A brief history of housing in England and Wales

The historical recognition of the form of houses tends to be identified by reference to a period of English architectural style, for example Tudor or Victorian. The majority of the current housing stock dates from the middle of the nineteenth century and later, although there are earlier houses in existence, such as sixteenth century (Tudor), seventeenth century (Stuart, Carolingian, William and Mary), eighteenth century (Queen Ann, Georgian) and early nineteenth century (Regency). Nearly all of the extant houses of the sixteenth, seventeenth, eighteenth and early nineteenth centuries are houses that were built for the so-called middle class (e.g. merchants and professionals) and upper class. Only rare examples of cheaper housing from these periods still exist.

The mid- and late nineteenth century (Victorian) saw a huge boom in the construction of housing in response to the mass movement of people from the countryside into the cities as a result of the Industrial Revolution. Cheap terraced houses for the workers, more spacious semi-detached houses for the managers and detached villas for the owners were developed in vast numbers on the outskirts of older towns, often by speculative builders, sometimes by the well-off themselves. These houses had solid walls of brickwork and/or stone, sometimes finished with render, roofs of clay tiles or slates, brick or timber-framed internal partitions, gas lighting, rudimentary cooking, washing and lavatory facilities and coal fires for heating. Much of the cheapest housing was of poor quality, using, for example, sun-baked bricks, and has subsequently been demolished. However, large numbers of terraced, semi-detached and detached Victorian houses are still in existence, albeit modernised at various times during the intervening period.

Houses built in the first decade of the twentieth century (the Edwardian period) are considered by many experts to be the pinnacle of quality in terms of workmanship and materials. Facilities are similar to those of the preceding century but of better quality. This period also saw the rise of the Garden City Movement, based on the writing of Sir Ebenezer Howard, who was highly critical of the urban development of the period and promoted the idea of a planned city with generous public spaces and buildings, low-density houses with large gardens in broad tree-lined streets and separate zones for factories and other industrial development. This led to the creation of garden city towns, such as Letchworth, Hampstead Garden Suburb and Welwyn.

The period between the First World War and the Second World War (the inter-war period) saw much greater state intervention in housing. Previously, involvement on the part of the state had been restricted to the provision of legislation encouraging local authorities to take action, but now the government legislated and provided the funding for the development of council housing, i.e. local authority social housing. There was also considerable private speculative housing development, leading to the suburban expansion of many cities. Both the council and the private housing of the period, particularly the former, reflected some of the principles of the Garden City Movement, especially the low-density housing, large gardens and broad tree-lined streets. This period saw cavity-wall construction and concrete foundations become standard. Floors and roofs were still constructed using cut timbers, bathroom and kitchen fittings were installed as standard, but were still very basic, hot water was often provided by a gas heater and space heating was again based on open fireplaces. Many rural houses still had no piped water, mains electricity or mains drainage.

During both World Wars housing development was suspended and after the Second World War little housing construction took place, apart from repairing bomb-damaged houses, until the mid-1950s when the post-war period of house building really commenced. Both council housing and private speculative development boomed for the next 20 years, although the standards were still relatively low, e.g. few new houses had central heating and roof insulation was non-existent until 1965, and then only minimal. However, most rural properties now had mains electricity and water, and mains drainage became more common.

Gradually, from the 1970s onwards, trussed roofs, often finished with concrete tiles, became standard and modern timber framed construction became relatively popular after a difficult introductory period; even where cavity construction continued to be used, timber or steel framed internal partitions were commonly installed. Central heating became the norm, and during the 1990s, cavity wall insulation and double glazing became standard in new housing developments. Dry wall finishes were also prevalent for new development. During the past 30 years or so, increasing use has been made of new materials and techniques. Examples include composite timber products for structural purposes and finishes and plasticised products, ranging from components such as windows to paint systems. There has also been recognition that many older and sometimes discarded, or unfashionable, products and materials are still relevant, e.g. clay roof tiles, roofing slates, lead work and lime mortar.

