25: How do I become financially independent?
02-05-2005
I find most visitors to PropertyInvesting.net are keen to increase their personal wealth with a view to becoming financially independent, through property investment. With this in mind, I thought I would give some guidance and insights into expanding your personal wealth, which I hope you find helpful.
There are two key ways to increase wealth – by:
- Capital value increase – where asset values go up.
- Positive cash-flow – e.g. making a profit – the higher the better.
Whilst asset prices have risen strongly in the
With this in mind, taking a disciplined approach, you should aim to maximise your cash-flow and profitability. This is commonly done by purchasing high yield rental property with good rental demand, low mortgage costs and low maintenance & service charges.
Purchasing property in an “up and coming” area will benefit both the rental income growth and capital value (or asset) growth. So properties close to rail, tube, road and other infra-structure links in areas with lowering crime rates and unemployment, and areas with increasing earning incomes (e.g. close to major service centres) should reduce your risks. An example is purchasing a 2 double bedroom flat within five minutes walk of
To get the highest rental income, you need to consider entering the “Homes of Multiple Occupancy” market. This is purchasing say 5-8 bedroomed houses and large flats – and renting them per room. You need to make sure you have all the relevant authorisation to do this, and get loans from a mortgage company that agrees to such lending. Skipton Building Society are particularly good with this type of property. Your yield, that is – the gross rental income divided by the price you paid for the property, could rise from say 8% for a two bedroom flat to 13% for a home of multiple occupancy. Yields higher than 15% can be found in some parts of northern England and Scotland – albeit the risks of high void periods is probably a bit higher in these areas, because in many cities the populations are not rising very strongly (some are declining), and there is not such a big housing shortage as in the south of England.
Bedrooms in houses with shared facilities will become increasingly popular because of the:
- Increased number of single men – divorced and separated from their partners – the women usually keep the family home if the family has kids.
- Increased costs of renting one bedroom and studio flats – many single men simply cannot afford £400-600 a month for such UK flats, particularly with recent increases in council taxes, utilities and other taxes
- Increasing amount of professional women and men who need to stay mobile for their work – and prefer a lower commitment in getting a room in a house rather than a longer tenancy on a flat – they also might need a “crash pad” for daily working from a city centre, before a weekend commute their family homes in the country. This is in part because commuting is getting more difficult with increasing congestion, traffic jams and slow progress in improving rail links.
- Increasing numbers of students – who would like to share a large house with other student friends – who have expensive student loans. Most students cannot afford their own studio or flat. After college, they take years paying off their student loans and prefer to stay in low cost rental accommodation to help clear student debits.
- High number of key workers, clerical and manual workers who cannot purchase their own home because of affordability constraints.
Providing such accommodation can help communities as well as being profitable for landlords – the key is to provide good quality, safe and secure accommodation for tenants. Also, be careful which tenants you allow into the house – you have a duty to the other tenants to make sure troublesome tenants do not live in their home. Of course, be prepared that such property can be more management intensive – either for yourself or your letting agent. You can normally persuade a smaller letting agent to take on such property – but the fees are likely to be higher reflecting perceived (and probably actual) greater risk and time/management required.
Also consider that - for example in the
- You have the option to manage the property yourself from short range – thereby achieving savings of some 15-20% of rental income per year (if you have the time and management system to do this)
- You will be able to study local papers and get a better feeling for the local market, so when a bargain comes up – you can react quickly and snap it up (or monitor before putting in a “low-ball offer”).
- You will have the inside track with local estate agents and contractors if you develop good relationships with them
- You will be able to spot opportunities – e.g. land deals, empty properties, up and coming ex-council property, areas with improving communications, lower crime and areas with improving rental demand.
- You can easily attend local auctions and view properties quickly and easily when a good opportunity arises.
All the above criteria make investment in your local area lower risk. In essence, wherever you live, you should be able to turn a profit by selecting the correct micro-area, type of property, investment opportunity and price you would like to bid.
If you have an investment portfolio which focuses on a particular area, when you come to retire, you might find it easier to manage either yourself or by out-sourcing to one or two local letting agents. The downside of this focused strategy is:
- You will miss opportunities in better improving/changing areas in other parts of the country or world
- Your portfolio will be less balanced – and hence if the market in your local area is impacted by a closure of a large employer or an increase in crime rates for instance, it leaves you more exposed.
This brings me onto general planning and goal setting. I advise the following:
- Describe what you would like to be doing in ten years time – how much money you would like to have made?
- Then calculate how much cash-flow and how much asset value you would like to have achieved.
- Now describe how you are going to get there – what actions do you need to take to achieve your goal?
I found it fascinating when I then started doing a financial spreadsheet – calculating how many properties I needed to buy a year and how much rental income they would produce. I rapidly came to the conclusion that “cash-flow is king” (as they always say!) – the more cash or income you make, the faster you will be able to buy the next property and then the more cash-flow you will earn on top. The numbers speak for themselves – try it and see! The curve does NOT rise like a straight line, instead it goes up exponentially! So the higher the income, the more income you will make in the future because you will be able to buy more high income properties. And it won’t even matter too much if the house prices fall – in some respects, this will help since you will be able to purchase property at lower prices and get an even higher yield and earned income. As long as the local and/or national economy is doing well, you should benefit as well.
You might have noticed I have restricted this discussion to the local market (
- Quality and reliability of tax and legal issues and advice
- Rental void periods – for holiday letting or for year round letting
- Currency risks
- Interest rate risks
- How well you know the rental and sales market
- Political stability
- Improvements in communications – certainty
- Local economy – how robust is it?
- Potential off-plan oversupply in rental sector
- Popularity of second hand or older property in the country
- Commission, fees and charges
- Local demographics and future prospects for international market development
- Is it a holiday home, retirement home or true (pure) investment you are making?
Most people believe the rewards – mainly increasing asset values – out-strip the risks. But please note, if you buy off plan in
The final point I think one should consider is – your vision and exit strategy. Do you want to hold the properties well into retirement – manage them or outsource and pull on the earned passive income? Or do you want to sell up one day and cash in. If you wish to sell up one day, you need to consider tax planning up-front. If you sell up, but have mortgaged up to gearing of say 80%, you might find a capital gains tax bill of 30-40% means you cannot afford to sell (it would make you bankrupt!). I understand for instance if you move to
My final comments I will expand on in future special reports. Financial independence is not just about making serious money (value and income) from property investment – its more holistic than that.
Some key principles to financial independence are:
- Stay alive! You cannot increase you earned income and asset value without being alive – so staying healthy and leading a healthy existence will help your family (and yourself of course!). Do you have a duty to your family – yes! If you increase your personal wealth by say 20% a year (this is of course compounded), and you live for another 30 years instead of 15 years – your ending family wealth will be 15.4 times more! So healthy eating, lots of exercise and positive thinking is an economic family concern! It pays to keep healthy and fit!
- Stay together! If you are a male or female, do not get divorced – at best this will commonly reduce your immediate value by 20-40%. If you are a woman, you will miss out big time on the value increase and income of your husband in future years, unless you are the property investor and earner and he is the spender! Happily married families are normally far more wealthy than divorcees. If your marriage is in trouble – try and repair the damage quickly – not only for any kids, but because it can lead to financial ruin!
- State a goal, plan and action! Be action focussed and plan to get wealthy. If you do not write down your financial and personal goals and discuss these with your partner, the chance of achieving financial independence and high net worth is dramatically reduced. You need to write it down, make a commitment to yourself, or to yourself and your partner, and then action the plan to achieve your goal. No pain, no gain as they say. The plan should of course include staying married (if you are married), staying healthy as well as (probably?) making serious money!