www.webuyhousesradio.com Episode 129 Buy-To-Let Variations Increase Profits The Complete Transcript www.webuyhousesradio.com 1
Narrator: You are listening to the We Buy Houses Radio show for street smart investing tips, trends and talk with your host Rick Otton, property investor and mentor. Property investing made simple. Hi everybody and welcome, it's Rick Otton. We are on the We Buy Houses Radio podcast and of course strategies, trends about what people are doing with property. I'm actually going to be speaking with a couple of people on the phone today from the United Kingdom who have actually built their property, the buy-to-let portfolio, but they have done some interesting things to it in order to increase their cash flow over the years. Let's get straight into it, Joe and Jane, are you there? Hello, hi. Hi, we are here. How are you doing? Okay, tell you what? For the benefit of everybody listening to the podcast, whereabouts in the United Kingdom are you? We are in Somerset, that's just right down in the South West, South west corner, in Bristol. Okay. Now give us a little bit of your background. How long have you been doing property for? What was the traditional method you have been using and what have you done to modify that over the years to sort of create more cash out of it? Okay, well we started off, probably, about 12 years ago now, about 2003. We used to have a hair dressing salon which had a load of empty space upstairs all going to waste. So we what we did we started converting the 2
empty spaces into flats and letting them out. We quite liked that it was working pretty well and so we started going the way most property investors do and we bought a couple of terrace houses and we painted them ourselves. Joe put in new a kitchen and bathroom and so on and we let them out and sold them and we did traditional buy-to-let, which was fine for a couple of years, it worked really pretty well. But then after that we decided to go back to the strategy of creating flats. We bought rundown guest houses and closed down hotels, all that kind of things, big properties which we could create several flats out of and we found that was a huge way of maximizing the potential of the building. So okay, hang on, let me stop you right there. So you weren't so much buying the typical residential property and then renting it out, or not only that you weren't just getting a typical residential building or house and refurbishing it, you were going to buy different types of property which were not used for residential leasing and then you were changing those and converting those into the flats, is that correct? That's right Rick, yeah we would buy guest houses with about four or five apartments in it and then what we would do, we would title split them. What title split means, it would be under one title with each worth 200,000 as we bought it. We would split the titles which would force the value up of the property. It could be worth 350,000 after we've done it. Now, once you've done this title split, therefore people if they wanted to, if they wanted to sell those you would be 3
able to sell those individually and people would be able to get individual mortgages. Would that be correct? Yeah. We use the analogy of saying that if you could buy a big cake for say five pounds, then you could cut the cake into 8 slices and then each slice, separately sold, would sell for probably two pounds fifty each. So by selling them individually you are raising the value. So we put the whole of the property into a free-holding company and then we create leases off of that company and by creating the leases that is what you will use to raise finance for yourself to re-mortgage and that way you can get all your funds back out and hold onto to the property and let it out, or alternatively you can sell each flat separately and your buyer would then be able to get a mortgage loan too. I want to back up a little bit, because you have just covered half a dozen components and I know people are busily trying to... going to go, "I have to listen to this podcast five or six different times to get the last couple of things that you said," only because of what you do is quite creative. Let's go back to the first step. The first step is, you go and find yourself a building which doesn't necessarily have apartments in it now or it's already got apartments but they are already under one title. Okay, you don't necessarily need to find a building that have apartments in it. You could buy a three-bedroom house and you could split the downstairs into a flat and the upstairs into a flat. You would then split the title so you end up with two units instead of one unit. 4