Five Golden Rules of Investing

1. Always buy from motivated sellers
Instead of looking for a property you’ll like and then negotiating with the seller, a smarter strategy is to look for motivated sellers who will be flexible on the price and / or the terms of the sale, and then decide if you want to buy that particular property.

If they are prepared to sell at a discount for a quick sale, the amount of discount will vary depending on the motivation of the seller and the general market conditions.

In a rising market you may be happy with a 15% to 20% discount. In a falling market you would want a bigger discount of 25% to 40% to give you more of a safety buffer in case prices come down further.

Just to be clear here, this is not saying that you always need to get a discount off the sales price. Sometimes property is already a great buy at the full asking price because it may already have been lowered for a quick sale. This is where knowing the values in your local market is really important so that you can spot a good deal when you see it.

Many investors get fixated about buying below market value, which means they are likely to miss out on potentially profitable deals because they don’t think they should pay the full asking price. If it is a good deal, investors may sometimes pay the full asking price and more, especially if they can add value to the property. We also need to recognise that some sellers may not be able to offer you a discount because there is no equity in their property. However, if they are motivated, they may be more flexible on the terms of the sale, for example, when you actually pay for the property.

Price is not the only factor in negotiation. This means you may be able to use strategies such as ‘Exchange Delayed with a Completion’, or ‘Purchase Lease Option’. These strategies only really work if the seller is motivated.

2. Buy in an area with strong rental demand
This is a very important rule. As a property investor your aim should be to buy an investment which will not only pay for itself, but also make a cash profit (positive cash flow) each month. There are running costs associated with owning a property, but the basic concept is that the rent you receive from your tenants more than covers all of the costs. If you have no tenants, you have no income, which means you have to cover the costs yourself. Your investment then becomes a liability, rather than an asset.

You need to accept that as a landlord you may occasionally have void periods on your property, which means no tenants, and so you need to meet the costs. You can dramatically reduce potential void periods by only ever buying property in an area with strong rental demand. You want to ensure that if your current tenants decide to leave the property you can quickly and easily rent it to new tenants at the full market rent.

A general rule of thumb is to buy properties in areas with strong local employment and good transport links with local facilities and amenities. When you know how to do it, you can easily assess the true rental demand in any area by using the internet to find like comparisons, speaking to local letting agents, and even placing dummy adverts to test rental demand. If you are not sure about the rental demand in an area, then don’t buy the property to avoid longer than expected void periods, which will cost you money. Due diligence is very important before you make any investment decisions.

3. Buy for cash flow
As already mentioned in Rule No 2, your property should create a monthly positive cash flow for you, so that it is an asset rather than a liability. As prices shot up towards the end of the last property boom, it became increasingly difficult to find properties that stacked up to give a positive cash flow. Many investors were buying properties which would only just “wash their face”, where the rent just about covered the monthly costs. Even worse, in the hope that prices would keep going up, some investors were buying properties that had negative cash flow, whereby the rent was not enough to cover the monthly costs. This meant that the owners had to subsidise the property each month, not a good position to be in, especially if you have a lot of properties like this.

When the property market crash came in 2008, many investors, both amateurs and professionals, owned properties that were worth less than they had purchased them for and were costing money each month just to hold them. In this situation, if you can afford to hold the property, you just need to sit back and wait for the market to recover. But if you can’t afford to continue subsidising it, and you are forced to sell, then that’s one of the ways you could lose money in property. Fortunately, the good news is that, with the benefit of hindsight, you can learn from other people’s past mistakes, so that you don’t have to make the same mistakes yourself.

You should only ever buy property where each month there is a profit from the rental income you receive after paying all of the expenses, including mortgage payments, insurance, repairs and management fees. Positive cash flow is king. Although we expect property prices to rise in the long-term, if you buy your investments ‘as if prices will never go up again’, you will be forced to buy only properties which give you great cash flow now. Extra cash flow will help you to build up a safety buffer, and help you cover potential rises in interest rates in the future.

