Financial Methodologies behind Property Deals.

The below explanations illustrate various methods and formulae used when considering purchasing property abroad or in the UK. Obviously the only real way to assess property in any country is by an inspection trip and assessing using our years of experience and by seeking local professional assistance. The below methodology applies to any country of interest, and although this information specifically mentions buy-to-let scenarios it equally applies to holiday property hotspots through the world.

Rental income in both short and long term letting's are also critical and and of course local management companies to take care of our investment. The final consideration will always be how will finance be raised, stangely for us this is the easiest criteria to satisfy as any properties secured by our club will always have a 20-30% cash deposit and the remaining monies being raised via our contacts in the various international banks and local mortgage companies. Remember that we have international contacts in place for raising money against most properties secured in virtually any country in the world. But we will need various avenues to purchase in such places as the former Eastern blocks, which mean that we need to create additional limited companies so that we can own the properties in the MakeMeaNestEgg name, as some countries do not allow foreign ownership in individual names, but is easily achieved by creating a local company.

Definitions of terms used are : (ROCE) Return on Capital Employed: Is a measure of the returns that a company is realizing from its capital. Calculated as profit before interest and tax divided by the difference between total assets and current liabilities. The resulting ratio represents the efficiency with which capital is being utilized to generate revenue.

(YIELD): The annual rate of return on an investment, expressed as a percentage.

Interest Rate: A rate which is charged or paid for the use of money. An interest rate is often expressed as an annual percentage of the principal. It is calculated by dividing the amount of interest by the amount of principal. Interest rates often change as a result of inflation and Federal Reserve for the U.S. and Bank Of England Rate for the UK market and governemntal policies. For example, if a lender (such as a bank) charges a customer £90 in a year on a loan of £1000, then the interest rate would be 90/1000 *100% = 9%.

The terms 100% Financing & Correlation between Yield (Return On Purchase Price), ROCE (Return On Capital Employed) & Interest Rate are now explained in a very simplied manor below:- Yield and ROCE When a property is assessed for investment purposes you should look for a yield between 9 & 12% yield. The main reason for this is because its easy to calculate whether or not a property is a 12% yield. e.g:If you see a property advertised for £50,000 and it’s a 12% yield it should rent out for £500 pcm. i.e. you knock off the two zeros from the purchase price and it gives you the expected rent. So if you find out that it rents out at £600 pcm you buy it without looking at it!

If you find out it rents out at £300 pcm you put the property out of your mind – no matter how pretty the property is!

Now for the science. Look at the following table(below). It details the ROCE based on the yield and interest rate being charged. I’ve assumed full occupancy, no repairs and £10pcm buildings insurance.

If you look at the 5% interest rate row (which is the approximate buy to let borrowing rate currently) you can see the ROCE increases with yield. If you look at even closer you will see that with every 1% increase in yield the ROCE increases by between 6.6% and 6.7%. It actually increases by 6.667% but due to rounding it is either 6.6% or 6.7%. This means for every 1% increment in yield your ROCE increases by 6.667%. This is why yield is important.

table two

Its easy to think ‘oh there’s not much difference between an 8% yielding property and a 9% yielding property’ but there is – 6.667% ROCE! So why do I say 12% yield? Well look at the 12% yielding column. At current interest rates of 5% your ROCE is 50.9% which is very nice. But at interest rates of 10% your ROCE is 22.5% which is still very nice even though you are in a high interest rate environment. If you had bought at 8% yield, which is still quite a respectable yield, your ROCE is -4.1% i.e. loss making. This assumes full occupancy and no repairs!

table One

In a rising interest rate environment investors that have bought between 4% and 6% yields will be forced to sell, as they will hold a liability (as it will cost them money to hold) rather than an asset (supposed to put money in your pocket) which is what they first thought they were buying!

Okay, so we’ve established that a 12% yield threshold is what we should be aiming for, but what about the level of borrowing?

Well look at the same table above but this time only 50% level of borrowing: looking at the 5% interest rate row we can see that the ROCE for a 12% yielding property is 18.8%. Compare this to the ROCE for 85% gearing above of 50.9%. You can see that if you raise your borrowing by 35%, i.e. from 50% to 85% gearing, you almost triple your ROCE!

