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Why does ‘below market value property’ ring alarm bells?

Quality below market value property investments
Feb 9, 2017

To most ordinary folk, buying something below market value (BMV) normally means they’re snapping up a bit of a bargain.

A last-minute holiday booking, a new car bought just prior to registration plate changes, a new lawn mower bought in late September – there are hundreds of examples of canny buying resulting in significant savings on market values.

Even in property, new houses can often be sourced with a developer discount to buyers prepared to purchase early during the off-plan phase.

But in the mildly hysterical online world of buy-to-let (BTL) residential property, the phrase ‘below market value’ can have all sorts of murky connotations – price-rigging, falsified mortgage applications, dubious discounts, asset seizure after vendor bankruptcy, dodgy sales practices and occasional charges of fraud.

This isn’t entirely fair on the innocent purchaser, who’s legitimately sought out a repossession property that’s been trashed by the evictees to do it up and sell it on or let it out to tenants in good faith.

But such residential investments tend to be highly speculative and are not something we’d recommend to our clients.

We do, however, recommend buying legitimate BMV properties – when that is genuinely what they are.

 

It comes down to the way property is valued

Buy-to-let: below market value properties

Residential property value is essentially based on how much people are prepared to pay to live in a particular property in a particular area.

This isn’t just about how nice a house it is, how many bedrooms it has and whether there’s a garage and a pleasant bit of south-facing garden, it is also dependent on the state of the national and local economy – which in turn affects other important factors.

Are the mortgage lenders lending? How’s the job market in the vicinity, and what kind of salaries are they paying?

There are a lot of external factors in play, all beyond our control and impossible to predict. Just look at Southern Rail – strike action and all-round unreliability have played havoc with residential house prices in that particular region.

If your priority is anything other than living there yourself, this can make buying residential property purely as an investment rather a risky and speculative venture.

Rental yields are not considered when valuing a residential property because a homebuyer is willing, 9 times out of 10, to pay more for a property than a prospective landlord.

On the odd occasion where a landlord does outbid a homebuyer, rental yield will be an added bonus; the landlord will almost certainly be buying it in the hope of achieving significant capital growth in the future.

Investing in residential property for rental income or capital growth is a long term, low yielding and highly speculative venture. Add to that the government’s recently imposed Stamp Duty surcharge on second homes and it really does begin to look a bit of a non-starter.

Commercial property, on the other hand…

High yielding property investments

Commercial property is traded almost exclusively on the basis of rental yield, and the likelihood of its continuation.

Occasionally, a degree of forward speculation will come into play when an area is undergoing such a period of gentrification that investors can see the potential for trickle down into the commercial property sector.

But on the whole, it’s judged by current NET rental yield and what’s known as ‘covenant strength’ – the stability or quality of the tenant and the ease of finding a similarly desirable replacement in the future.

Any NET yield below 4% would probably indicate a property needing a solidly secure tenant for a prolonged lease period – perhaps 30 years or more. This might suit a landlord who has a well-established High Street name in their customer portfolio – or one who is not buying so much for yield but in anticipation of significant capital growth in the wider market.

A 4-6% NET rental yield is quite acceptable; it’s not going to tear up any trees, but may be the best deal in the vicinity that a landlord can find within budget and on portfolio strategy.

A 6-8% NET yield represents a very healthy return; given the right levels of covenant strength, yield compression could also greatly increase the owner’s capital growth options.

 

What is yield compression?

Understanding yield compression

Yield compression is a way of balancing NET income and property value. It depends on reliable, high quality tenants and regular, fixed rental income.

To keep the sums simple, let’s assume you bought your commercial property for £50,000.

Let’s also assume that your NET yield is at the top end, say 10% (again, it makes the sums easier).

Think of your NET income as an annual cash sum – in this case, £5,000 per annum.

Most investors and observers agree that any NET yield of 7% or more is perceived as very attractive to a potential buyer.

So, in order to make this £5,000 per annum income as appealing as possible, you could set a property sale price of £60,000. This would give you 20% capital growth of £10,000, and your buyer a NET yield of 8.33% – bite your hand off time.

Or set a higher sale price of £70,000, make 40% capital growth of £20,000, and you can still offer your buyer the £5,000 annual income at a very tempting yield figure of 7.1% NET.

 

An original property investment strategy

Buy-to-let headaches

It so happens that the two property sectors we focus on, Purpose Built Student Accommodation (PBSA) and serviced apartments, are classified as commercial property.

We offer sector-high yields of 8-10% NET, fixed for 10 years; the reason we can do this is because of our developer partner’s established business model whereby they retain the freehold of all their properties.

This is because they are more than content to make their profit from a long-term commitment to continuous rental income growth.

Many of our competitors have chosen to use yield compression to offer their investors around the 7% yield mark and thus make a bigger profit on the higher initial sale price of the unit.

So not only do their investors receive lower incomes (usually for shorter periods), investor capital growth prospects are also reduced.

We, on the other hand, want to make our properties as attractive as possible to investors at all levels of experience all around the world – and we want them to sell like hot cakes; hence the generous returns and lowest possible purchase prices.

 

Ring-fenced assets providing security in this model

High demand UK properties

The nature of our sectors ensures covenant strength; UK student numbers have been increasing regularly over the last twenty years, with the last four in a row setting new record levels. The weak pound means that a highly-prized UK degree is now even more affordable to overseas students.

The recent boom in UK tourism won’t be hurt by the exchange rate, either, and the demand for serviced apartments continues to grow as more and more travellers turn away from traditional hotel accommodation.

Another factor that makes our properties exceptional value is that the sale price includes 24/7 onsite management to look after every single aspect of your investment; once you’ve signed the contract,  there will be nothing more for you to do, not another penny to pay for the next 10 years.

You’re also getting 250 years of leasehold ownership and, in the case of new builds, an independent 10-year warranty.

Our aim has always been to offer affordable investment opportunities providing an effortless income to all our clients, regardless of their experience (or lack of it) and wherever they may be around the world.

If delivering that promise means that an Emerging Property is defined as a ‘below market value property’, then we’ll happily settle for that.

 

 

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