Insider Secrets: Auctioneers’ Knowledge Tips & Hints From The Pro’s

What do I think of as yield and how does the valuer express it? A yield from an orchard is in tons of fruit and from shares is net cash. That’s easy. Equally easy in property, as it’s the amount of income we receive compared to market value. Almost invariably, it is the gross amount receivable before expenses and before tax. To add to the equation in valuation jargon we often talk about YP, just to confuse the issue! YP, dare I say, of course, stands for Years Purchase. That is the figure by which you divide the value of the property to produce the gross amount of rent. Conversely, it is also the figure by which you multiply the gross rent to give you value. Let me give you an example:

A property sells at £50,000; assume this represents market value.

The gross rent is £7,500 pa; thus, our Years Purchase is 6.667 and the yield is 15%.

£7,500 pa produced by the investment of £50,000 (15% represents 7,500 divided by 50,000 times 100).

Let’s apply this approach to a theoretical bargain-priced auction property, a typical end- terrace built about the turn of the 19th Century, with three bedrooms, combined bathroom, two entertaining rooms, and let on a normal assured shorthold tenancy for twelve months at £60 per week (£3,120 per year) – very much a run-of-the- mill ‘up north’ residential investment, in a rather down-at-heel area (ie rough).

The guidelines are £12,000 to £16,000, and the sale price £15,000.

In round terms, this is just under 5 Years purchase (YP). Therefore, as you will already have calculated, it will be showing a yield of just under 21%; the sort of gross yield that many would-be-buyers tell me they are looking for in this sort of property.

But, as I have stressed before, when you are buying residential investments gross yield is not net, even when we are ignoring the taxman’s cut!

When you have reached completion and coughed up the balance of your £15,000, what sort of income might you expect?

Let me remind you of the expenditure you should allow for. Are you going to use an agent, who is likely to charge you 12% or 10% of the rent he collects, plus, probably, letting fees and costs on top? With this type of property you will be likely to find that your tenants, on average, move every 2 years.

Even if you decide to manage the property yourself, you should still allow for your expenses at about the same sort of level. You should budget for annual repairs of about 10% per annum of the rent. Immediately after you have bought, you can be pretty sure that the tenant produces a long ‘wish list’ of repairs. You should also consider the longer term needs of redecoration; outside every three to four years and, quite possibly, partially inside every time the tenancy changes. There may be a small rent charge and don’t forget that insurance premium that could be £75 or so per annum. I talked about gross yield for the value calculation but your net yield is coming down and down. The only consolation you can have is that all these expenses reduce your tax liability so the taxman is bearing some of your burden.

I have still not pointed out that you also need to make allowances for empty periods between lettings (“empties” in estate agents parlance). Where’s all your income disappearing! Lets look at the true net result.

Gross Income pa:              £3,120

Expenditure pa:

Insurance                             £75
Repairs                                £312
Long-term repairs              £150
Rentcharge                        £8
Empties with costs            £300
Agent’s fees                       £375
Total Expenses                 £1,220

Net income                       £1,900
Net yield                           12.7%

Still, not so bad with interest rates at the level they are today and, of course, we have only looked at the income position. You will, no doubt, wish to take the future growth of income and capital value into your equation as well. For that, you will have to start coming to conclusions for yourself as to the future. They do issue crystal balls to all chartered valuation surveyors when they qualify, but our professional negligence insurers don’t allow us to use them to come to public conclusions!

But , have you thought about the possibility of gearing your finances? Let’s look at the consequences of gearing your purchase with a loan of £12,000 at 5%.

Capital cost                                           £15,000
Costs of loan, say                                £500
Total investment                                   £15,500
Less loan                                               £12,000
Personal investment                            £3,500
Net income                                            £1,900
Less interest on £12,000 @ 5%        £600
Resultant final income                        £1,300
Resultant net yield                             37+%
£1,300 pa from a £3,500 investment

Apart from increasing your yield considerably let me also, gently, remind you that you have also “kept much of your powder dry” for the next purchases: £11,500 to be precise. Maybe that will help your portfolio to grow almost instantly with two or

three more purchases at this level before you even start thinking of your existing holdings increasing in value and remortgaging to give yourself an even greater yield. I’ll let you develop the figures. Before we get too carried away with enthusiasm, may I now dig deep into my years of experience and issue a caveat or two. This story is not allegorical. Once upon a time when people never really thought of inflation, when mortgages were even cheaper than today, there was a man in Manchester named Steel who found he could buy rentcharges at between 18 and 20 YP and that garages could be built and let to produce 12% gross return.

In contrast, today rentcharges sell at less than 10YP and the last garages I sold produced a 26% gross yield. Steel was a big buyer and an even bigger “gearer”, but he became complacent and did not watch the market and economy movements. By the time I was instructed to sell his assets by his liquidator, mortgage loans were at 20% to 22% interest (if you could get them) and annual inflation was close to that figure. Yes, I am that old! I sold his rentcharges at between 3 and 4 YP and his garages – where they hadn’t been vandalised or destroyed – sold at a 33% yield. This is not, dear readers, meant to be an encouragement to buy garages, but it is a warning that times do change and with them values, interest rates, rental levels and inflation: not necessarily to our advantage. Furthermore it is only those investors who constantly watch their market place, who buy in the right areas and who maintain their properties well that are going to prosper.

Thinking briefly of buying, and on a different hobby horse of mine, why is it that in almost all our articles in PAN and, I fear, in your thinking, are we always talking about residential investment? Is it because you feel more at home with domestic properties? Much of my professional career has been in dealing with commercial properties in the shopping, industrial and warehousing fields. You have may well read this plea from me before. Shops are rather specialised but, nevertheless, don’t you experience and come to know the month by month development of the secondary shopping pattern in your area? Have you thought about combining domestic with shopping investment by looking at shops with flats above? Have you never thought that well-chosen commercial tenants are much less likely to move than carefully selected house occupiers? Very frequently, commercial and shop leases are for longer periods and generally with rent reviews. Almost invariably the tenants take responsibility for repairs and insurance premiums. Rent is paid by the tenants as a business expenditure and before tax. We’ve got the taxman helping again! Almost invariably you can arrange payment of the rent by standing order. The whole management is easier, so that you may even be able to dispense with a managing agent altogether or, at least, pay him a smaller commission. I know how you all hate paying estate agents’ fees! Incidentally, before you ask, most of my family investments are in shops and commercial properties!

Good luck with your purchasing in and may all of your investments be strong, firm, lasting and rewarding deals.

The Secret Auctioneer