Now look at the ROCEs for a borrowing level of nil, 50%, 85% & 100% for a 12% yielding property. So we can clearly see that the ROCE increases rapidly the more we borrow. If we do not borrow all we can expect to make on the ROCE is the yield itself – which is not that exciting. We can see that the ROCE is higher for 50% gearing and even higher for 85% gearing. We can also see that it grows from 50.9% at 85% gearing to infinity at 100% gearing. It seems strange that this extra 15% level of borrowing would make such a difference – but it does!Okay

ROCE
Interest Rates	Nil	50%	85%	100%
5%	12	18.8%	50.9%	∞
6%	12	17.8%	45.2%	∞
7%	12	16..8%	39.5%	∞
8%	12	15.8%	33.9%	∞
9%	12	14.8%	28.5%	∞
10%	12	13.8%	22.5%	∞

IF THE YIELD IS IN EXCESS OF 12% THEN BORROW THE MOST YOU CAN! You can see that the closer you get to 100% LTV financing your ROCE tends to infinity. So if you want to maximize your ROCE you should aim as close as you can to 100% financing, although some of the countries that we will be buying property in will insist on a minimum 20%..So if we started with say,£500 15 years ago. and bought a house worth £49,000 with £500. This equates to 99% financing. If I sold up now and got net £3m after clearing all borrowings, my ROCE over the fifteen years is:£3m/£500 x 100 = 600,000%

Now 600,000% is not infinity but its not bad! Achieving 100% LTV Financing

So how do we reach close to or true 100% financing? Well lets look at how you are expected to fund a buy to let or short term rental property: So the majority of the purchase price comes from a mortgage lender and the rest from you. There is a very good reason why the banks expect you to contribute. Look at this next graph.

Return on Investment

This shows the ROCE if the tenant/holiday renter didn't’ pay you any rent at all. You can see that as the borrowing increases the ROCE tends to minus infinity! This is how people go out of business very quickly. If they are over borrowed and cash doesn't ’ come in on time or at all then its bad news! The banks job is to make sure you’re not over-borrowed. The way they do this is by lending you only 85% of the purchase price and making you come up with the rest to ensure they don’t encounter a minus infinity situation.

Making you come up with the other 15% however restricts you to the number of purchases you can make. So if you wish to buy a £100,000 property then you need to come up with £15,000 out of your personal funds.

Return on investment

Obviously in our case we will not be looking at property unless we have these funds sitting in the bank ready to invest. This is not an easy thing to do. On an average salary of £20,000 it would take you at least 9 months to do if you lived on the streets and ate only bread and drank only water! More realistically it would take you 3 years to save this kind of deposit. If you could only buy a property every 3 years then you should keep the day job. It won’t be until retirement age before you could say good bye to the rat race and retire on the income produced from your property portfolio. But in our case we have 250 members all that have invested a minimum of £10,000. therefore we have that pot of money equal to £2.5 Million. Using the same principal of maximum leverage, you can see that we should be able to have quite a sizeable portfolio of holiday/investment property, in a very short time. (Hopefully within the first 2 years) But constantly under review, for maximum returns.

If you did find a lender that would lend to you 100% then you could theoretically buy all the properties in the world subject to your credit limit. There would be nothing to stop you earning what you desired. The only thing that would limit you is the time to actually acquire all these properties! What a luxury to be only constrained by time and not money. The truth is that this luxury is achievable but you have to be brave, believe in your abilities and be willing to persist! This is were the directors experience, knowledge and contacts come into this situation.

Achieving The Other 15% Deposit There are methods were we can even get the Vendors and mortgage companies to finance these deposits. By offering incentives – Vendor Gift or Cash back This is where you basically get the mortgage lender to pay most of your deposit! This is best explained by the following example of Vendor Gift below: MakeMeaNestEgg has agreed to buy a property advertised for £60,000 for £51,000 but we have no additional money for the deposit. So we tell the vendor to sell it to him for £60,000 + £9,000 vendor deposit. This is perfectly legal and above board and is very commonly used for investment clubs and discounted special offers. There are many other techniques, which effectively net the same results, but the above was just to let you know about some of the basic principasl and to demonstrate that you are in good hands with regards assessing properties through the world.

So to sum up we look forward to hearing from you shortly and joining this exclusive membership.

kind regards

MakeMeaNestEgg team