Basically what we look for are larger properties. It can even be blocks of offices or disused shops or warehouses, anywhere basically which is a residential area where somebody would ultimately like to live. So just basically you're looking for big enough space, not boggled in criteria. Now you found a building and you go This could be a great building. What we're going to do is we are going to split these titles and do some work. How hard or how difficult is the learning because understanding when you ve got to split these titles then what has to happen is the various councils have to agree that this particular property qualifies under a whole number of regimes in order to have its own title, to learn that... This could be one of the main hurdles to get over. At the moment, in the UK, we are very fortunate in that because there is a new government directive, about a year now, we can convert empty office buildings into residential without needing planning permission. You still have to go through a sort of process, like a permit development process but it's much quicker and much easier than planning. Yes, you do have to follow guidelines about room sizes. Every council has got different criteria which you need to be aware of what the criteria is to make sure that what you propose is going to be acceptable to them. Yeah, they can be quite a hurdle to get over, it is one of the main issues to deal with, really. Now, do you therefore go to the council to get approval to what you want to do before you buy the building or do you wing it and buy the building and hope for the best? 5
What we do, we always run it past the council first just to see whether or not they foresee they are going to be any likely issues. Then wherever possible, we would use an option, we would use the utility option, subject to planning and we would try to tie this in for as long as possible. So if we could get them to agree to an option of six months or something to allow us to apply to planning, that is the number one choice. If they won't agree to that, the next thing we do is to exchange contracts, again subject to planning, so we don't have to complete if we don't get the planning. Unfortunately, some of these properties there's quite a lot of competition for and in that situation then we really do have to just get the best advice you could possibly get beforehand and just go for it and trust the planning is going to go through. We try not to do that if at all possible, as you can imagine. I totally get it, but I understand also sometimes with the market pressure you won't get what you want because someone else will come and snatch the deal and they will commit themselves to the contract, which of course in a perfect world, sellers would always like you to commit yourself to the contract. When you go to these plannings, so now we have got our planning, you come and now do the work. So now let's go to the next stage, you do the work and you have now got a number of separate titles. Now let's step through the next bit, Jane, that you are talking about that you do. Now that you have the separate titles and you have done the work, what's the next step of the process? Once you have got the planning permission, we now set about creating the individual flat and it's not like doing a 6
normal refurbishment on a house. They've got the building regulation that you need to follow. For instance, in the UK, it is quite a rigorous sound testing procedure that you have to go through. You have to separate each flat separately from the other in order that sound can't be heard and there are also quite strong insulation requirements as well and there are various tests and standard assessment procedure tests, which measure how energy efficient your properties are. You have to pass all these tests in order to get the building certificates and in order to create the individual flats. So it's during this process, while this is being done, that we leave the title splitting to the solicitors to go on and do. So when we finish doing the development, the titles are already split and we're ready to go with whatever action we can take. Okay, now that you have split all the titles and now that you have turned these things into flats, what's the next bit that you do? After we split the titles, at that point we've made the decision, depending on the local market, what should we do? Should we sell these flats or should we refinance and hold them? If the rental market is looking really strong at that time we would probably refinance each flat separately on a separate buy-to-let mortgage and then we would pull the money out, we would put it in the development finance side, and the investment that we use in order to purchase the property and some additional funds for ourselves as well. Of course it is tax free because it is a loan and then the mortgages are paid for by the tenants, much the same as we when we do the normal buy-to-let mortgage. Yeah we do that, another 7
alternative that we could do is look at tennant/buyers, that would also be a great scenario to use and they could pay a small income amount as they would in a normal tenant/buyer situation, pay over a number of years, that would also be a really good strategy to follow. Okay, so what we are doing is we then put people into those properties and then you re-mortgage to pull all your cash out and create a lot of debt against the property but enough that could be serviced by the person who is moving into the property. As you said because it's a loan, it's tax free, you are taking a loan and creating debt as against pulling cash out. You said something earlier about creating company structures and entities. Can you run us through that again? Yeah. It is not possible to actually hold a freehold and the leasehold yourself, you just can't do that. So what we do is that we put the actual property itself, the freehold into a company and the company then runs ground regs and runs a maintenance company then to control all the flats with your individual leases, because in the UK you cannot get a mortgage on a freehold flat. It has to be a leasehold flat, as the block of flats have to be managed by a management company. This is to ensure all the communal areas and the upkeep of the entire building is looked after and so it is pretty standard for any mortgage company in the UK. They would definitely want the flat to be leasehold. It's something you have to do. But of course, this also has another advantage because the freehold company has its own value because over the years it collects ground rent off of the leases and then 8
