Buying Income At Auction – Returns Over 33%

Buying Income At Auction – Returns Over 33%

pound-sterling-money-coins-notesNow, most people go to property auctions to buy property though a few, particularly the sellers, go to watch property being sold and some go to find & buy one of those “bargains” and, by that, I mean without even viewing the property or doing any Due Diligence.

I once sat next to a couple in a Cardiff auction who bid & bought a nice looking property (catalogue) that was actually little more than 4 walls and roof for 24K, I had viewed it, which was probably wasn’t worth even 10K. On asking why, they said they had come over the “Bridge” from Bristol for a day out and to look at auctions and to find a 3 bed terraced house for less than 25K just had to be a bargain so they bought it!

Few if any go to buy income, literally a pot of money, or maybe a wad of £50 notes, that you will receive about one month after the auction and then every month after that and yet, in that same auction, the probability was that income was for sale which could have been a real bargain depending on how much you would pay for that pot of money, wad of £50’s?

Property auctioneers selling income call it property to start with and sell the property along with an occupier (tenant) who every month will give you that pot of money and yet this source of income is, broadly speaking, ignored by most investors who are, presumably, happy putting their money into a savings account or maybe some shares and receive far smaller pots of money and fewer £50’s for their troubles.

Now before getting you all excited I must include some caveats.

  1. I am not recommending that you buy any similar lots to those mentioned in this article.
  2. It is essential that you carry out thorough due diligence both in respect of both the property and occupier (tenant), and didn’t follow the example of the Bristol couple
  3. You should take independent qualified financial advice before committing yourself to any property purchase and I am not qualified to give such advice.

All figures are purely for demonstrative purposes; their accuracy is not guaranteed and cannot be relied as Due Diligence.

On April 14, Auction House London held a 110 Lot auction at the Landmark London Hotel 222 Marylebone Road, a number of which are offered with tenants in occupation.

Often London auctions include properties which are located a considerable distance from London, which was the case with this auction, and six of the properties deserved closer inspection by virtue of their relatively high yields when dividing the annual rent by the guide price to produce the gross yield.

These let properties can turn out to be real bargains because often local investors aren’t going to travel to London to buy a low-cost property and likewise a London investor isn’t going to travel a distance for the same low-cost property when there is so much opportunity closer to home so the number of interested punters can be few if any!

In the case of these six properties, 2 were located in Northumberland & 4 in County Durham. As a bonus guide prices were all below the new SDLT threshold of 40 K, effective April 2016, so provided successful bids were less than 40 K, subject to any Special Conditions in the legal pack, the only extra costs would be the Auction House premium of £600, VAT inclusive & your legal costs.

On the downside, the properties may not be mortgageable. Ignoring any lender criteria a minimum mortgage is 25K needing a bid/offer of just under £33,500 at 75% LTV (£25,125). Increasing the LTV to 85% reduces the minimum bid to £29,500 but you need to be absolutely certain that you can get an 85% LTV mortgage for any of these low-cost properties, I mean bankable DIP’s.

Over the years I have bought many tenanted properties and in each case carried out due diligence, but before going into the detail it is essential that you prove the tenancy as it is not unknown for unscrupulous landlord investors to make up fictitious tenancies as often the hammer price is based on the rent and the return the investor is looking for and in some cases the investor never visits or views the property.

For example, an investor looking for a 10% gross return would pay £100,000 for a gross rent of £10,000. The same principle can be applied to buying net rents and cash-on-cash returns.

I know of one case where the property was auctioned as a fully let 10-room HMO and on viewing it seemed that all rooms were “occupied”. Post-auction it transpired that all rooms were occupied by “friends” of a single tenant who was also a friend of the landlord and staying at the property for security purposes! Suffice to say that the auction was subsequently voided because the “arrangement” constituted fraud.

By prove I mean that the property is let to the person(s) named on the tenancy agreement, check the utility bills & Council tax and the rent quoted in the auction catalogue, check the rent receipts. Also if you get a chance, talk to tenants and generally satisfy yourself that they really are resident at the property in the room designated.

So, let’s look at buying income, and I’m not talking about buying a property which needs fixing up to generate tax-free rent & NMLI, though the rent could become tax-free if you are running my Tax-Free Rent Strategy concurrently.

Ideally, over and above the deposit (15%-25%), legal fees & disbursements + auctioneers premium there shouldn’t be any other costs to pay before the pot of money (£50 notes) starts to flow into your coffers every month. In reality the probability is that there will be repairs to carry out as landlords seldom sell property in pristine condition, also you won’t be getting the keys until at least a month after the auction during which further wear and tear may have occurred.

To calculate the value of the pot, I’m assuming an 85% LTV to keep my tied-up cash to the minimum, an interest rate of 4% and 20% of the rent to cover operating costs including letting & management.

The first of my Lots is No 56. The rent is £5,100 PA and, as a percentage of the Guide, returns 26% before any tax-deductible costs which is a bit more than current savings account!

At 85% LTV the hammer price would need to be £29,500, somewhat more than Guide and even Guide +10%, the recommended variable. So, at this point, assume a cash purchase and reduce the rent by 20% for operating costs leaving you with around seven £50 notes each month.

