In this article I want to look at the power of Bank Financing and why all the proven successful property investors like Robert Kiyosaki have built their property empires using this formula.

Property Investment is always a medium to long term business it is nearly always tough at the start but over time as the values of your assets increase and the income from those increase against your fixed costs you make bigger margins and have more profits and assets to acquire other assets.

Cash V Financing

Let’s start by saying there is absolutely nothing wrong with using your cash if you’re a conservative investor not interested in building a property portfolio but just want to create some income and capital for the future. However, if you want to become a professional investor you might want to discover the power of Financing your investments.

So for this test case example I am going to look at the United Kingdom and Manchester and here we will show the differences between using 100% costs and using bank financing. In essence Manchester offers realistically 3% PA Capital growth PA and 3% Rental Growth a year which is a perfect long term scenario for property investors. We will base the investment on 300,000 GBP plus buying costs.

The Cash Option

So first we need to look at the buying costs

Property Purchase                                         300,000

Stamp Duty                                                      14,000

Legal Costs                                                      1,500

Company Formation                                     600

Misc.                                                                 1000

Total buying costs                                          317,100

Initial net yield                                               5%

Net Yield after 5 years                                  5.8%

Asset Value after 5 years                             348,000

So as you can see that is a pretty sound inflation beating return on your investment and producing you a good income and protects the value of your capital. Based on a net income of 82,000 and property value of 348,000 Total return over five years is 430,000 for an investment of 317,100 a 135% ROI or 7% PA.

The Financing Option

We are assuming the same numbers as the cash option the only difference being that you would take a mortgage of 70% and the buying costs would be slightly different

Property Purchase                                         300,000

Stamp Duty                                                      14,000

Mortgage Fees                                                4000

Legal Costs                                                      1,500

Company Formation                                     600

Misc.                                                                 1000

Total buying costs                                          321,100

However, you would have bank financing of 210,000 i.e. 70% off the purchase price thus making your cash investment of 111.000.  So in essence for 333,000 investments you can buy 3 units in the project nearly the same amount you bought the one unit for cash. So let’s look at the returns over 5 years.

Value of Assets                                               1,044,000

Income over 5 years                                     246,000

Sub Total                                                          1,290,000

Then you need to subtract the financing cost and the actual Mortgage from the above. Financing costs are around 3.5% PA on an interest only basis

Total Mortgages                                             630,000

Total Financing Costs                                    110,250

Sub Total                                                          740,250

NET RETURN                                                   549,750

So based on an investment of 333,000 the ROI equates to 165% over 5 years or 13% PA.

So almost double the return of the cash investment of a similar amount and now those professional investors have different options at their disposal including selling two units and having next to no debt on the remaining unit, using the net value of the assets to finance further acquisitions or just keep the status quo.

Some important information here but very logical in that you need cost of finance to be less than the yield. In these examples we have been quite conservative as it is quite possible to get 6% net and maybe higher growth but it is always best to underestimate these calculations.

You need a growing market with good medium to long term growth prospects and that is why we picked Manchester. Most importantly you need a market where financing is available. So for example in the Philippines the property market has grown over 20% PA for the last 5 years but as a foreigner it’s almost impossible to get financing and financing costs are more than the yields. So this strategy doesn’t work in the Philippines.

Finally, as covered in my Tax Implication on UK Investment Blog the tax treatment of the investment by the Government is ultra-important.

I hope you have found this article interesting and should you need any help or advice in relation to any points raised in this article please feel free to contact one of the Gray Stuart UK team or Myself directly.