Wednesday 10 February 2021
We have been running a free webinar on Property Due Diligence and giving helpful insights – in case you missed it, or want an overview of the content, we have summarised the webinar for you here.
Thank you to everyone who attended the free Property Due Diligence webinar over the past week. We really hope that you learnt something you didn’t already know and enjoyed it overall.
We’re sure that you probably took some notes, but because this is such an important topic that should be available to be reviewed whenever we have decided to give the information a permanent home on our blog here.
What Is Property Due Diligence?
Property due diligence is the process of properly evaluating an investment property before you buy. Investing in property is a big investment, and you want to properly understand the risks involved as well as the rewards. Thorough property due diligence will do this for you and ultimately inform you if you should go ahead with the investment.
Why Is Property Due Diligence Important?
Although there are different property strategies – holding property short-term or long-term, buying property off-plan or already built, buying for cash flow or capital growth – property investors generally all have the same one thing in common – they are investing to create a return on their money. Due diligence is important to make sure the money you’re investing is invested wisely and as safely as possible also.
During the webinar our host, Sophie Lane – Acquisitions & Communications Executive at ERE Property, covered 4 main topics; location, the numbers, the developer and deposit protection.
Sophie covered these in the order suggested to carry out your due diligence. Although these topics do not cover all the due diligence needed, at least knowing what to look out for here will certainly give you a better-informed decision on whether to put that reservation fee down.
When looking at the location of a property investment, you want to be aware of three main things:
Number 1: What does the tenant look like who would be renting your property?
To understand your tenant demographic you should be finding out within that area
- Who are the major employers in the area?
- Are there many job opportunities in the area?
- Or is it a commuter town to a large city?
- Any universities in close proximity?
Number 2: What’s the likeliness for good capital growth?
This will be determined by regeneration plans – such as improved transport links, new employers coming to the area, new shopping or entertainment centres.
Any new developments or big news for the area that is going to be improving and making it a more desirable place to live, is likely to see property prices increase.
At ERE Property, although we do have a lot of opportunities within city centres, we also look for opportunities in commuter areas with exciting regeneration plans in the pipeline. For example, we’ve recently launched a development in West Bromwich, only 14 minutes to Birmingham City but properties half the price. The demographic we are targeting here are young professionals in a junior role at one of the large employers within Birmingham such as HSBC, BT or HMRC moving to the city this year, as the rental prices are a more favorable price-point for the area. But as an investor you still get good returns as the purchase price is low.
Number 3: What’s the competition in the area?
Is the area undersupplied or oversupplied with property similar to yours? An area that’s undersupplied could bring a disadvantage or advantage. An advantage because with limited competition your property is likely to be 100% occupied, or disadvantage because it could be that there’s no demand in the area. By looking at the two points above you can determine how successful your investment will be.
Oversupplied can be disadvantage because it may drive rental prices down, but if the property you’re looking at has more desirable facilities it shouldn’t affect you negatively.
Once you’ve established the area is a good area to invest, you need to look at the numbers. There are four main areas to look to analyze a deal; Property purchase price, rent that can be achieved, associated costs and yields.
Number 1: Property purchase price
You need to be looking at sales comparables in the area, 1-mile radius is a good indication usually and sometimes in cities half-a-mile even. These must be like-for-like comparables in terms of specification, facilities, number of rooms and sqft.
To find comparables you can simply go onto Rightmove and input the postcode of the property you’re looking at, set your radius and search. If you are working with a property investment company like ERE Property we can send these over to you showing properties both on the market and already sold.
Number 2: How much rent can your property achieve?
Similar to above, take a look at like-for-like comparables in the area of the property and figure out how much rent you can charge in your property. This will help you to work out what your yields are.
Number 3: Additional costs
Additional costs with a typical apartment includes service charge to maintain the building, ground rent to pay the freeholders and any management fees if you are a hands-off investor.
