Property Criteria & Checklists: Building on Solid Foundation | PVP S1E03

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The Property Voice Podcast - Series 1: Episode 3

If the last couple of weeks have been cruising at high altitude, this week we get closer to ground level; as we look at how to determine what makes a good property deal for us. Having some pre-determined criteria to evaluate an investment opportunity and some measures of what that looks like financially is what this week’s show will address. So, seat belt signs are on – we are coming into land!

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Resources mentioned

• Property Investor Toolkit – here is the book link on amazon.co.uk & amazon.com in case you would like to get yourself a copy to accompany this series
• For further reading on investment criteria based on my ‘STAR Matrix’: commuter towns, school catchment areas, train commuting maps & employment mapping
• For further reading on understanding investment returns and how to calculate them: Return on Works, BTL investment returns, how to become a property developer, the rental yield illusion, five common financial traps, Rodney, you plonker!, costings, cashflow, ROI & cash margin & my top 3 metrics
• Website tool – Property Wizza to undertake desktop research to evaluate a property against key criteria
• Shout Out – fifighter.com an inspiring blog charting the progress to financial independence by age 30 of one young man.

Today’s must do’s

1. Determine the right set of criteria and KPIs that make a good deal as far as you are concerned
2. Subscribe to the show in iTunes…and while you are at it please help us to spread the word by telling all your friends too!
3. Send in your property stories, questions or moans to podcast@thepropertyvoice.net and we will try and feature YOU on the show too!
4. Rate and review the show on iTunes…this helps us to get noticed and that means more people can get to hear our property content and join in
5. If you would like to, grab yourself a copy of the book: Property Investor Toolkit (link in Resources above)

Get talking!

• Join in the discussion, either here in the comments section below, or anywhere else on the Blog
• Start a conversation on Twitter with us @PropertyVoiceUK or on our Facebook page

Transcription of the show

Hello and welcome to another edition of The Property Voice Podcast, my name is Richard Brown and it is a privilege to have you join me.

Now, you may be expecting to hear from Casa, however she is not here this week unfortunately…I think she went for a reboot or something like that! Do you like having Casa on the show…she did mention fan mail last time, so at least some of you do. Wherever you are right now Casa, I hope you are having fun.

OK, so what do we have for you on today’s show then? We have Property Chatter, where we will be looking at ways to evaluate a property investment deal effectively. Then we have a listener question from Andy, who left us a voicemail on SpeakPipe, which is freshly installed on our website and finally the Shout Out, where we will direct you to a very impressive young chap that is aiming at achieving financial independence at the age of thirty. He originally set that age target at 37 and a half but has revised that target down a couple of times – an inspirational guy then I believe, so stick around for that a bit later won’t you? OK, so let’s get started!

Property Chatter

Today’s topic is: Property Investing Criteria & Calculations

Let’s start by quoting one of the most famous marketing gurus of all time:

"What gets measured gets managed" –Peter Drucker

How to decide if an investment is a good one or not – criteria and key performance indicators

If you are following along in the Property Investor Toolkit – today’s episode aligns with section 2 of the book.

In business there are many performance management methodologies that could be adopted – the balanced business scorecard, goals & objectives, sales figures, customer and employee satisfaction and so on…the question is: why?

The reason is a Peter Drucker said – it then gets managed…and what gets managed gets done!

In our last couple of episodes we have looked at high level strategy and principles – flying at 30,000 feet if you like. Today we are going to get closer to being on the ground by knowing what makes a good deal for us and what does not.

Our starting position has to be to define what a good deal might look like for us. This breaks down into two main sections: KPIs (key performance indicators) & deal criteria.

KPIs

Starting with KPIs, here are some of the different measures we could adopt in property investing:

1. Gross yield
2. Net yield
3. Capital growth
4. Net monthly cashflow
5. Return on Investment (ROI)
6. Time to rent / sell
7. Debt coverage ratio or return on debt
8. Net equity (gain)
9. Price per square foot / metre
10. After repair / refurb value
11. Tenant /buyer demand
12. Payback period

I am not proposing that a) there are not more KPIs than are listed here or b) that you necessarily need to adopt all of them either. But I am proposing that you adopt some and set your own level of acceptability.

I would say that the main metrics in property investment tend to be:

1. Yield – gross & net
2. Various ways of looking at return on investment – RO(C)I (return on cash invested) / ROD (return on debt)
3. Net monthly cashflow – how much money is left in your hands after paying all bills, direct and indirect
4. Net equity gain / profit or return on works (ROW) – especially valid on Buy-Refurb-Refinance (BRR) deals & Flips
5. Payback – this is always worth looking at as it tells us how long before we will get our initial investment back based on our returns

I do look at other factors as I undertake my full due diligence in a deal, such as tenant demand, time to let, and so on. However, when screening a deal at the top level these are the metrics that I use the most.