4. Invest for the long-term buy and hold
Some investors like to buy and sell property to make a profit. This is a good strategy (in a rising market), however, each time you sell a property you will crystallise your profit and you will never make any more money from that particular property. Whereas, if you buy and hold, you can make money from the rental profit each month, as well as long-term capital growth. This way you work once and get paid forever by that property. The real profit in property is in buying and holding for the long-term to benefit from significant capital growth. The key here is being able to afford to hold it and this is why a positive cash flow is so important, so that you don’t have to subsidise ownership of the property. If you plan to hold for the long-term and your property is rented out creating a positive cash flow, you needn’t be concerned by short-term fluctuations in price.

If you do sell a property investors may suggest you reinvest some of the proceeds into another property that will give you a better return. To conclude, many believe it is best to hold property for the long-term. That is how you can become very wealthy and pass wealth on to future generations.

5. Have a cash buffer
Often you meet investors who had to sell their properties because they could not afford to hold them. A problem investors sometimes hear about is of properties occasionally getting damaged or just enduring wear and tear, making them difficult to rent. The landlord may not have the spare cash to make the necessary repairs and improvements and so the property remains void, which ends up costing the owner even more money. This becomes a vicious circle whereby the landlord can’t afford to make the improvements because he has no rent coming in, and can’t get any tenants because he can’t afford to make the improvements. These landlords often become motivated sellers.

The way to avoid this potential problem is to make sure you always have a cash buffer set aside to cover unexpected expenses. In reality, you can get insurance to cover most of the potential issues, including a tenant not paying the rent. However, the more insurance policies you have, the higher your costs and so the less cash flow you will have each month. Investors may recommend you have a cash buffer in place, which you can use if need be. This could be cash in your bank, a clear credit card, or some cash in someone else’s bank that you have agreed you can borrow if necessary. The size of this buffer depends on your personal level of risk. A few thousand pounds per property might be a good idea. This will help you avoid becoming a motivated seller yourself.

An introduction to planning permission

If you are ever considering being a buy-to-let landlord it is likely you will envision at some point making changes to your property in order to enhance its value. Depending on whether you wish to alter, you may need to obtain planning permission. In fact, it would not be unreasonable to go as far as to say that knowing about planning permission is an essential part of any buy-to-let landlord.

In 1948 the right to carry out property development was nationalized. In other words, landowners’ right to build and alter buildings, or to use land or buildings for a different purpose, was taken away by the government. Since that date, anyone wishing to carry out development needs permission to do so.

Permission is given mainly by the local planning authority for the area, which in most cases is the district, borough or city council (collectively referred to as ‘district’ councils). In addition, local government was charged with preparing plans for their areas showing where various kinds of buildings could and could not be built. Thus, the modern comprehensive planning system was born. The system is now overseen by Department of Communities and Local Government in England; the Scottish Government; the Welsh Assembly Government and the Department of the Environment in Northern Ireland.

The planning system was introduced so that property development could be controlled in the public interest. Previously, buildings could be built anywhere, or they could be demolished, and land and buildings could be used for any purpose the owner chose. This was thought to be inefficient and sometimes had harmful consequences. The idea behind the planning system is that new buildings and uses are controlled to ensure:

that incompatible uses are not sited together;
the preservation of important buildings and areas;
the conservation of the countryside and natural environment;
the prevention of urban sprawl;
that the appearance and layout of new development is compatible with existing development;
that resources are not wasted;
that infrastructure can be provided efficiently;
that people’s enjoyment of their properties is protected;
highway safety;
co-ordinated provision of new housing and employment facilities.

However, the planning system is not coercive. It relies on landowners wanting to undertake development. An owner does not have to use land in a particular way just because it is allocated for that use or development. Similarly, even when permission is given, the owner is not compelled to act on it. The system is only concerned with what can be built. It does not deal with how it is built. Structural stability, health and safety, sanitation and so on are dealt with under separate legislation and regulations.