actually has a value of its own in the future. So it's another little added bonus basically. So what you do is you create your own management company? Yes, yes. So you create your own management company, you set these things up, you take the income from them, you borrow the money out and then you go on to the next one. So this is a model you have been applying now for how long? Oh, since 2003. We did not have much competition for it in those early days, there weren't many people doing it at all, but since May 2013, when it became okay to do offices to residential in the UK and to permit development, it's becoming quite a hot topic at the moment. So we're expecting a lot more competition out there these days for the good properties and the last two we bought we had to do seal bids to get, which ten years ago would not have been the case for a commercial property at all. Now when you go into this, the crew that come in and fixes and does these jobs for you, are these employees or people you contract in? We always use contractors, we do not employ any builders ourselves at all. We don't use major, major building companies, generally small building companies but we prefer them to control the plumbers and electricians and so on rather than us completely managing it and bringing in separate subcontractors because... the electrician that we brought in was to be a 9
JH or something that completely messed up plaster and the other trades and so on. So we find it better if the head of the building company controls the actual project itself. That's not to say that we're not hands on. We're around nearly every day just checking up on the project, just keeping an eye on things, just making sure everything is running on time and how we want it and to the standard we wanted it to be as well. Well, one of the issues that people run into when they do this, and we hear about it all the time in the property investment clubs or at conferences or whatever, is people look at what you do and they go, "Oh, great, I am going to go and get this refurbished and the building company in." The next minute it's got massive cost overruns, it takes a lot longer than what I thought and the profit is burnt up either in the holding costs or the overruns. How have you learned to control those things? Because let's face it, some of these jobs are getting somewhat large. How do you kind of control how these things do or do not blow out? What we do is we re fortunate because we built good relationships with our power team. They know what we expect and they know the timescale for each average flat, what we want doing with all the services and everything done. We do kind of time them on a bit more contracted work, so if they come in on time they get a bonus, if they go over time they actually kind of don't get bonus. It's actually our power team, we know them really quite well and so we're just lucky with the relationship that we have built up over a period of time. 10
We find it good to work with the same building teams because it's just a lot simpler then, particularly with things like the sound proofing. They know the exact procedure we like them to follow to ensure that the tests get passed. So what happens is, they probably use the same equipment, the same colors, the same look, the same design and they know all your bits and pieces, they sort of like take off the shelf and put it there for you. I like the idea that when you say you give them a bonus, which means they are obviously going to quote you a time frame to get the job done, and Joe you just said you give him a bonus if they come in earlier than that. Now, that bonus, is that done as a percentage or is it just something that you pull out of the air at the last minute and give them a couple of thousand pounds? Is that structured? It's a couple of thousand pounds as a bonus but not percentage. Okay, just a couple of thousand pounds you give them, okay. Now do you also use the same builders, when you go into these properties to decide which one to do and not to do? I could see that one of the issues a lot of people could have is they walk in and they will go, "Ah, heck I could convert this, but wow, I don't really know what I'm getting into. I don't really know what things are going to cost to get done." Now you would have had this when you started doing this. It would have been, "Wow, I want to do this but you just don't know what things cost to get this done." Now I am going to suggest that now Joe and Jane when you walk into a property, you probably have a fair idea what things cost to get done. Now, for someone who is listening to this podcast, what is the best 11