Let’s take a closer look at these metrics now:

Yield

Gross Yield = total annual rent before deductions / current property valuation

Note: I always use the current valuation on the bottom of this calculation to give a true reflection of this measure as it relates to the current market. Some people use purchase price instead but for me that is not as accurate a comparison. The result is expressed as a percentage.

Net Yield = total annual rent less all annual operating costs / current property valuation

Note: all operating costs including mortgage interest (not capital payments), letting agent fees, insurance, regular checks (gas safety, EPC. Etc.), repairs and maintenance & void periods (non-payment of rent). The result is expressed as a percentage.

By definition, gross yield is a crude measure as it ignores all of our costs and so if I were to use a measure of yield it would be net yield. However, as we shall see that still only tells us part of the story.

ROI

Return on Investment = net annual cashflow / total cash invested into the property

Note: the net annual cashflow is as per the definition above. Total cash invested into the deal calculated by adding up ALL cash costs (not added to a mortgage) associated with purchasing the property. These could include cash deposit (or full purchase price if not using a mortgage), refurbishment and conversion works, broker, lender and solicitor fees, sourcing fees (if applicable), etc. The idea is to capture all £s invested in pure cash terms.

ROI is to me the king of investment metrics and the reason for saying this is that it allows me to compare investment alternatives, regardless of the asset class. I can easily evaluate whether I should be putting my money into different property deals or even deciding between a property deal and another type of investment. Crucially, it also takes into account that all important leverage too, so that’s pretty cool. That said, there is more to evaluation a deal that just the numbers…although the numbers do make up a very significant part of the exercise for me at least.

ROD – Return on Debt: gives us a clue as to how sensitive we are to interest rate rises

To vary ROI for ROD simply substitute the total cash invested sum for our outstanding mortgage balance.

Net Monthly Cashflow

Net Annual / Monthly Cashflow = total annual rent less all annual operating costs ( /12 for monthly equivalent)

Note: the net annual cashflow is the total annual rent less all of the operating costs of running the property (mortgage interest, letting fees, insurance, maintenance, voids, etc.). Total cash invested into the deal calculated by adding up ALL cash costs (not added to a mortgage) associated with purchasing the property. These could include cash deposit (or full purchase price if not using a mortgage), refurbishment and conversion works, broker, lender and solicitor fees, sourcing fees (if applicable), etc. The idea is to capture all £s invested in pure cash terms. The result will be a percentage and you can then set yourself a target to aim at with your investments, property or otherwise. The result will be expressed as a positive or negative £ value

You may have heard the phrase that revenue is vanity, profit is sanity and cashflow is reality. Just as with a person, pretty much the main cause of death is a lack of oxygen to the brain (even if caused by some other issue), so too is cash the life-force of any business and that includes a property business. Consider that if we can always pay our bills, then we can sit out the storms that arise along the way. So, any property investor should have cashflow as a top priority measure in my view at least.

Net equity gain / return on works

ROW = Value post-works – purchase price – cost of works and fees / personal cash invested in the works

Note: make sure that all costs and fees are taken into account when calculating this, so include things like professional fees, financing charges and fees and selling fees for example.

This allows us to evaluate whether a refurbishment project or similar is worth undertaking or not. I have written on the topic of return on works on our blog if you would like more in-depth on this subject. In addition, there are a few projects on the projects page that illustrate the concept and more importantly, some actual results…so that’s a signpost for you to follow too.

Payback

Payback = total cash invested / net monthly cashflow

With a flip project, this is simply how long the project is likely to take.

Payback period is one of those investment measures that the professionals use. If you think about it, which would you prefer:

With a starting investment fund of say £50,000 and faced with these alternatives, which one is better?

A single project that takes 12 months and generates a return on that investment of £50,000 – that’s an impressive 100% ROI remember

Or

Two projects that each take 5 months and generate £25,000 each. Now each project will have an ROI of 50%, which of course is still impressive and more for illustration purposes you understand – but which option do you think is better?

It is the second example as that one allows us to get our money back the fastest and that means we have a high deal velocity and can move onto another project after 10 months instead of 12 with the same financial return.

