How to become a property developer

Buy-to-let vs buy-to-sell

A key decision you’ll need to make is whether you want to operate on a buy-to-let or buy-to-sell business model.

Buy-to-let

With buy-to-let, you’ll purchase a property in order to rent it out, using the rental payments to pay off the mortgage on that property – and provide a bit of extra profit, too.

While this may sound attractive, and given the fact that the rapid rise in UK house prices has created a huge market for attractive rental properties in towns and cities, you will ultimately be responsible for the maintenance of the property – including arranging for repairs, ensuring that things like the smoke detector and boiler are regularly inspected, and potentially even finding tenants and checking their references and credit scores. A letting agency will take care of much of this work for you, but obviously will charge for these services, cutting into your profit.

Buy-to-let is a great way to provide a long-term income stream, but it’s not an easy way to make a quick buck – you’ll need to be dedicated, and always recognise that the needs of your tenants are paramount (they are providing your income after all). You may also need to plan for void periods, as it’s likely the flat will sometimes sit empty while you’re in the process of finding a new tenant.

Buy-to-sell

With buy-to-sell (also known as property flipping), you’ll buy a property, hold it for a short time, and then sell it on again. For this strategy to be successful, you’ll generally need to buy a property that needs work, whether that’s upgrading the interior or converting the attic into an extra bedroom. You then make the necessary renovations and sell for a profit, making sure to factor in the costs of the work. The more work required, the larger the risk, and the bigger the potential profit – but it’s a good idea to start off with somewhere small to get your head around the process.

Staying on top of costs during renovation/construction is crucial, so make sure you set out a detailed plan before you start, and include some leeway (at least 10%). A project coming in under budget is almost unheard of – the majority cost more than initially expected.

Your contacts will be vital, so make sure you have a “black book” of builders, plasterers, architects, and electricians that you can trust to do a good job. Alternatively, you can try to do some jobs yourself to keep costs down. The upside of this model is that if you do sell at a profit, you’ll get a lump sum that you can then use on your next project, making this a much quicker way to build a property portfolio.

It’s also important to note that you may shift from one model to another, eventually selling a property after renting it out for a few years for example, or using the profits from a buy-to-sell property to invest in a buy-to-let property.

Your approach might also change depending on the market environment, so flexibility is crucial.

Bruce Burkitt, the Managing Director of residential property investment company Property Experts, recommends planning an exit strategy. “If the primary plan is to resell the home, then budget to sell the home for 10% less than today’s market value, as it is a difficult market.

“In this way, if the prices drop, there is a buffer for the investment – but if it sells for more, then it’s a pleasant surprise. However, in the event that prices slide away and the property does not sell, investors should ensure that there is finance in place to take out a buy-to-let mortgage on the property, and that rental values will cover mortgage repayments by at least 150%.”

Whichever route you choose, doing thorough research is crucial.

Calculating ROI/Rental yield

In any business, ROI (Return on Investment) is crucial, as it’s the only way you’ll know whether a particular project has made a profit or loss. And property development is no different – you’ll need to make sure you get your maths right, and know exactly what needs to be considered in terms of costs.

Buy-to-sell ROI

On paper at least, working out a buy-to-sell ROI is simple. It’s your sale price minus (purchase price plus costs).

Depending on your financing, the purchase price may be more complex than it sounds, as you should only use the money that you’ve actually put up – which, in most cases, will be the deposit on the loan or buy-to-sell mortgage (a conventional mortgage is unlikely to be suitable for a buy-to-sell property). Of course, you will also need to pay back the loan amount when you sell, so include this in your calculations, and make sure that the property will increase in value enough to leave you a decent profit after you’ve repaid your loan or mortgage.

The really tricky bit is working out your costs. The bulk of this total will be the money you spend on renovating or refurbishing the property, but you also need to consider the costs of arranging finance, any loan/mortgage repayments, survey fees, solicitor fees, estate agent fees, and smaller costs like insurance, utility bills, and council tax.

You’ll also need to consider the tax implications.

