for safer investments as immediate returns in any investment regardless of property can be a high-risk strategy. In property investment expecting very high yields will often mean a higher risk investment and expecting very rapid 1-year capital growth can equally be a difficult strategy to deliver.
If you are in a position to look at the property over a 5-year minimum term you will have a strong view to compare price paid, expected growth and rental return to understand which will give the highest returns.
If you are categorically looking for quick returns, ideally with some knowledge already of doing so you have two real options:
- Buying off plan and ‘flipping before completion’
Some clients are very affective at this strategy but it will require good planning with your broker. Essentially you buy at a discount 12-18 months before completion, then sell to an owner occupier 1-6 months prior to the property completion.
This means that you don’t need to mortgage or stamp duty the property and can often make 10% or so on the investment.
Before you consider reserving a property on this basis make sure you pick the right development, could afford to mortgage the property if you were unable to sell before completion, and have an assignability clause in your contract allowing you to flip the property.
- Buying completed and refurbishing
The ‘Sarah Beeny’ approach which brought many of us into property investments is buying a run down or dated property which is structurally sound, have it cleaned up and modernised and selling at a profit.
Before you look at this option make sure you want a hands on approach, can refurbish within budget, the property is structurally fine, and your profit will cover stamp duty, valuation after refurbishment and capital gains.
3. Risk appetite
Comparing whether you should buy an off-plan or completed property investment will require a risk appetite. Some suggest that off-plan developments come with a risk, which is true, but with good developers the risk isn’t what you think it is.
Looking at the good developers in the market (use our expertise on this if you are unsure), likelihood of the development not completing is minimal, however there is chance for delay. If you have refurbished a property yourself, you will know that even on this small-scale, issues can occur causing delays.
Equally with a new build development a bad winter or a complex issue can delay a development.
While completed buy-to-let properties are built you may find your risks are different. There may be existing issues you are unaware of, roof problems or drainage issues you were unaware of. Access to the lease agreement can be more difficult and must be addressed before a comparison is made.
Naturally with a new property you should be receiving a 10-year build warranty reducing any expenses for the term of your investment.
When looking at off-plan developments it is critical to know who the developer is and their track record. When you buy a new car, you know what to expect from Mercedes or Ford, if you ordered a car from an independent car maker you may be nervous about what you will receive. This is the same with developers, work with the top developers and you will get what you expect. While you may not know who these developers are, speak to us and get your head around who the best UK developers are.
4. Buying under market value / at a discount
When buying a property, naturally getting at a discount will improve your profits. The investment is based on getting as much money as possible in the safest manner possible and a discount can certainly support this.
In the completed market there can still be some bargains around, but they are unusual unless you have a relationship in the industry which enables you to get these.
A fairly sizeable question you must ask yourself on a completed property which is available under market value is why has it been reduced so much? Like you, owners of property don’t sell significantly under the market value unless there is a problem, either with their property, or their financials.
Today buying a distressed sale is increasingly more difficult, as unless you are in the property industry you are unlikely to see any real deals, most will be mopped up very quickly by the estate agents or others aware of the situation, and almost all distressed sale will need a very quick cash purchase.
Auctions are a similar experience, the reality of it is that any significant savings which are not associated with a poor property are purchased before they reach the auctioneers floor.
In the off-plan market as an investor you must be sensitive that the ‘deals’ or under market value properties are genuine savings. Developers will often have very strong marketing strategies and a savvy investor must first make sure that there are real savings.
With new properties understanding the future value of the property is also useful. If the development will be completed in 18 months for instance and you are investing 30% at today’s value, and remainder on completion, what is the likely value of that property in 18 month’s time?
There are various free and paid for resources that Baron & Cabot use to value an off-plan development but you can start with the likes of JLL market reports and various historical growth figures to get an expectation. If a city hasn’t grown much in the last 5 years is there something to suggest significant further growth in the future?
A good broker can give you this information and re-assurance, there is natural added value in terms of build warranties so you can be comfortable there will not be further significant costs, but your starting point is knowing that the investment is good value.
5. Rental Demand
Naturally new builds if next door to an older completed property will see increased demand as tenants will generally prefer a new property. A savvy investor however when comparing a completed property to a new build property will look at a 5, 7 and 10 year return on investment.
Property investment, unless you have significant experience should not be looked at short term. Medium to long term will provide the most stable and predictable returns, as well as lower the average yearly cost of your initial stamp duty investment.
When looking at an off-plan v’s completed property if you can try and get the tenancy agreements on completed property to understand how long the tenant has been there and how long for, check comparable rents in the area and see whether the yield suggested is suitable. Look at the growth of both properties and rental income with your broker to see which delivers the most bang for your buck.
6. Location
Location, location, location as they say. Naturally new builds will often be in emerging area’s of a city due to the nature of land availability in city centres.
Some new developments will be in core city centre locations where land was ‘banked’ for future developments or there has been a refurbishment of an original block.
As a rule of thumb the closer to the core of the city centre will give more rental demand but often lower rental yield as the property prices are higher (due to a high rental demand). Understanding yield is important, ultimately the lower the yield will generally relate to a lower risk, and vice versa.
Working with your broker to balance yield return that you want to achieve with rent each month against your costs, and growth ambitions is important. When comparing a completed property next to an off-plan property will make this easier than comparing two in different parts of the city. As always looking at the return over 5 years will give you a much easier comparison.
7. Lease
One of the biggest problems we come across when supporting clients with a risk/ return assessment of a completed property against a new build property is getting lease information on the completed property.
The truth is there is absolutely no way to compare a completed property with a new build unless there is a lease available on the completed property. An example of this is a client that we had who believed her completed property was the best in her portfolio. It had been purchased in cash and had a café on the ground and upper floor of the development.
While the building looked beautiful when we started to work with her on re-mortgaging the property and looking into the lease there were various issues. One issue was that properties with café’s can be very difficult to mortgage as they are higher risk. Baron & Cabot do this mortgage assessment before we take on a property development but when a client already owns this can cause issues.
Secondary to this was the way that the ground rent increased. At Baron & Cabot we don’t have properties which have ground rents that increase faster than inflation. The reasoning here is that it will always ‘feel’ the same cost, as the 10 year increases in ground rent will be equivalent to the increased value of the pound.
Unfortunately, with this particular client’s property the ground rent had not been checked by the company who sold it to her and doubled every 10 years, again this devalued the asset as eventually the ground rent would become unmanageable and many mortgage lenders would not touch it.
Although early on in the comparison viewing the lease is not always time effective, always walk away from anyone who won’t share with you the details of the lease, or estate agents/ brokers who do not have a copy to hand. They should have checked this before offering to you, and if they have not they are putting you at risk.
Conclusion
To conclude there is no right or wrong route, the important aspect is looking at 5-10 year overall return, and then making sure you are protected by the lease and location of the property.
Property investments make clients very wealthy, historically property has almost doubled in value every 10 years. In most cities significant growth should continue in completed and off-plan properties. The majority of property investments are safe, our job and your job is to get the best possible investment returns from the safest possible investments.
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