Fundamental to the planning system is planning policy. As well as allocating sites and areas for certain types of development, council development plans contain guidance and standards for buildings and uses, relating to matters such as design, layout, density, garden space, privacy, noise, highway safety, size and mix of buildings, parking and many other issues. This guidance, and standards, is known as planning policy and can be set out in a range of development plan documents. There is a preparation process that development plans must go through and public consultation and opportunities for public comment are built into the procedures.

In addition to local policies, the governments of the UK publish national planning policy documents. Inevitably, these are more broad-brush in nature. Their function is not only to guide decisions on individual development proposals but also to give direction to the development plans drawn up by local authorities. The government indicates what should be taken into account when preparing local plans and, in some areas, the thrust of what they should say. When seeking permission for development, planning law requires the body responsible for making the decision to do so in accordance with formally drawn up local planning policy, unless there are sound reasons for coming to a different conclusion. Therefore, planning policies are the prime consideration in whether planning permission will be given.

Permission is needed for development; consequently there is an application process for seeking that permission. Two types of planning application can be made. First, there are ‘full’ or ‘detailed’ applications. These show all aspects of the proposal and are specific about precisely what would be built, what alterations would be made or what use would be made of land or buildings. Second, there are outline applications. These are made to establish, in principle, whether a building can be built, leaving some or all details of the scheme to be determined subsequently. Outline applications can only be made for buildings not for changes of use, including conversions. The details of the building and site layout are called ‘reserved matters’, because they are reserved from the outline application. Another type of application is then made for the approval of reserved matters within the scope of the original outline permission. Once they have been approved, the outline and reserved matters together are the equivalent of a full planning permission.

Although planning permission is supposed to be obtained for development before it takes place, inevitably building work and changes of use happen without the necessary consent. In these circumstances, an application can be made for permission after the event. This is generally referred to as ‘retrospective’ planning permission.

There are various other applications which can be made after planning permission has been granted. Conditions are attached to permissions and there is a procedure for applying to remove or vary conditions. In certain circumstances, this type of application can be used to make changes to the design or layout of an approved scheme. There is a separate procedure for making very minor changes to a planning permission, called a non-material amendment. One condition attached to a planning permission is a time limit within which to begin the development permitted; this is usually three years for full planning permission (five years in Northern Ireland and Wales). Applications to extend the duration of planning permission are often referred to as ‘renewals’ although they are, technically, new applications.

Of course, not all planning applications are successful and the system includes an appeals process. Appeals are made to central government bodies: the Planning Inspectorate in England and Wales, and the Planning Appeals Commission in Northern Ireland.

The appeals system in Scotland is a little different. Appeals against decisions taken by council officers are decided by a group of elected councillors. Appeals against decisions taken by the council’s planning committee are made to the Scottish Government’s Directorate for Planning and Environmental Appeals.

Appeals can be made when a council refuses permission, fails to make a decision within set time periods, or grants planning permission subject to conditions which the applicant wishes to vary or remove.

Appeals provide the opportunity for the merits of a proposed development to be considered by an independent inspector (reporter in Scotland, commissioner in Northern Ireland), free of local politics. Appeal decisions, and the interpretations they contain, are supposed to be taken into account by councils when deciding planning applications. Thus the appeals system is intended to keep a check on councils and to provide some consistency in decisions between councils.

Factors influencing property development

Deciding to become a property developer as a vocation is an important decision that requires various considerations before you take the plunge.

Developing a property in poor condition as basis for a successful business venture which gives a sound return on investment requires a lot of energy, time, money and luck. How much energy, time and money are required multiplies with an increase in the scope and level of activities. If you move from developing a large, Victorian property to two properties, or more, the demands rise commensurately.

Using project management ideas to succeed – the feat of managing a project based development process, whether of a single Victorian house, a single larger scheme, an old warehouse conversion to provide dwelling units for 20 people, as in for example, a block of flats being adapted for Home in Multiple Occupation (HMO, each require the application of the same basic principles. Even when the challenge is that of working on two sites simultaneously, sites, which are next door to each other, you still need lots of energy. The point of note here is that, each of these scenarios will pose their own challenge.