way to get your head around that? Because let's face it, you could walk into something and go, "Oh, this is a 5000 pound fix up." The next minute you've spent 20,000 pounds. So what can you use like a safety mechanism, if you like, so you know what you are getting into before you've gotten into it? Well certainly take a number of builders around and get some different quotes, but I think what I would do, I would look for somebody who is doing this similar kind of strategy already and maybe take them around as well. Either that or perhaps enter into like a joint venture with somebody who has done this already, so you can piggyback off of their experience or look over their shoulder and learn as they go along. Then maybe, perhaps, get their builders to have a word with the builders you want to use as well, to make sure that they are all working to the same standards. We've come across lots of different methods of working, particularly with sound proofing, and some of them we found really expensive and not terribly effective. So if anybody was asking our advice, we would steer them away from doing that kind of thing. I would say piggyback off somebody else's experience, try and link up with somebody who knows what they're doing and get them to come around with a couple of builders and get some different quotes I think. Have you had any experience of working with builders, over the years, where you've suggested to a builder that maybe you do something together as a joint venture? So the builder comes to the party, you come to the party with the property, the builder comes with the skill set, you fix it, 12
you get out of it and you split the profit in some way with the builder. Have you done anything like that before? No, we haven't Rick but it's something that we're talking to our builder about at the moment and it was only mentioned to him last week, when we said, "Well look, if you did a self-fund, what type of factor would you be looking for? Right. And he said, "Maybe about a 10% uplift." Which I thought was very, very good. A bargain. So whether or not he thought that through properly, I do not know, but this particular builder we use was actually quite open to it. I am doing one at the moment where I was at the coffee shop, meeting with a builder the other day and the biggest problem he had, he was probably a small team builder more like a sophisticated renovator, and his problem is getting the finance to his next project all the time, which is one of the issues that holds that industry back and I said, "I tell you what, why don't we do this, I will fund the projects, you come in and do all the work get us in and get us out of it very, very fast and what we will do is take out all the costs and split the profits." Now, what's tempting for me to do that is if I've got a builder who will get paid based on his performance of getting in, getting out, and getting it done efficiently and splitting profits with me, I probably don't have to supervise his as much as a guy that is on a contract but it's my $0.10 that 13
runs over board, he's all over that, loves the idea of it and I'm just going to do the mathematics that makes simple sense for me to get it in and get out. I want to be able to do two or three at the same time, knowing that my builder is in there on a percentage of profit basis. And I have always found actually that if I ever had builders in there on a percentage profit, it is always surprising how they get the cost of materials for a much cheaper price when it's going to affect their percentage profits. So I say, "Look, I tell you what I'll write all the mortgages, I will pay the holding cost, I'll pay material costs and whatever is left we split." And I just find magically, they've called in all these favors and all these material costs get a lot less and they seem to get out of the property fixed and done a lot quicker than the other way. Are you working on a project at the moment? Yes, we've got about three projects on at the moment. They are all at various stages of planning. One is going to be a four-flat development with a VTEL underneath, one is seven flat development with a sandwich bar or coffee shop underneath and another one, we've actually got quite a long delay completion on it, because at the moment it is a listed building, which in the UK if it is a listed building is of stark importance, then unfortunately it has to go for full planning permission and we have got a council official who wants the property to be marketed for a little bit longer to test whether there is any need for an office in the area. So that one we've got on a delayed completion in order to ride out this extra period of marketing. 14
