Sarah has posted an end of year update on her blog.
I am not sure I agree with her that house price falls are largely down to money supply – I am sure greed was a significant factor in sellers expectations of what their properties were worth as well.
I remain convinced that there is money to be made out of property development provided you can buy cheap enough in the first place. Let's face it, if you could buy a three bed house for a £1.00 and you would make money provided all the other houses in the road were valued at £5.00!
Is Sarah right to wait with her property rented out until there is a recovery? Perhaps, but don't forget that it always takes longer for a price to recover than it takes to fall. £100.00 to £80 is a 20% decrease but £80.00 to £100.00 is 25% increase!
Personally I will sell out if I can make a reasonable profit and then look to do another one straight away. Whilst I won't view a profitable rent as a failure, it isn't what I set out to do so is very much the second best option. There is a limit to the amount of debt I feel comfortable with (always assuming you can raise the money of course).
8 comments:
I thought her comments about the reasons for house price volatility were spot on - and certainly in line with the Barker Reviews of house prices and land uses. The reason Mars Bars don't fall (much) in price in recessions is that the Mars Corp produce less of them in a recession. But since (almost all) houses available in 2009 are already produced, prices are volatile in both directions. For that reason house prices can sink well below equilibrium levels, and the buy-hold-and-rent option is very risky if for any reason you need to sell in the next 5 years. Remember too that rents may fall. So yes, if you can sell at a profit do.
I definately think a profitable rent is preferable to a loss - which is what I stand to make if I tried to sell the completed property at the moment. My first property was a fairly low key affair which was never going to set the world of property developement on fire. I bought it for £102,000 with a renovation budget of £10K and a resale value of £129,000. Currently similar properties are not selling at £89000. My market was the first time buyer market and they are the ones really struggling to get finance at the moment.
As the debt incurred is managable at the moment, I have decided that the best route for me is to wait and see and take advantage of the rental income. It was not what I planned, but my intention was not to make a huge fortune on this property, but to gain experience (and additional revenue over a number of builds) which I could take forward on to my eventual self build plans.
Sarah,
Clearly you don't have to reply, but I wonder how you define profit here? There are in essence two options: accounting profit and economic profit. Accounting profit would ask whether the rent, after expenses, covers the interest on the debts that you incurred. I assume that this is what you mean by profitable rent. But to an economist you should also include the interest forgone on the deposit, plus the value of your time, plus a risk premium for the fact that you can't take your money out tomorrow if you get run over by a bus and need 24 hour intensive physio, and a risk premium for the fact that you may never get it all back. Making an economic profit is rather harder!
Assuming that your property would sell for £82k, then you need a more than 35% rise in the market. I think that might be a little way off, so renting looks like the sensible way forward, given where you are.
Best wishes
Tim (housing and land use economist, among other things)
It is but a tiny nuance but I think your statement, “if you could buy a three bed house for a £1.00 and you would make money provided all the other houses in the road were valued at £5.00!” should more correctly end with “..........all the other houses were worth £5” or better still, “..... other houses in the road were selling at £5”.
If I detect it correctly, you are suggesting that Sarah should not wait for a recovery. Is this not slightly diluted by your qualification, “if I can make a reasonable profit” that follows your assertion that you will sell? Possibly leaving taxation issues aside, if it’s right to sell, it’s right to sell regardless of whether a loss has been made. I would maintain that the profit or loss that you will have made prior to the day when you make the decision is academic. It’s the value of the house on the day that is important (not what you paid for it) and the decision should be the same whether you paid £10k or £200k.
You are quite right. I did think about my use of the word “valued” when I used it and wondered if someone might pick me up on it. I should have used “realistic value” or “achievable value” or something similar. Even “could be sold for” would have been better.
Your second point is interesting. You only make a profit or a loss on disposal of an asset so presumably it is reasonable to value the asset at the acquisition cost rather than the disposal cost for the purposes of renting as you are generating an income from your asset less the cost of owning the asset (interest on debt, management fees etc). Your decision on whether to dispose of your asset would largely depend on what you considered its future or current value and the cost of owning the asset. It would also depend on what other plans you might have for the money tied up in the asset. I am not sure I am particularly recommending any course of action to Sarah but it may have seemed that way.
What is fascinating in all of this is the discussions on values of asset and property prices. Conversation people should have been having over the last few years instead of just blindly believing that property prices would go up forever.
Ah, I’d maintain that profit or loss is a continuous fluid thing and that you are referring to the crystallisation of profit when you say that it can only happen on disposal. The reason for my focusing on this distinction is that to my mind it’s pivotal to inform business decision-making. Someone who bought a house for £25k in the distant past which was now worth £500k shouldn’t consider that, if they obtain £25k a year rent, they are getting 100% rental return. They’re not, they’ve made £475k profit (assuming fthsoa that the £25k includes notional/actual interest and all other costs) and are now getting a 5% return. A house carelessly burnt to the ground must surely indicate a loss to the owner (insurance excepted) even if the resulting plot is worth more than was paid 10 years ago for the house.
I expect you can see how this works in decision-making terms.
Looking at your example above:
“Your decision on whether to dispose of your asset would largely depend on what you considered its future or current value and the cost of owning the asset.”
is absolutely correct: it is the comparison between forecasted value and the asset’s current value, how much was paid has no relevance to that decision making process.
In Sarah’s case (I hope that she does not mind me using her figures), she has an asset worth £90k for which she has paid £110k. If she has no holding costs and thinks that it will be worth £100k in 1 year’s time then to my mind she has already lost £20k and will make a profit of £10k over the next year. If she works on the £110k paid, then with the same assumptions, she’ll be keeping the house for a year in order to sell at a loss of £10k.
Of course the figures above end up in the same £10k loss over the year either way but it must surely help to focus the mind to be working with values not cost.
Tim - "There are in essence two options: accounting profit and economic profit."
This is an interesting question; I am an economist by education but an accounts trainer by profession. The measure that I have chosen here is the accounting measure - basically because it is easier to calculate!
Sarah & Nuanced Observer: It is rare to have a blog discussion in which all of the participants understand economics! A pleasure. Like NO I think that decisions should be based on the expectation of profit from here, except that (a) crystalising a loss is difficult when negative equity is involved, (b) taxation can cloud the picture and (c) transaction costs mean that buying and selling too frequently is expensive.
Assuming that Sarah's rent exactly covers all mgt fees (or the value of her time), plus the interest on any debts, plus the interest she would have received on the deposit and improvement costs, then she still needs a c. 35% rise in house prices to break even, and that is without any return to compensate for the loss of liquidity, or the risk. That is a pretty challenging target. Given that property prices usually lag the economic cycle (the London low point in 1996 was years after the end of the early 1990s recession, for example) I cannot see her making money in the true sense of the word any time soon, and there may come a point at which it is better to quit rather than hang on. It is, for example, better to take a loss now, if the amount you do realise is sufficient to buy a better investment.
Decorum is more likely to make money because he bought at a lower point, and therefore his necessary price to sell and make a profit is lower. We shall see.
Post a Comment