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24/07/2014 : Title: Could London Ruin Your Portfolio?

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It has been noted that London has been hot for property investment.
Prices in the capital rose by 25.8% between the second quarter of 2013 and the same period this year, Nationwide said based on mortgages approved, pushing the average to £400,404, the first time it has topped £400,000 and 30% higher than the peak reached in 2007.
With prices having risen like this property is a hot investment.
However, if you attempt to use your crystal ball and the reports and facts out there to attempt to look into the future, let me explain how London property could be your undoing.
Property is a business, when done right you should have a plan and a cash flow forecast like any other business.
Unless you have projected your property business well or have oodles of expendable income the changes ahead could potentially be disastrous.
London prices are not the most affordable and it is well known the income to price ratio is a higher multiple generally than the rest of the country.
Rental yield is typically lower in London that other areas of the country too.
This means for the typical investor that looks to make their investment capital go as far as possible they use mortgages.
Mortgage lenders typically have equations and criteria to meet for lending. LTV (loan to value) 125% Rental coverage etc
Money at the moment is very cheap to borrow especially on mortgages. The Bank of England base rate has been at only 0.5% when the average over time is typically higher.
With the base rate being this low since 5th March 2009 everyone appears to have grown accustom to this being ‘The Norm’ and the payments to their lenders are actually artificially low when compared to history.
This comfort without lack of planning and consideration could become very awkward and potentially ruining for property investors especially in the lower rental yield areas like in our capital: London.
If the base rate, and the lenders rates in line, moves back to the historical average, will your mortgage payment cost you more than the rent coming in?
The loan to value will make a big difference and the FCA suggest this is the volume of borrowers in each LTV bracket:
Obviously this is looking at residential as well as BTL investor’s mortgages.
BTL typically now have 75% as the LTV (Loan to Value) limit, although higher LTV’s are still available for BTL property.
Let’s use the example of a typically strong sales and rental market like Wembley, it is out of central London so the market values are not as stratospheric as the £400,404 average in London, and the rental can still be around a 6% yield.
Earnest Knight often use a 4.09% illustrative interest only 75% LTV mortgage as an example when examining property deals, even though our recommended Mortgage Brokers regularly secure BTL mortgages with rates from between 2.7% to 3.5%.
Let’s use a £249,950 apartment typically gaining 6% yield (£1,250pcm)
At 4.09% having borrowed 75% of £249,950 on an interest only basis a popular online mortgage calculator suggests your payments would be £639 per month.
If the chart below that suggests the time and the rate that interest rates could raise based from the Bank of England's most recent Inflation Reports is accurate or close, the following calculations should be noted:
Having borrowed 75% of £249,950 on an 4.09% interest only basis a popular online mortgage calculator suggests your payments would be £639 per month.
If you add 1.7% on the top, bringing the base rate to 2.2% in as little as 2 years and you assume the lender reflects this rate rise pushing your rate up to 5.79%, having borrowed 75% of £249,950 on an interest only basis a popular online mortgage calculator suggests your payments would then be £905 per month.
I can hear you saying but that’s ok I’m getting £1,250 a month in rent.
Lenders often want to see 125% rental coverage of payments and 125% of £905 is £1,131.25.
So interest rates returning only halfway back to the average base rate are getting close to pushing the limits of  the possibility of refinancing.
Why would lenders use 125% rental coverage? Assuming like most investors you are using a management agent at circa 10% of the rent (£125 a month) and you take off the other costs of a flat like a typical ground rent and service charge and other costs of letting like electrical and gas certification etc You will need that 125% now using today’s interest rates.
You can see that in as soon as 2 years your investment could need you to pay for it every month.
If you have a huge income subsidizing for the long term growth profits this way may be fine, but if you don’t have surplus income you need to act now to prepare your property business for the future.
Earnest Knight Consulting help clients restructure their strategy and some have been looking for low cost high yield property investments to hedge against their London property investments by bringing in rental excess to cover any potential upcoming shortfall.
Additionally for others strategies we have recommended whole of market mortgage brokers that can discuss the 50% additional 5 year fixed rate mortgages that have appeared in the last 2 years.
Assuming the BOE base interest rate does go back to 5% over time the interest only payment monthly shortfall could be sizable in London, if those rate rises are passed on by the lenders pushing up this example to 8.59%, on this interest only mortgage payment rising to over the total rent at £1,342 per month! Then adding on the other ownership and letting costs means there could be around £400 a month or more shortfall to cover.
Plan your protective profit boosting property strategy now and this potential situation is easily resolved or managed to your gain, speak to us today to see what you could do to help your strategy.
Equally if you are looking to invest in London do call in to gain ideas of how to build your portfolio especially using those rare discounted London properties we manage to secure.
We have clients just like you that we help with strategy ideas for free every day.
Charles Brittain



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