Service charge is charged usually depending on how many sqft your apartment is. The amount charged all depends on the area your property is located and the facilities it has to up-keep. The more facilities, generally the more expensive the service charge as someone has to be maintaining these and being paid for it too! Similarly, the bigger and more desirable the city to live in usually the more expensive the service charge. However, to give you an idea of price at ERE Property our developments service charge ranges from £1.50 – £2.60 per sqft. We did have a development we analyzed the other day and their service charge was £3.60 but we declined this as it was just too high for the area and facilities.
You should be able to request a breakdown of where these costs are being spent before you purchase a property, or at least the developer will have a draft copy.
Ground rent has been in the news recently, with the government leaseholder reform committing to abolishing ground rent to £0 and offering leases of 990 years when extending a lease. The main reason for this is that some developers were exploiting leaseholders/apartment owners and increasing the fee every year, some even doubling every year.
However, for a while now mortgage companies will not offer lending on a leasehold property if it is any higher than 0.1% of the purchase price, reviewed on Retail Price Index every 10 years, so only ever increasing in-line with inflation. This mitigates the risk of the developer hiking up the charges to unreasonable amounts. So, ground rent conditions is something you need to be asking when purchasing your apartment.
Management fees at ERE property are 10% of the rent every month but some companies can charge higher. Of course, you can self-manage if you want to be a more hands-on investor, but just be aware that managing a property can take a lot of work, quickly becoming another full-time job. Additionally, with laws changing regularly you will need to also be staying up-to-date with all new legislation.
Number 4: The yields
There are two types of yield – gross yield and net yield. Gross yield is the % return on your money before any costs have been taken out such as the above associated costs. The net yield is the % return on your money once all costs have been subtracted – the money that’s yours to keep in your back pocket! Net yield is really the most important figure to be looking at, because it’s all ok having a high gross yield but if the costs associated are so high it completely erodes your profit, then you won’t be making much money.
Net yield is worked out by dividing the net annual rental income by the property purchase price. Therefore, generally speaking the lower the price of a property the higher the yield.
Again, dependent on the city or town your property is located will determine the average yields that can be achieved.
The next section of information is specific to off-plan apartments. Do you know who the developer is who is building your off-plan apartments?
The questions to ask are:
- Has the developer got any previous developments completed that you can have a look at?
- How long have they been developing for, what’s their experience and track record?
- Do they have a schedule of works for the development you’re purchasing in so you can be aware of the development progression and expected completion?
- Can you see the planning permission and land ownership? The planning should be approved and the developer should own the land, before putting any money towards an investment.
- Is the development fully funded or partly funded?
A lot of developments have forward funding from banks and some developers put all of their own money in. Other developments are only partly funded and do rely on some property sales to activate funding by the bank later down the line. This is more risky and ERE Property always ensure we are 100% clear with the developer and the ERE investor on how the development is funded.
Credit checks –
- What is their rating?
- When was the company formed?
- Who are the directors?
- What are their past or current companies?
- Checking for any CCJ’s (county court judgements)
At ERE Property we also do the same for the construction company as to ensure they are creditable, reliable and to ensure the likeliness of major delays are small.
Most developments will have a non-refundable reservation fee to secure the property, and at this point you should have already done your due diligence on all of the points above before putting this down.
Next comes the deposit or otherwise known as the exchange amount. Some deposits can be as low as 5-10% or as much as 30% and some even higher. Building warranties in place will ensure that 10% of your deposit is protected under the warranty, so check that the development does have one in place.
The remainder of the deposit, if higher than 10%, can be kept in many different forms – in an escrow account with solicitors where the money cannot be drawn down upon for the build or in an escrow account that can be drawn down after a certain milestone is hit.
All developers have a slightly different method however, some hold deposits as a stakeholder which means if the development ever didn’t get built, you will own part of the land. Of course, we would never put forward a development to investors if we were unsure that the developer would build it, and this comes down to knowing the developer and their track record.
There are more in-depth detailed questions to be asked that may be more complicated and should be thoroughly investigated by your solicitor – it is their job to look at the legalities and go through everything with a fine tooth comb.
So that’s a snapshot of the four major things to look out for when analyzing a property deal. Use this how you wish, but always remember to do your own property due diligence.