For some, these challenges can sometimes prove so daunting, that developers with years of experience get into trouble, which is when, some take appropriate, corrective measures and the result can be survival from where they rebuild and live to tell the tale. Others may not be so lucky and go under. You have to keep your eye on the ball in relation to the factors which will help you to not only avoid going down but to move from one successful development project to another. This said I am reminded of the old Chinese saying which goes something like; the glory is not in not falling but in rising even higher after any fall.

When it comes to property investment, as with other times, location and unrealised, hidden values hold the key to success in this business. Furthermore, in a UK context, London and the south of England, are the ultimate magnet for property developers. This is an area consistently identified as offering ideal investment returns on account of; development opportunities, the high rents achievable and the considerable capital appreciation over time are all contributory factors. Demand and supply factors, which favour the developer’s side of the equation, have contributed in no small way to property price appreciation over the last three decades and more, with supply unable to match or catch up with demand in over three decades, especially since the 1990s.

Spreading London ripple effect – what is often referred to as the ‘London ripple effect’ in relation to high prices always sees the higher London price rises, spread to the surrounding regions and beyond. Such ripple effect is dependent on the prevailing economic climate of the time. Examples abound of out-of-London property hotspots like Birmingham, Manchester, Liverpool and Leeds to list a few.

Scotland and Wales Farmers’ diversification into the market for holiday accommodation – for a couple of decades now, it has been noticed that in locations far removed from the hustle and bustle of city life, for example in Scotland and Wales, areas which have not witnessed property price increases, like those found in the south of England, farmers have included diversification from core farming activities into providing accommodation for tourists. For the farmers who have taken advantage of the opportunities opened by tourism, refurbishing old barns and disused farm cottages has become an established strategic route to generating additional revenues. This has to be seen in the context of dwindling grants and subsidies, formerly built into the income streams of members of the farming communities. It is as much driven by political pressures and dwindling government support as by the survival exigencies of the day. You can be sure that where there is a development tag attached, you will soon find a property developer knocking on the door. Could that developer be you in the near future?

Scotland and the City of Aberdeen and surrounding districts – still on Scotland, there had, until recently, over several decades, been intense development activities in and around the city of Aberdeen. This relates to Aberdeen being at the centre of Scotland’s oil industry, with people coming to work in the industry or to study about different aspects of the oil industry at Aberdeen University and the surrounding colleges.

Supply demand factors as drivers – in Aberdeen once more demand – supply factors act as drivers and according to 1st quarter figures from the Halifax Price index, annual price rises in Scotland stand at 9.3%, in August 2016, while that for the UK as a whole is 10.1%. A check on house prices in Aberdeen and its surrounding districts, relating to different types of housing; flats, period properties and new builds, prices are comparable to those in some areas around Greater London. A fact, which may come as a surprise to many of us, cocooned as we are in our city life bubble. The government estimates a shortfall of 3 million homes exists at the present time.

Scotland and the cities of Glasgow and Edinburgh – the cities of Glasgow and Edinburgh, between them have a combined population of just over a million, and 8 universities, four in each city and several colleges in their patch. There has always been a steady hive of development activity by which students’ accommodation needs have been catered for. Over several decades developers and buy to let investors busy themselves working the students’ districts assiduously.

Ever present opportunities – there are constantly emerging development opportunities, which can be capitalised on, if you’re at the right place at the right time, and for those who know their patch, and are also known, they are first to be notified, when opportunities suddenly crop up. And the elephant in the room requires that you be financially ready to take advantage of such opportunities when they arise. These are hallmarks of discerning developers.

The feel good factor as relates to the property market, may come and go and irrespective of the state of the market, opportunities are always there, explained another. When asked about the negative equity phenomenon, one property developer’s response was that the phenomenon which descended on the property market in the late 80’s and early 90’s is a distant memory, and long forgotten. Negative equity was the term coined for properties losing their value – even overnight properties became worth far less than had been paid for them just a few weeks before.