Okay, well how do you work out, when you do all their mathematics, to get in and out of a project, do you have a formula that says x percentage goes towards acquiring the property, x percentage goes towards the fix up and x percentage profit. When you decide to get into or out of a project, how do you decide what profit margin it has to make for it to be a good call or a bad call? Well, out of the two of us Rick, Jane is the brain in the outfit, so what I will do is let Jane let you know how we do it, we put the n value forward. We always start with the end product to site, so the first thing we do is we assess what the likely value is of all the completed units. So if it is a commercial units we look at the yearly rent and then multiply that by a certain number depending on how good or weak the area it is, and the individual value of each separate flat. Then we add them together, then out of that I would take 75% and that 75% figure then I know I would to be able to re-finance at or about the amount. So even if we were planning on selling the units, I would still look at 75% as an absolute minimum. Then off of that figure we then take off all the costs, all the holding costs, the building costs, planning, legal, dressing, the property sales afterwards, agent cost, the whole myriad of costs. Then I would also take off what fee did we want for actually doing the work ourselves, what wage did we want out of that. Then the figure that we would be left with after all that would be the absolute maximum that we would offer on that property regardless of what it was marketed for but that's what we would base our offer on as a maximum. 15
Ricky: Okay, so if you look at Joe and Jane, just for the benefit of people, Joe what do you do? Jane what do you do? I am sure you both do different components. So who does what bit? Well, Jane is the brains, Jane works out all the figures, what we can afford, what we can't afford, how we can do it. What I do I negotiate. So I love to negotiate the vendors and with the agents. I must say Rick, being on your course, when we were on your course last year we learnt so much from you. It was amazing. And I just love to negotiate and that is what I love to do and that's what I do. Jane doesn't like to negotiate, Jane send me in, so I've got to break the ice, so I 've got to meet the vendor or the agent. Once the ice is broken then Jane will come in and then starts kind of working figures out. Okay, so Jane is the analytical and Joe, you are the big picture guy, you bring the deal to the table and then Jane comes and then cleans up your mess. Exactly, exactly, yeah, that's exactly... Joe comes up with all the ideas and then I take the ideas and see whether they are going to work or not and if they are, if I feel it is a good project, then I'll take it on from then and maximize it, yeah basically. In other words Joe comes up with the idea and then Jane, you turn around and say how is that ever going to make us some money Joe? Then Joe has to sell the idea to Jane. Yeah I get it, I understand. There would be nothing worse if you were both analytical and nothing worse if you were both big ideas people. Image two big ideas people, 16
you would never get anything done but you talk about some great ideas. Joe would want to do every project out there if it wasn't for me saying, "Hang on a minute, let's make sure that will really work, because then you need somebody to keep your feet on the ground, don't you? I totally, totally get that 100%. Hey guys, if you listen to the podcast and you're in Australia and you want a free copy of the brand new property investors tool kit, subscribe to webuyhousesradio.com and we will ship it to you free. For everybody here in the UK, like Joe and Jane, you want to download the property investors tool kit, go to www.rickotton.co.uk that's www.rickotton.co.uk/toolkit. Joe and Jane, it's really interesting, we've been chatting for just about 30 minutes about how you're putting these transactions together. So guys, I know we have come to the end of our podcast for another week. So I want to thank you Joe and Jane for coming in guys and sharing your time because I know what you're doing with the property and I think what's great about it is there are a lot of people listening to this podcast and going, "Now, there is something that I've never thought about before." So I think that's really fantastic. So guys, thank you very much for coming on the podcast with us today. Thanks Rick. It has been my pleasure, I thoroughly enjoyed it. Thank you very much for asking us, I totally find it interesting. 17
Narrator: No worries, guys, everybody listening we have come to the end of the podcast. Listen, to subscribe to our podcast and to get the free transcripts, a lady said to me the other day, she said, "I love your podcast because you actually have the transcripts," at webuyhousesradio.com and send questions to us at support@webuyhouses.com.au and ask any questions about could you interview somebody who does this or does that or how do you put a different type of strategy around bearing in mind that the audience is somewhat worldwide these days. Okay everybody, looking forward to catching you on the We Buy Houses podcast next week. Good bye. If you would like to download the audio or transcript for this episode, go to www.webuyhouses radio.com. And if you have any questions please email support@webuy houses.com.au. Thank you for tuning in, you are on the right path to real estate success. This show does not provide legal, financial, accounting, investment or any other professional advice. Any information shared on this podcast is that of the hosts. Nevertheless, Rick and his students are abundantly successful and would not transact real estate in any other way. 18