How do I make sure my deals work?

This week I answer a question from Jake, a budding investor who is keen to know; “What are the criteria I use when assessing whether a deal is viable?“

…And whether these criteria can be applied to BRR (Buy, Refurbish, Refinance) in terms of Rental Demand, Yield and Return on Investment (ROI).

(You can find the video at: https://www.youtube.com/watch?v=KJ5MYAqfK3c)

So this is a huge question, one I could speak for a whole day on!

The BRR Technique (In a nutshell)

BRR is a technique that doesn’t just apply to straight buy-to-lets, but works on HMO’s, Serviced Accommodation, Commercial Property etc. It works by first buying a property,  then adding value to the property and finally refinancing it.

The key is to add a disproportionate amount of value to the property against what you spend. Nearly all BRR refurbishments will aim at increasing a property’s market value by a larger sum than was spent on it, which is made a lot easier if you are buying the property for less than the market value of the property (Below Market Value BMV).

For example:

However person 2 also had an extra margin of £10,000 that they had achieved before they had even done anything to the property…

… And with a total margin of £40,000 they can refinance the property and with a 75% LTV mortgage pull out £90,000, the same amount they’ve paid for the property (£80,000) and the refurbishment (£10,000).

They’ve got back all the money they first started with (less fees and stamp duty).

Through this method you can build a portfolio with a single pot of money. Many people across the country have done it this way, including myself!

When determining Rental Demand, I start by speaking to Letting Agents. Typically a Letting Agent will be able to tell you;

Whatever you do, don’t buy before you’ve done your research and assessed whether there is a Rental Demand!

It doesn’t matter how much the property is selling Below Market Value (BMV), 20%, 30%, 50% etc- if you can’t rent it out once you’ve bought and refurbished it then your model will not work – you’ll need to pay the mortgage out of your other income, if you have it, and you might not be able to afford to do that.

The tenants are ultimately the people who are paying the mortgage and the reason you can refinance it.

So what do I look for in terms of Return on Investment?

I look for properties that I can refurbish and add value. Refurbishing a property isn’t the only way of adding value, but I believe if you are starting out and are selective of the property you choose to purchase- refurbishment will be the simplest way of adding value to your portfolio and forms the vanilla, most common way of adding value in the BRR model.

Look for properties that are “a bit run-down“, typically needing a new bathroom/kitchen and a lick of paint. There are many things you can do to a property that will add a lot of perceived value but not cost the earth- such as having the windows redone. Another example would be adding central heating in if there isn’t any or changing from storage heaters.

Ultimately however your refurbishment will be led by what your tenants want which you have researched thoroughly! If your tenants will be students- look for modern touches such as USB slots in the power sockets. If your tenants will be retired couples by the coast you will have different refurbishment priorities.

Yield is an essential metric for working out whether a deal is going to be viable.

Having done the research, you should know what the rough rental income will be for your given property post-refurbishment. Take the annual rent and divide it by the property’s value and multiple by 100 and hey presto… you have the % yield!

As you can see if you play around with the numbers, the property’s value will have a big effect on this final percentage, and is going to move in a positive direction if you can buy the property below market value.

In round terms, what sort of yield will I be looking at? Well 8% is a good benchmark, but it depends on so many factors such as the refinancing, the property’s size and type and where the property is- that it is impossible to provide a hard and fast answer.

To answer Jake’s question, what are my personal criteria when looking at whether a deal is viable?

It’s important to me to run the figures and take all the costs into account, with a view of pulling the money back out (thus completing the final R of BRR). After refinancing there needs to be a positive cash flow… so after mortgage costs, taxation, any ground rent or service charges and the expected running costs or management fees… if I’m still up then it’s probably a viable project!

Short answer, if I can pull all or most of my money out, and it still has positive cash-flow, that’s probably a deal to me.

Thank you to Jake for the question this week, keep them coming in and as always….