It’s the most wonderful time of the year – the time for reviewing your goals and planning what you want to achieve in the year ahead. (Call me boring, but I’ll take a good sit-down with a spreadsheet over a Morecambe & Wise re-run any day.)
The goals you set need to be SMART (that’s Specific, Measurable, Achievable, Relevant and Time-bound), and in this post I’d like to focus on “Achievable”- which I think are the hardest to pin down.
How do you know if you’re setting an ambitious goal that will push you to do your best, or just indulging in a pipe dream that’s guaranteed to end in disappointment?
Earlier in the year I wrote about different targets that people set in property – including wanting a certain number of properties, or a certain total portfolio value. Of all the targets that I see being set, the most common is probably the monthly income target, where someone aims to make a specific amount of rental income from their property portfolio each month.
It’s obvious why this is a motivational goal for a lot of people: you (should) know what your monthly expenses are now, so once you’re making at least that much from your property portfolio…you’re free! (Apart from having to manage a property portfolio.)
In many ways it’s a good goal to have because “£5,000 per month in rental profit” clearly means something very specific, whereas “100 properties” could mean anything: how much equity is in those 100 properties, and are they actually making any money?
But a mistake I’ve seen several times recently is people setting an ambitious monthly income goal then patting themselves on the back for thinking big…without going on to form a detailed plan of exactly how they’re going to achieve it.
Let’s say someone wants to be making “£10,000 per month from property in 10 years”. Is that achievable? Well, yes – most things are – but it’s not going to happen by just buying the odd property whenever you have money to spare and hoping for the best. It’s an ambitious goal, and one that needs a detailed plan for achieving it – a lack of such a plan is a recipe for feeling disappointed in a couple of years’ time when you realise you haven’t actually made any serious steps closer to it.
In the course of forming this implementation plan and seeing what’s really involved, you can decide whether the goal still seems achievable – and adjust it if it doesn’t.
So, in this post I’m going to break down what it really takes to achieve that ambitious goal: £10,000 in rental profit (before tax) within 10 years.
For the purposes of this example I’m going to assume that every property bought has a gross yield of 9% (good, but by no means unachievable) which results in a net yield of 3.5% by the time you’ve paid a management fee of 10%, allowed 10% for maintenance and voids, and paid the interest on a 75% loan to value mortgage at a 5% interest rate.
Here’s a sample set of numbers:
Purchase price: £125,000
(75% loan: £93,750)
25% deposit: £31,250
Purchase costs: £5,000
Total cash invested: £36,250
Monthly rental income: £950
Gross yield: 9.1%
Interest payments @ 5% of £93,750 borrowed: £390
Management fee @ 10% of rent: £95
Insurance, maintenance and voids allowance @ 10% of rent: £95
Monthly cashflow: £370
Net yield: 3.5%
You might disagree with my allowances for expenses, which will depend on the area, the nature of the property and the type of tenants. That’s fine – you can adjust them accordingly – but the point is that this is a very standard purchase which someone with no special strategy or experience could conceivably make.
Remember that this investor has a target of making £10,000 of profit (pre-tax) on their rental income. Let’s assume that they can find as many deals with exactly these numbers as they want. So the question becomes: how much cash will they need to invest for deposits and purchase costs to achieve their target number?
£120,000 (annual income) / 0.12 (ROI) = £1,000,000 investment needed
So before time’s up and the goal needs to be achieved, the investor needs to put in £1,000,000 in deposits and purchase costs to buy the 27 properties that they would need to have their desired monthly profit.
If a million is looking like a lot of cash to drum up, all is not lost – because rental income is only part of the equation, and you would hope to experience growth in the capital value of the properties too.
If we assume annual house price growth of 5% per year, by Year 7 the first property will have gone up in price from £125,000 to £175,000. This will allow it to be remortgaged at this higher value to release all of the initial cash input to invest somewhere else…
…Although the higher mortgage payments will dent the monthly income from the property, which was the goal in the first place.
So this £10,000 month goal is looking achievable if you’re likely to have £1 million to invest in the project.
But what if you have less – maybe less than 1/10 of that. Is the goal still achievable?
Yes, absolutely – but clearly it’s going to take a different plan, because you can’t afford to be socking that much money into each property.
So instead, you need to incorporate one or more of these into the plan:
All of these (with the exception of HMOs, which could double your ROI but will still see you running out of money eventually) are ways by which the goal could become achievable, but all have different challenges attached to them. The next step then is to look into all of these strategies and see which are achievable for you, then incorporate those into your plan.
The exercise of drilling down deeper into a goal to test whether it’s “achievable” accomplishes three things.
Firstly, it really highlights the importance of having a carefully considered goal from the start that allows you to take the right first steps. For example, if you only have £40,000 to invest (with no prospect to easily save more) and you sink it all into a property that gives you a 12% return on investment, by most people’s standards you would have done well.
But will that acquisition help you to achieve a goal of £10,000 per month? No – not unless you’re using one of the angles from my list above. And that’s the second point: digging in helps you to identify where your plan of action is lacking, and identify what strategies you need to employ to get over your barriers (in this case, your lack of cash).
And finally, the exercise might make you question whether the goal you set was the right one in the first place. In the process of getting into this example, we assumed that property prices would rise by 5% per year – which would lead to the price of the first property doubling after 15 years.
If you think that’s realistic (and the historical average for the UK is actually doubling every 9 years), that makes the odd couple of hundred quid in rental income per month look pretty insignificant . Maybe, if this motivates you, you should buy with the aim of benefiting the most from the 18 Year Property Cycle rather than maximising your yield – because this growth doesn’t affect every area and property equally, and doesn’t happen uniformly year after year.
Firstly, if you don’t have firm goals in mind already, go set some – and don’t just blindly hope that you’ll achieve them just by working hard or getting lucky. Dig deep into what needs to be done, and work out exactly how you can make your goal achievable.