Buy-to-let ROI (Rental yield)

While buy-to-let ROI is not fundamentally different from buy-to-sell ROI, it is a little more complex, as you’ll need to work out your rental yield (the annual return on your rental property). In its basic form, this is relatively simple:

Total annual rent divided by purchase price

Let’s start with the easy bit. To work out your annual rent, multiply your monthly rent by 12.

So, let’s say you rent out your property for £1,250 a month – the annual rent would be £1,250 multiplied by 12, which equals £15,000

You then divide this by the amount you bought the property for – let’s say £400,000 in this hypothetical example.

£15,000 divided by £400,000 equals 0.0375

To convert this to a percentage, multiply it by 100.

0.0375 multiplied by 100 equals 3.75

So in this example, your basic rental yield is 3.75%.

Unfortunately, things are a bit more complicated in the real world, as you’ll need to consider buying costs (i.e. agent fees, survey costs, and other expenses), plus the costs of both arranging and paying for a buy-to-let mortgage or other similar financing.

The basic formula is as follows:

First, add together your deposit and buying costs, as you’ll need that combined figure for the next bit.

Now, use this calculation:

(Annual mortgage cost minus annual rent) divided by (deposit plus buying costs)

To properly explain this, let’s return to our hypothetical example.

If we use the same example as before, the purchase price was £400,000. A buy-to-let mortgage is commonly offered on the basis of a 25% deposit, so your deposit would be 25% of £400,000. The easiest way to work this out is to multiply £400,000 by 0.25.

£400,000 multiplied by 0.25 equals £100,000

So, your deposit would be £100,000.

Buying costs vary, but for a £400,000 property, around £3,000 is reasonable.

So, the total of your deposit and buying costs is £100,000 plus £3,000, which is £103,000.

Now, we need to work out the cost of the mortgage. Buy-to-let mortgages are most commonly offered on an interest-only basis, where you only pay the interest on the amount loaned rather than paying back the amount loaned itself.

If the interest was 5%, then the total cost of the mortgage would be 5% of the loan amount. Remember you put up 25% as a deposit, so the loan amount would be £300,000 (75% of £400,000).

You now need to work out 5% of £400,000. The easiest way to do this is to multiply £400,000 by 0.05.

£400,000 multiplied by 0.05 equals £20,000

To work out the annual cost of your mortgage, you’ll need to divide this amount by the number of years your mortgage covers. We’ll say 2 years in this example, so the annual cost would be £20,000 divided by 2, which is £10,000.

You now have all the elements for a good idea of your annual return – in other words, the profitability of the project.

Again, this is the formula:

(Annual mortgage cost minus annual rent) divided by (deposit plus buying costs)

In our example, the annual mortgage cost is £10,000

The annual rent is £15,000 (£1,250 multiplied by 12)

The difference between these is £5,000 (£15,000 minus £10,000)

The deposit + buying costs total is £103,000

So, finally, divide £5,000 by £103,000

This equals 0.0485

Multiply this by 100 for the percentage, and you get 4.85%…

…which we’ll round up to 4.9%.

While this might seem a reasonable annual return, you also need to consider tax, maintenance costs, letting agent fees, and other expenses, all of which will eat into your profit.

The calculation above also assumes that the property will be rented for all 12 months every year, but in reality, you’ll also need to budget for void periods when it’s empty and no money is coming in.

If you’re going to make the economics of buy-to-let work, it’s absolutely crucial to work out what you need to charge in rent, and what you can afford to pay for a property.

Renovating for sale or rent

Speed is also of the essence when renovating – the quicker you can fix up a property, the quicker you can get it back on the market and making money. However, don’t be hasty and don’t cut corners – potential buyers or renters will be put off by rough edges or a poor-quality finish. When doing up a property, always bear in mind the following points:

Consider your ideal buyer or renter

If there’s a golden rule of property development, it’s this – it’s not about you. Every decision you make should be based on ending up with a property that’s going to appeal to as many people as possible.