Hopefully, you can start to see the merit of having more than one measure here? Now, I have worked in various global companies that use tools such as benchmarking and the Balanced Business Scorecard and that kind of thing. But they often have dozens of different metrics that they are tracking. I am not advocating this, certainly not in the early stages, however having a few core measures makes a lot of sense as they complement each other.

Personally, I look at ROI, net monthly cashflow, return on debt & works and payback period as my core metrics. These are my KPIs.

Deal evaluation criteria

This is a list of must haves and non-negotiables that need to be present for a deal to be classified as a good deal to us.

Factors to consider for BTL deals might be:

1. Population
2. Employment
3. Crime
4. Transport
5. Schools
6. Amenities
7. Inward investment / regeneration
8. Tenant demand
9. Rental supply
10. Average time to let

 

‘STAR Criteria’

Whilst there are ten separate items listed above and plenty more besides; I have developed my own headline methodology that I call my STAR Criteria. STAR stands for the following key fundamentals that have to be present in any property investment for me:

Schools – for family rentals this is vital, to be close to good schools. For student lets, obviously this would mean access to good universities instead. For non-family rentals, perhaps the equation could be inverted as a different spin? School league tables and catchment areas should be examined closely here.

Transport – good transport links are vital for our tenants, whether that be road, rail or bus. We need to ensure that the appropriate type of transport is accessible to meet the demand and needs of our target tenant group of course. No point having access to a bus stop if we are appealing to white collar professionals (outside of London probably) as they are more likely to use train and car. However, students is likely to be the opposite…or even bicycle lanes even! Transport infrastructure improvements are a signal that an area could become more appealing as time goes by, so look out for new roads, train lines and trams here.

Amenities – this is shops, bars, restaurants leisure facilities and public services (e.g. doctor / hospital), post office, banks, etc. Again, matching to our target tenant group. An easy question to ask yourself here is: how far away is x and insert the relevant amenity instead of x to have an idea of what it might be like for someone to actually live in the property.

Revenue – which is a combination of employment & investment opportunities. If we are targeting working tenants, then we are ideally looking for a healthy economy with plenty of jobs. Of course, if we are targeting non-working tenants then it could be the opposite but beware the trap of serving non-working tenants in economically deprived areas as capital growth may be stunted. Inward investment means how much money is coming into the local area, either by government spending or by companies investing in the area. Consider for example, the effect that HS2 and the Bull Ring redevelopment is having on Birmingham, or the BBC relocating to Salford, or Siemens and others bringing green technologies to Hull for example. On the other hand, consider what effect austerity has had on places such as the north-east, or an over-dependency on a single industry can have on certain towns and cities such as shipbuilding, coal-mining and so on. Think through these points as too few employers or industries can be a significant risk and so too can hard-to-reach towns and cities from the main employment hotspots.

Are we likely to find a perfect property to invest in each and every time? No, this is not realistic, as there are always trade-offs to be made between different properties and our budget may not allow for us to invest in certain areas either.

That said, it is a good idea to jot down certain factors that we are looking for and what our ‘hurdles’ or ‘benchmarks’ are. Personally, I have a criteria checklist that I use, where I score each item as above or below my personal hurdle. I then tot up the overall percentage to assess whether or not it is worthy of further investigation or not.

This means that I can quickly assess any given deal just by doing some desk research and using tools such as Property Wizza, which has most of the info that I need to screen a deal at the first level.

If a deal passes my initial assessment, then I will make further in-depth inquiries and investigation looking at a range of other factors and not forgetting a viewing!

If I then put my KPIs together with my deal criteria I can very quickly assess any property investment deal and decide whether or not it works for me or not.

The exercise is also useful as it forces you to think through what you are looking for. Aside from having a clear picture yourself, of course it allows us to discuss this with other people, such as estate agents or deal sourcers say.

In practical terms, I have developed a couple of deal calculators and checklists that are available to anyone that owns a copy of my book: Property Investor Toolkit. So, apart from having what I believe to be an excellent property book, for the price of a cup of coffee, you also get my personal checklist and evaluation tools thrown in… that can’t be too bad now can it?

What makes a good deal for you?

I suggest that you sit down and work through the list of criteria and KPIs that I have listed and set your own ‘hurdles’. Then, you can undertake some desk research to see if an area in general can meet your criteria. I will cover research in a later episode, so for now it is just about knowing what you want really.

I would finish this episode by sharing with you how sometimes I have done a deal that does not meet my criteria.

For example:

An overseas holiday let, when I said I would only invest in standard lets,

Or a property with some personal usage, when I say I am a hard-nosed property investor,

Or selling a property when I said I am in it for the long-term capital growth.