Question is, how much do you pay for £350 each month or £4,080 each year.

If you would be happy with a 15% return, way above savings accounts, bid £27,200.

Not enough then to get a 20% return on your cash, bid £20,400. The calculation is simple, divide the annual rent by your target percentage return.

In the event the hammer came down on Lot 56 at £35,000, considerably above the 20K guide and the effect on the numbers & returns is as follows and remember you are using cash to buy income and therefore the higher the cash-on-cash return the better the investment.

35K hammer price, @ 85% LTV raises £29,750, above the minimum, with a cash deposit of £5,250.

In addition we have to pay £600 auctioneer’s premium & £500 legal fees plus £2,610 seller’s costs, which I will come back to, increasing the cash spend to from £5,250 to £8,960.

The current rent of £5,100 nets down to £2,880 after deducting £1,020 (20% operating costs) & £1,180 (interest @ 4%).

Result, a cash-on-cash return of 32%, which is way above any return that could be achieved with a 100% cash buy.

Excluding auctioneers premium & legal fees this property has cost £37,610, 35K hammer, £2,610 seller costs which have had the effect of grossly inflating the cost and therefore value of the property, but it is quite common for Sellers of low-cost properties to recover all their costs from the buyer.

Generally you find reference to these costs in the “Special Conditions” which is part of the Legal Pack and often not available until close to auction day.

Given that the best previous last-sold price (2015) was 25K it may be that a valuer will not confirm a mortgage value of 35K and, if he did, the lender may not agree to an 85% LTV. Either or both will reduce the cash-on-cash return. Hopefully both negatives will have been part of your pre-auction DD report on this property, so no surprises. Interestingly this sale was subject to a 14, as against normal 28 day completion.

What I am sure about is that the valuer’s valuation will not include any part of the additional £2,610 spent on behalf of the seller.

Lot 56 had an interesting history which raises questions. It was sold after a Graham Penny auction in January 2015 for an undisclosed amount with a guide of 25K. January 2016 and the property reappears in the Agents Property Auction only to be withdrawn prior and then reappear, same auctioneers, February 2016 when it was unsold. No apparent changes other than the off-street car space has been fenced off and we have first sight of the kitchen, guide 22K. March 2016 same auctioneer, Agents Property sells the property for 19 K and it then reappears in this month’s Auction House London’s catalogue with a guide of 20 K, same fence, same kitchen but now we have a bathroom pic + another room, all clean and tidy and ready to occupy but of course it’s already let from April 1 for 6 months so outside of confirming that the tenancy is legit there won’t be any tenant performance history another important part of DD with income properties.

I never like going to an auction just to buy one property principally because there is always the chance of another bidder buying to house a relative when due diligence and value for money may not be that relevant, so I continued through the catalogue and found Lots 61 & 101. Two flats in the same development giving me a lot of flexibility. I can buy Lot 61 and go home, I can wait on and buy Lot 101 as well, maybe cheaper, I can be outbid on Lot 61, it’s gone to the “housing a relative” bidder and still buy Lot 101.

But with 20 K guides we are way below minimum mortgage land but it is possible to consolidate mortgages. I raise the point because buying one of these flats will probably fail the 25K test and become a cash purchase, but the pair wouldn’t, so they’re worth looking at as they are generating a yield around 20% on guide.

My principal concerns though are that they look a bit “ex-local” though there is no mention of this in the catalogue. Also unless either of the tenancies are extensions, both appear recent with January & March start dates, giving little tenant performance history and Lot 101 is 2nd floor which, in the absence of a lift, will restrict its appeal.

In the event, Lot 61 sells for £21,750, definitely a 100% cash purchase and Lot 101 is “sold prior to auction” for the usual “undisclosed amount”. Don’t know if Lot 101 was “sold prior” on or before  the auction day, if before notice would be included in the Lot Amendments distributed before the auction started, a very good reason for attending auctions.

Continuing on through this catalogue we come to Lot 74 which is the first of 3 in the SR8 postcode, Lots 74, 80 & 90. Both Lots 74 & 80 guide at £27,000, increasing to £29,700 at guide + 10%, making them mortgageable at 85% LTV (£25,245) but, a bid of £33,529 qualifies for a 75% LTV (£25,147) mortgage which you can virtually guarantee obtaining subject to status.

I’m going to look at Lot 80 with the AST rent of £5,700 which in the event sold for £35,000 providing a cash-on-cash return over 30% for a £10,440 investment including deposit, auctioneers premium, legal fees & massive seller costs of £4,090! You are not only buying the property but paying to sell it as well but the result is a cash-on-cash return of 32% or £3,370 a year before tax.

So for a little over 10 K including legal costs, auctioneers premium & seller costs and possibly some minor repairs you could buy an income of over £3,250 each year for the foreseeable future and into the bargain own an asset worth around £35,000.

All base information is courtesy of EIgroup.co.uk with special membership terms available.

If you’re interested in Buying Income At Auction and the thorough & extensive Due Diligence that is necessary to identify & authenticate a Property Auction Bargain plus prove their financial viability using my Auction Income Analyser email me, David@BuyingAuctionPropertycom.

© David Humphreys 2016