Negative equity may well be a distant memory. However, it serves to remind us that while the last forty years have seen steady property price increases averaging over 9% annually it is worth stressing once more that property prices can go up but they can also come down. A cautionary tale: as distant memory it may be, but it serves to remind us that whilst the last forty years has seen steady property price increases, averaging over 9% annually, it’s worth stressing that property prices can go up as well as come down.

Healthy employment figures – among the many factors impacting on the property market, are recent UK employment figures, (August 2016) which show a high proportion of people in work compared to the years 2007-2010. The importance of healthy employment figures to the property development process lie in its relationship with other factors which impact on the market for materials, labour and income.

Traditionally, factors such as interest rates reflect the state of the market in relation to supply and demand and its impact on the property market. Interest rates is a subject to which we will return later. The simplest relationship which can be adduced is that higher labour costs can lead to higher incomes for the working population. Improved incomes in turn mean those who wish to purchase properties; flats or houses are better able to afford them.

A dynamic market is good for development – a corollary of the above, is this; the greater affordability made possible for those purchasing in any segment of the market; low, high or in the middle, the more dynamic the market is, the better it is for the developer. It means the greater the numbers of people in the market well placed to afford to purchase properties, the likelier the chances the developer has for a quick sale and turnaround, followed by a move to the next project.

A developer who takes too much of a narrow perspective, may end up paying the price, as a result of the adverse consequences which may result from ignoring details from other perspectives, even when such details are minute. For example, using wrong structural engineering calculations or failure to take account of small recommended measurements because the builder thinks you could get away with not doing so. When the correct details are ignored and corners cut, they can result in unstable structures, which end up imperilling thousands of pounds of development investment.

Property development is much like any other economic activity; retailing, banking, running or hotel or any of the businesses we see on the high street. Each one of these businesses requires coordination of human, raw materials and financial resources with the latter acting as the glue that holds the business together.

Deciding to become a property developer is an important decision. There are many considerations to be undertaken beforehand, and during the process. But done correctly, it may be rewarding, both financially and vocationally.

Reasons for investing in properties

A lot of mediation cases result from disputes between landlords who want to maximise their bottom dollar and spend as little as possible, and tenants who feel they are being pushed to do the landlord’s job of upkeeping properties because the landlords are not responsive enough. What makes someone want to invest in property in the first place if they are not prepared to invest time and money into maintaining it?

Cash Flow: Whether you buy with all cash or use today’s favorable financing with a low mortgage payment, positive monthly cash flow occurs when the monthly rent is greater than the monthly expense. This gives you a monthly income from your property investment.

Appreciation: Appreciation is the increase in the property’s value, which generally occurs over time and can also be increased by an investor who adds value to the property through repairs and/or enhancements. This is a great way to create equity in the property.

Depreciation: Even with an increase in the property’s value, the government allows owners a tax deduction on their property over its life span. This annual deduction is called depreciation which you can start taking when you have owned the property for at least one year. By taking advantage of depreciation, the cash flow you receive is protected so that you receive some or all of it tax free. If you are an investor with an income from another source such as a regular job, it can also protect all or some of that income from state and/or federal income taxes. Talk to an accountant to completely understand the full benefits of depreciation.

Tax Benefits: In addition to depreciation, an investor can usually claim the interest portion of his monthly mortgage payment as a tax deduction.

Leverage: Leverage is a very powerful reason for investing in property. If an investor uses 100% cash to acquire a house worth $100,000, and the house increases in value by $5,000 in one year, then the investor makes a return of 5% (assuming no other costs in this case). However, if the investor obtains 80% financing, only $20,000 cash would be required at the closing table, and a bank or other lender would loan the remaining $80,000 to acquire the property. Assuming the same $5,000 increase in value, the investor’s cash contribution of $20,000 would yield a 25% return on investment ($5,000 increase in value divided by the $20,000 investment) in the same one year period of time.