As veteran property investor and chair of Women in Property Mandy St John Davey notes, “Do not be tempted to over personalise an investment property, and make sure to keep your business head firmly screwed on.” Be particularly careful about using too much colour – one person’s bright and bold is another person’s garish, and while magnolia walls may be dull, they make rooms feel bigger and present a blank canvas that can be customised by whoever buys or rents your property.

It’s equally important not to blow the budget on fixtures and fittings, especially if you’re investing in a mid-priced area. Always bear your target audience in mind, and think about what they would expect. Student renters may not need, appreciate, or want to pay for a swanky bathroom suite, while young professionals may be willing to pay a premium for a stylish and elegant property. Area will always be a huge influence on price though, so check property sites to see what’s selling, and to learn more about what sort of interior is found in higher priced properties.

Stay on schedule

When renovating a property, your key skill will be project management, ensuring that you know when and how each element of the renovation is being tackled, and how much it will cost.

To ensure you can keep track of every little detail and won’t incur the added expense of having to change things during the renovation, Progressive Property co-founder Mark Homer recommends producing a detailed specification sheet that sets out what needs to be changed in each room, what needs to be replaced, what needs to be inspected/tested, and what should be left alone entirely.

You can also take advantage of some of the great project management tools listed below, which make it easy to get an overview of the project, make notes, update progress, and issue instructions on the go.

The bare necessities

Even if you’re not renting to Baloo the Bear, there are still some things that everybody will expect from a rented or purchased home, and will cause plenty of worries and strife if you don’t get them right. These include:

• The boiler

Until it goes wrong, you won’t appreciate quite how much your boiler does for you. It heats the home, provides hot water for your morning shower, and even pulls its weight in the kitchen too (just try washing up without hot water).

They come in all shapes and sizes, but make sure you do your research carefully – not all boilers are suitable for all properties. The right choice for yours will depend on where it will be stored, the requirements/size of the property, and the existing pipework. Make sure you consider all relevant factors when choosing a boiler for your renovation project.

• Home security

No matter who buys or rents your property, feeling safe in their own home is likely to rank pretty high on their list of priorities, so make sure this is a key area of emphasis.

This is even more important for a buy-to-let property, as it’s the landlord’s legal responsibility to make sure any rental property meets basic security needs, including doors and windows that can be closed properly and locked. Any money you invest in home security will also reduce your insurance premiums, and while there’s no legal requirement for landlords to have insurance in place, your buy-to-let mortgage provider may require you to take out a policy.

For higher-price properties, your home security needs are likely to go way beyond lockable doors and windows. An intruder alarm should be a must, and you may also want to consider a guard response system and CCTV.

If you’re confused by the latter, then help is at hand – simply click here to start comparing the best CCTV systems and find the right one for you.

• The kitchen

Exactly how much money you spend on the kitchen will depend on your target market, but it’s a key part of most homes, and a space that needs to be carefully planned. The minimum requirement is a clean space that functions effectively, so think about how the room is likely to be used, practical requirements like storage, and making sure the sink and any appliances are easily accessible.

Remember: it’s a landlord’s responsibility to ensure that all electrical appliances are safe at the start of each tenancy, so make sure they are regularly inspected and upgraded when necessary.

While this may be a significant expense, it will make your property more desirable to renters, and reduce the risk of fire or other problems from outdated equipment. Legally, you must also make sure your appliances are regularly checked for gas safety by a Gas Safe registered engineer, and anyone renting out an HMO (Houses in Multiple Occupation) needs to ensure PAT (Portable Appliance Testing) checks are conducted at least once every five years.

• The garden

Outside space is a key consideration for many buyers and renters, so if you buy a property with a garden, make sure to maximise it. Again, your target market is key here: families with children are likely to want an unbroken expanse of green lawn, professional couples will want something easy to maintain, while students probably just want a nice place to have a drink in the sun.

Think about the movement of the sun as well – if that old shed in the corner is occupying the sunniest spot, then knocking it down and constructing a pergola could make a huge difference to the usability of the garden, and increase the desirability of your property.