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Karen Wheller

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Traps of developments for buy to let investors

Don’t be fooled by developments, there is more to it than meets the eye. I get developers wanting to sell developments with the dozens these days. That is no surprise, but since the market turned the buyers are far less than before.

Fundamentally there is nothing wrong with buying developments as investments. Developments in the past sold like hotcakes. I have nothing against developments, I think they are great if priced correctly and suited to the investment strategy of the investor. There were a few pitfalls that investors didn’t look at in the past with developments. And I won’t even talk about contracts of developers and many other serious issues that need discussion (maybe another time) but right now I want to mention the obvious, which seems wasn’t so obvious.

In time of great capital growth many beginner investors wanted to get into the market. The barrier with property is that it is expensive. That is the truth, and add to that transfer costs and other costs, it gets out of budget for many beginners.

The solution? Of course developments, because developments were different, or so they thought.

They were different and still are in the sense that those costs are none existent. Therefore, if an investor wanted into the market a development was a brilliant opportunity if the cash was not available for the transfer costs. The costs are included in developments, plus in the past beginner buy to let investors got 100% bonds all the time.

This doesn’t make developments bad. It only created the perfect environment for some beginner investors to make some irrational financial decisions.

Developments are more expensive at times than second hand property and add to that the fact that costs, lets’ face it, were actually factored into the price, the investor got a higher bond with a higher price and the only benefit was not dishing out money to buy the property at the beginning. In other words the cash flow. They used all the way Other Peoples Money (OPM), which is great, but comes with a price if done incorrectly.

This gave a phenomenally false sense of security. All bonded, even some cash back from developers, bond to be paid much later, and good to go as a property investor. Everyone can do it, its' easy. Right? Not so fast....

But life turned out pretty different at the end. This false sense of security, made property investors quickly forget that the bond is high, the rent is low and they put no cash in or very little from rentals.

But that is not all. Developments had massive capital growth, so investors bought more and more and more. This more purchasing also meant more false sense of security, more high debt and more risk that was not really calculated.

When interest rates went up and with no reserves and a few properties to take transfer, life started to look different. Some investors did not have the money to actually pay all the bonds even with all the cash back. Maybe for a few months, but the whole strategy was completely unsustainable and re-financing when affordability was gone due to the bonds, was not even an option.

So in short, developments can be great, no doubt about it. But don’t fall into the trap of false sense of security because you have to pay no transfer costs. If you haven’t got that much reserves, where will the reserves come from if the interest rates goes up even to service that high bond.

In property investing and any other investing, capital, in other words cash and cash flow comes first and investment second. It is the nature of the game. Trying to cheat the game you will only cheat yourself in the long term.

Playing the game by the rules, rules with constitute solid fundamental knowledge about investing; will get you rich for the long term and generations to come.

Related article: Property transfer is nearing and no money to pay the bond, now what?

 

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Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved.

 
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