Using the above example, if the investor is able to net even a conservative cash flow of $200 per month, this will result in an additional $2,400 per year added to the increased appreciation. The return for the year would now be $7,400 ($5,000 appreciation plus $2,400 cash flow) and the return on investment would now be 37% ($7,400 divided by $20,000). Even if the property value remained stable with no appreciation, there would still be a positive return of the $2,400 in cash flow with a return on investment of 12%.

Considering these benefits in addition to the low interest rates for financing, you can see how easy it is to accumulate wealth and become a successful investor.

Other Reasons Why People Invest in property
Now let’s look at other reasons why people invest in property. First, let me ask you a very simple, yet provocative question: Why would you invest in property? Understanding the answer or answers to this question will help you along your investment career. Following are the most common answers I have heard during the course of my property career:

Freedom: Frankly, this is why most people start investing in property. They get star struck with the idea of riches that would give them the freedom to stop working for someone else. They may have a great job that they absolutely love that pays the bills, but they still want to achieve long-term freedom. They can see that by buying and holding cash flow properties over time (and sacrificing and delaying gratification), in five, ten or twenty years, they can have a pile of monthly cash flow and have gained the freedom they desire.

Control: Some investors I speak with want property in order to gain some degree of control over their financial lives because, let’s face it; we have zero control in financial investments outside of property investing. If you invest in the stock market or money market funds, you have no control over the return you will make. With property, there are things that you can do to control your return on investment as shown above.

Alternatives: Some investors will admit that property is nothing more than a portion of their overall investment portfolio. Perhaps they have divided their portfolio to include mutual funds, stocks, property, etc. Or they may be looking to achieve higher returns from their cash through active management.

Job Escape: A few investors look at property investing as a career, or a chance to own their own company. Others may look at property as a means to eventually replace the job or career they currently hate. Creating Value or Thrill of the Hunt: Many investors love the thrill of the hunt, chasing down a deal or cashing in on their last remodel. They pursue that addictive feeling and are always looking for the next rush or opportunity to turn an ugly duckling into a beautiful swan.

Options: After many years of property investing, I have come to realize that in the end people love investing in property because it has given them so many more options. They have the options to keep working their current job, to buy property as a full time career, to have the time and money to travel, etc. The more they invest, the more option doors are opened.

The Real Reason to Invest in property
People fall hard for the sexy pitch of earning freedom. Frankly, freedom is good but I think what people really want is options. That is why they keep working so hard to find the next deal, to find the next investor, and to keep building their growing portfolio. Some might think freedom and options are the same things. But freedom is more sustained while options are more temporary. But to me, freedom means that a person can stop doing something while options mean a person can do other things. I can tell you firsthand that having options is better than having freedom. I would say you get freedom first and then you build or acquire options.

Property Investment Appraisal

What exactly does the ‘appraisal’ of property mean? There are two distinct applications in mind. By ‘appraise’ we could mean

a. To fix a price for (an asset);
b. To estimate the amount, or worth or value, of (an asset)

The first of these meanings implies what is known, in the UK, as the valuation process or, in the US, as the appraisal process: the estimation of market value or the prediction of the most likely selling price. There is now widespread acceptance of the international definition of market value set out in the valuation standard of the International Valuation Standards Committee, commonly known as ‘the White Book’ (IVSC, 2005), which is now in its seventh edition.

This definition is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had acted knowledgeably, prudently and without compulsion.

Many nations also feel the need to have their own valuation standards, not least the UK, whose standards [maintained by the Royal Institution of Chartered Surveyors (RICS)] have been through a number of editions of what is commonly referred to as ‘the Red Book’. The latest edition (RICS, 2003) is the fifth and has adopted the aforementioned basic international definition.

There are even attempts to create regional standards (such as the European ‘Blue Book’, published by TEGOVA, The European Group of Valuers of Fixed Assets), and this has created some tension and rivalry between international, regional and national bodies, particularly in Europe.

