How Many Properties is Enough?

By specialist property accountant Stephen Fay ACA

In any business, it pays to think about the size of business you are trying to build. Many property investors build enormous portfolios that leave them teetering on bankruptcy, while other investors are excessively cautious and should have more faith in themselves!

You can’t Buy an Unlimited Number of Properties!

It sounds obvious – but realistically, every investor is constrained by deposit funds and mortgagability. Many investors with 50+ properties built their portfolio in the days of easy credit – times have changed, and so it is now much more difficult to create a large property portfolio.

That may be no bad thing, however. While it may be an ‘ego boost’ to have 100 properties, how many people really want the hassle and risk that go along with that? And how many have the work ethic and business skills to find, fund and manage that many properties?

For most investors, a smaller better-quality portfolio is not only achievable, but also strikes a balance between ‘risk and effort’, and ‘financial reward’. Not everyone wants to be the next Duke of Westminster!

What are You Trying to Achieve by Investing in Property?

Some investors want to replace their day-job, whereas others want a safe long-term investment. The former is more concerned with rental profits, while the latter is aiming for exposure to the property market.

To replace a day-job of £2k per month might require 10 single-let properties, or maybe 4 HMO properties. This is a simple way to work out how many properties you need. Some investors are not selective enough about their purchases, and settle for rental yields that don’t meet their criteria – the more astute will only buy property that meets their objectives. Poor yielding properties mean more are needed to generate the same income – and more property means more work for the same reward!

For those that are buying property as a pension, again it should be a simple matter of estimating the retirement income needed, and therefore the rental profits needed to that. Divide the rental profit by the rental yield to get the number of properties needed. Bear in mind that if an income is only needed in 25 years time, and you plan to repay the mortgages, perhaps only 2-3 properties may be needed.

Tax tip: Ensure the beneficial ownership structure of your property portfolio is right for your circumstances. Using a property investment company is often a good move if profits are to be re-invested & tax-efficient dividends can be paid out. However, the right set-up depends on your property profits & wider financial circumstances.

What is your Attitude to Risk?

The more properties you own, the more risk needs to be managed. A large portfolio generally means large mortgage debt – are you comfortable with that? Are your rents sufficient to pay the debt interest, as well as the letting costs? Could the portfolio stand base rates at 6% or even 8%?

The larger the portfolio, the less scope for an investor to be able to ‘swallow’ any financial hiccups from their other income. That means there is more reliance on selecting the right properties and financing using sensible gearing levels. Good financial management skills also need to be developed – no more ‘back of a fag packet’ budgeting!

Tax tip:Interest on borrowings to finance a decent working capital fund is tax deductible. Also, think about using your residence to drawdown additional equity to keep yourself in plenty of cash – the borrowings are treated as business debt, regardless of where the funds are secured.

How Much Cash Have you Got?

Let’s face it – property investing tends to be capital-intensive. Most investors have a modest income, a modest residence, and limited savings. This puts a natural cap on the number of properties that an investor can acquire. Expansion beyond this will therefore require an ability to raise finance – which means it is even more crucial to build a good portfolio, to demonstrate to outside investors that you are a ‘safe pair of hands’.

Tax tip: Forget about tax for a minute! Concentrate on building a successful and profitable business – too many investors ‘win the tax battle but lose the profit war’! Appoint a property tax adviser & get back to the business of running a profitable business!

How Much Time and Effort are you Prepared to Devote to Your Properties?

Building and running a large portfolio requires a lot of time, money and attention. Property can be addictive – are you prepared to invest your spare time on your business that might otherwise be spent with your family? Are you prepared to limit your personal spending – a smaller home, cheaper cars & holidays?

These are some of the tough decisions that need to be made if investors want to build a large portfolio in the ‘post credit crunch era’.

Tax tip: Involve your family in your tax-planning as early as possible. This can mean anything from Higher Rate taxpayers sharing property beneficial interest with Basic Rate-paying family members – to employing family members or using children as mortgage hosts to avoid Inheritance Tax. Thinking ahead can be very tax-effective.

Larger Portfolio = Larger Profits

Of course, the reason that investors try to grow their portfolio is simple – more good properties equals higher rental profits, and more total capital gain over the longer term. With a 5% net rental profit, and 3% average house price inflation, a £1m portfolio will deliver a £50k annual net profit, and grow in value by £30k per year. A similar £3m portfolio will, all things being equal, provide £150k net profit, and £90k per year capital growth.

Tax tip: Tax-planning involves making good use of the various allowable expenses and claims, arranging the ownership structure correctly, and the judicious use of companies to skim excess profits into for later withdrawal. The larger the portfolio – the more that more exotic tax-planning becomes worthwhile.

My Own Personal Strategy

My strategy is a mixture of running a large & small portfolio. I began investing in property in 1999, and have a 30 year plan. The first 10 years or so were to build up a large-ish portfolio, and then to ‘churn’ this each year, to utilise CGT allowanced and reliefs every year over a 20 year period. We will hold the portfolio for 20 years or so, and then begin selling it off as we approach retirement, using the equity released to repay other mortgages.

We sell off one property each year, that we bought 10 years earlier, and which is showing a good capital gain. We also sell off any property that hits a gross rental yield of 5% of less based on the current valuation (in other words, the rent has not kept pace with the capital value sufficiently). The equity released is used buy another bargain property, and the cash left over is used to repay mortgage debt. This enables us to benefit from a long-term exposure to the property market, to grow the capital value, while also steadily reducing mortgage debt and so increasing rental profits.

As a self-confessed petrolhead, my present to myself when we are left with 10-12 mortgage free houses will be to buy myself that Porsche 911 I have always wanted … even property investing accountants need their toys!

Summary

Investors should think about how much of their time, money and energy they want to devote to their property portfolio. Property is time and capital-intensive, so be sure that you are following your own dream, and not somebody else’s! Above all, build your portfolio on solid foundations – there is no rush, and carefully selected & financed residential property, in rental demand, and maintained & tenanted over the years is a great investment & one of the few ways that Jo Public can become wealthy in a relatively safe and predictable way.