I have stepped into all of these types of property investment and all had their pitfalls…my criteria are therefore borne out of these experiences and have developed over time.

Whilst I did not lose out in any of these investments, they were not my best ones it has to be said. However, I have evolved and sharpened up my criteria and I may not undertake some of these in the future.

On the other hand, I do have properties that meet the large majority of my investment criteria and these are standing in excellent fare for my own long-term investment goals.

In summary, I am now a better and more focused property investor as a result of having set, written criteria and KPIs to monitor.

The key is to set your own criteria and KPIs and then stick to them. Remember though, if you are getting too many deals that get over the hurdle, then you probably have not raised the bar high enough! The opposite could also be true however.

I am curious to hear how you determine a good deal from a bad one – why don’t you share your views in the comments in the show notes over at www.thepropertyvoice.net/podcast. I have also referenced a number of blog posts on related topics for you to take a look at in the show notes too.

Your Voice

Andy's voice message:

[what impact will the run-up to the General Election have on London prices and do you see any policies to relieve first-time buyers from relying on the ‘Bank of Mum & Dad’?]

Thanks Andy for leaving us a voicemail with that question. As I see it right now we are less than a month away from the General Election and so there is bound to be a lot of uncertainty around. Who will be in Government from May, will there be compromise required due to a coalition, as with last time or will we have a single victor…honestly I wouldn’t know. However, I am pretty sure that in the lead up to the election there will be a bit of a lull as people wait to see what happens.

That said, I think generally speaking London has been bubbling along at a very fast rate of growth in recent years and so a natural cooling is what I would expect regardless of who gets into Number 10 next month. I think from an investor point of view there are better options to be had outside of London over the next year or two.

As for first-time-buyers, again this rather depends on who gets in and what their policies are. The main parties have committed to stick with Help to Buy and so that will assist first-time buyers with access to lower levels of deposit. Other policies have been mooted but this is the only one we know for sure right now at least. Whether it is the bank of Mum & Dad or the Bank of England that dips their hand into their pockets to support first-time buyers it is true that getting onto the housing ladder, particularly in London is getting more challenging due to rising house prices.

That said, it hasn’t changed that much in principle – deposits need to be saved up and this requires both a commitment to saving and some level of sacrifice. I remember my own first home and I had to stretch myself to make it happen. Right now house prices have outstripped wage increases and so I appreciate that many would-be first-time buyers are feeling further away than before. However, things change and policies such as Help to Buy are evidence of that, as with low deposit, low-start and longer-term mortgages of days gone by. I expect additional products to come into the lending market as the economy strengthens therefore. It happened before and no doubt it will happen again, rightly or wrongly.

As this podcast is about property investment, I do want to highlight one point here and that is, our own home is not an investment in the conventional sense. I define an investment in the same way as Robert Kiyosaki – something that puts money into our pocket! Our own home probably takes money out of our pocket and waiting to see if we make a capital gain when we sell it is both speculative and also not that useful if all we do is plough it into a bigger, alternative. So, if I were living in London I might be inclined to use my savings to invest elsewhere where rental returns are higher and pay rent where rental returns are lower. This would imply renting in London, whilst owning an investment property elsewhere. The question of deposits is still the same and so one way or another we would need to generate the funds for a deposit. The difference with a rental property is that it should, if done correctly put money into our pocket and not the other way around.

Finally, Andy to you personally, I know we met at a property networking event and we have since stayed in contact. I know that you are so positive, committed to a customer service ethos and are always looking to grow and learn; I really appreciate you taking the time to get in touch with us with this question. Good luck down in Chiswick!

If you would like to have your voice heard on the show then check out the voice recorder at www.thepropertyvoice.net

Shout Out

In the shout out segment we are trying to share tools, tips and resources that perhaps you might not be that familiar with to aid you in your property journey. Today’s shout out is a blogging site from an inspirational young person with the aim to achieve financial independence by the time he is 30.

The site is called FI Fighter, the path to financial independence and outlines the investment journey through property and stocks to get there. I will link to a blog post that specifically talks about his evaluation of a deal and some of the metrics and criteria that he uses, so it is linked to today’s theme: http://www.fifighter.com/finance/real-estate-updates/2015/04/walking-away-from-a-deal-even-when-the-numbers-make-sense/#more-16557

OK, so that about wraps it up for another week, I hope that you enjoyed the show. Don’t forget to check out the show notes and get involved in the discussion over at www.thepropertyvoice.net. Don’t forget those Your Voice contributions either.

Until next time on The Property Voice Podcast…ciao-ciao