However, there is now very little disagreement, if any, on the general wording of the market value definition, even if there are some differences in interpretation. These differences will continue to diminish as the property investment market becomes more and more international.

The second of the two meanings, the estimation of worth or value, is not necessarily market-based. Since 1995 this concept has been developed and institutionalised, having entered UK valuation standards in the 1990s as the ‘calculation of worth’, and now defined in the White Book under the term ‘investment value’.

The term ‘calculation of worth’ has now – happily – been dropped by the RICS in favour of the international definition.

The definition is as follows: the value of the property to a particular owner, investor or class of investor, for identified investment objectives. This subjective concept relates specific property to a specified investor, group of investors, or entity with identifiable investment objectives and/or criteria. This definition does appear to fudge a major issue, specifically whether worth or value is to an individual investor or to a group of investors. This has significant implications about how it might be assessed in practice, as the value to an individual and the value to a group may not be the same.

Individual investors are influenced by a set of criteria by which the value of an asset might be assessed. For example, their tax situation, the rate at which they can borrow, how much equity capital they have to spare, what adjoining assets they own and the strengths and weaknesses of their existing investment portfolio are all factors that may lead them to perceive value in a particular property.

Hence, while all investors may agree upon such important variables as the size of the asset being appraised, the cash-flow implications of the lease and the likelihood of achieving planning permission for a change of use, individual investors will always be subject to different motivations.

The distinction between value and worth can be important. Further, it is possible that a group of investors will use the same criteria and share the same characteristics, and would as a result attach a similar value to a property asset. Identifying the possible buyer group is very relevant to appraisal, which is therefore the process of identifying a mixture of objectively measured market variables and the prospective owner’s (or group of owners’) subjective estimates of other relevant factors.

We could use the term ‘appraisal’ to cover the process of estimating either market value (the prediction of the most likely selling price) or investment value (the estimation of worth to an individual or to a group of individuals).

We could therefore encourage the use of the term ‘market valuation’ or ‘valuation for pricing’ for the former, and we would prefer to use ‘investment value’ for the latter. We hope this will not cause too much confusion, but the possibility of confusion unfortunately exists, grounded in the fact that the development of property terminology has been influenced by the isolation of the property world from the securities markets.

There is no doubt regarding the meaning of valuation in the securities markets: it means the estimation of worth.

Pricing is a function that is carried out by buyers, sellers and market makers. The price of a particular company in the stock market is publicly quoted, and large numbers of identical shares in that company can be bought and sold. In property, however, there are no market makers.

The price at which a transaction will take place has to be influenced by an expert opinion – a ‘valuation’ – because there is both insufficient market evidence and insufficient homogeneity of product for traders to be able to fix prices. It is therefore to be expected that at any one time different views of worth will be held by different individuals and these differences will fuel market turnover.

In addition to the main concepts of market value and investment value, ‘sustainable value’ (mortgage lending value), a relatively new phenomenon used in the bank-lending process, has been developed in mainland Europe. It has found some favour, particularly within German banking systems, and the mortgage lending value basis has been adopted, along with market value, within the international banking regulatory process known as Basel.

The concept sustainable value has been subject to intense criticism, as of it does not conform to any recognised economic concept of value and the definition is virtually incomprehensible. The implications for investors can be damaging and may have had some impact on the German open-ended fund crisis of 2005/2006. But it is arguably of no merit and should be abandoned.

The stock (property) selection policies of both major and minor property investors often include an examination of the mismatch between estimates of market value and investment value in order to spot pricing anomalies, and any investor or advisor will benefit from a clear understanding of the difference between the market value of an asset and its worth to an investor or group of investors.

If there is a difference, is this evidence of poor-quality appraisal? It is widely believed that market valuations should primarily be accurate; that is, they should closely predict selling price.

Accuracy may therefore be a relevant and useful test of the quality of a market valuation. Investment valuations, on the other hand, should primarily be rational; they should be professional and expert reflections of a combination of objectively measured market variables and the prospective owner’s subjective estimates.