When you are investing in property for the first time, the benefits you can gain from purchasing properties below market value doesn’t always stand out, and believe me there will be benefits you won’t even know existed. Understandably, buying as cheap as one can, slightly does sound pleasing to the ear and it’s a no-brainer. But understanding exactly why this is will potentially add excitement to your investment strategies.
In this article, you’ll become enlightened on five major benefits of buying properties below market value. I’ll show you what effect this could have upon your investment over a long-term period.
A buy-to-let-mortgage is defined as a loan for purchasing or refinancing residential properties which are let to tenants rather than lived in by the borrower. We can say rates and fees are typically higher than a standard residential mortgage. But, when you apply for one of these loans, the lender will need a deposit based upon the actual purchase price, not the value of the property itself. You will only be able to borrow a certain percentage of this price, and this price is called the ‘loan to value ratio’ (LVR). Typically, this will be 75%, although some lenders will lend more. If you borrow a lower LVR, the lender will then see your investment in the property as a low risk, hence making it simpler to borrow.
As an example, let’s say you have £50,000 to put down, and the purchase price of the property is £200,000. The mortgage of £150,000 is the 75% LVR. However, if you negotiate a reduction in your investment of, say, 10% or £180,000 in this case, you therefore only need to borrow £130,000 to fund the investment of the property. That’s an LVR of 72%. This enables you to portray yourself as a more appealing proposition to the lender, due to the larger comparative deposit. However, keep this in mind, that even if the property is valued at £200,000, the lender will always work on the lesser of the value and purchase price, never the higher.
When purchasing properties below market value, you instantly defend yourself against a drop in the general market itself. Now, let’s take the aforementioned example, so let’s say you invested at a price of £180,000 when the valuation put on the property was £200,000. Here the market stalls and then the price falls. If for any reason you may need to sell, the market value would have to fall by 10% for you to actually start losing money.
Let’s say you paid the market value at the time of your investment, then any drop in the value of the property would translate directly into a loss of profit.
Here’s another example, imagine this, you’re investing in a property in which is valued at £200,000, as mentioned before. The rental income is £1,000 per month. Your buy-to-let-mortgage of £150,000 is a capital repayment and will cost£792 per month – which is at a 4% interest rate. Property management fees are another £108 per month net rental or £1,296 per year. Therefore, I can tell you it’s only going to take you to incur a few maintenance and repair costs before this profit will evaporate soon.
Essentially, by buying properties below their market value, you actually cut your mortgage payments. In the example, we used previously if you only need a £130,000 buy-to-let mortgage, your mortgage expenses would fall to £686 each month – which again is at the 4% interest rate. So your rental income remains the same as would your property management fees. However, this time your net income would rise to £214 per month, or £2,568 each year. Your profit has nearly doubled. This has increased investment cash flow leaves adequate room for the unexpected costs such as maintenance charges to be handled in a much easier manner. Get it?
I don’t commend flipping properties, which is essentially buying properties to sell it quickly. I’ve seen on too many occasions and nevertheless, young investors end up losing a lot because of this. The reason for this being is they relied so heavily on the property itself actually selling. However, there is no doubt that purchasing properties below market value yields an instant paper profit. Additionally on this, if you were to sell at a market value quickly, you’d make a great return on investment.
Again, in the example we have been using, if you paid £200,000 for a property valued at £200,000, then you’d make nothing by selling it quickly. But if you did only pay £180,000 and sold at the market value of £200,000, your return on investment (ROI) would be quite generous. Your original investment was £50,000 being the deposit, and you made £20,000. This is an ROI of 40%. You need to take into account that this is excluding any costs and these can add up.
While this is definitely good, think about what your ROI could be after a year if values increased by 10%. The property would be worth £220,000. Now that’s a direct profit of £40,000 – or 80% on your original investment, also not forgetting the added advantage of rental income for that year.
It’s common for property investors to only buy off-plan property. This is defined as purchasing a property – typically an apartment – in the early stages of its completion. Off-plan property is usually sold prior to construction which beings at a significant discount to its market value and often with a small deposit being required. This can, therefore, build in a natural buffer and profit when you’re investing in a property. You have to wait for the construction to be completed, but if values have improved in the meantime then your profit so too increases. On the other hand, if values don’t rise, you probably have a quality product with maximum appeal to the rental market anyway. Pretty straightforward right?