Thank you for the positive feedback we had about the new look format and content for the newsletter. Judging by the number of new subscribers we've had since, you must have forwarded it to “everyone you know.” We will endeavour to send the newsletter out every Friday although on occasions we may be a little early depending on business schedules.

Jet to Let Magazine

We placed an order with our printers yesterday for a further print run of the latest edition of the magazine. The incredible demand has taken many of us by surprise and is also attracting advertisers as diverse as private hospitals and shipping companies!

New Staff Additions

I would like to welcome onboard four new members of staff this week. Hugh O'Shaughnessy ACCA joins us full-time as our Group Accountant, Dawn Hignett joins the marketing team and Emma Merry and Emelia Kajda bolster the customer services team.

Bank of England

The Bank of England has left base rates unchanged at 5.25% which is in-line with most expectations.

European Central Bank

The European Central Bank has left base rates on hold at 3.5%, but watch out for a rate rise next month.

Negative cashflow investing – Part 2

In my last newsletter, I said that I didn't think it was wise for novice investors to pursue a negative cashflow investment strategy and used Romania as an example. Let's look at this in more detail here:

Property investing is a numbers game

One of the worst mistakes an investor can make is to ignore cashflow. Cashflow is like the blood which runs through our veins. Without it you are dead (and buried). Property investing should be treated like any other business and to remain in any business, cashflow is paramount.

Let's look at 2 investors:

Investor A is a novice and he buys three properties with negative cashflow. These are the first properties in his portfolio. He has been advised that capital growth is the aim and that you just “subsidise” the cashflow in the short to medium term:

The negative cashflow is:

Property 1 per annum = (3000)

Property 2 per annum = (2000)

Property 3 per annum = (4000)

One year's subsidy is £9000 - that is, assuming that you have tenants from the beginning! Most of us who invest are aware that this platinum scenario of fully tenanted properties on completion, paying a good rent does not always materialise.

So, let's now assume that only 2 of those properties have tenants from the start and that the rents they pay are slightly less than the predictions made in the sales brochures on which you have based your cashflow projections.

As these properties complete, a glut of supply hits the market as other developments spring up at the same time due to investor and developer appetite. Rents then fall, explaining why many projections of rent in Eastern Europe are generally not met in reality. Admittedly, over time they will recover in line with economic activity, but this does not help the novice investor. He would have to have a lot of cash to continue subsidising his portfolio over this length of time.

Let's assume that the third property doesn't rent for 6 months or more, further increasing our investor's costs. And then he loses his job! What then?

Well, he can sell - or can he?

That depends on the re-sale potential in the market in which you are investing. Looking at the Romanian market again, I was kindly sent an investment appraisal, by a subscriber to this newsletter, for properties in Bucharest. I commend the company selling these properties for its honesty in assessing the re-sale potential of the units. I paraphrase here:

we predict that the rental market will have increased, as a growing number of people will not be able to afford to buy, and will be forced to either rent, or rent for longer before buying.

This means that "sell on completion" strategies in this market are more difficult and holding and renting is a more logical strategy, albeit initially in a soft rental market.

So how does Investor A exit this investment when the yields will be too small for the investor market and the price too high, according to our experts, for him to sell? And at the same time more and more units are being brought to the market with developer incentives. Whether he can sell or not, property is not a liquid asset and as such will not be of any help in the short-term.

This is a classic case of liquidity and financial risk as he must continue to make the payments on the properties or risk foreclosure.

My own experience in Luton in the early 1990s springs to mind. Despite one investment property in question being in negative equity due to the overall market fall, I never became a forced seller due to a healthy and positive cashflow. This property was then sold many years later at a significantly higher price. So remember that cashflow is king and cashflow reduces risk.

The increase in re-possessions in the UK at present is due to higher interest rates and falling positive cashflows, whether you are a houseowner or an investor. Indeed, many novice buy-to-let investors in apartments in some of our UK cities have seen falling rents and falling prices with rising interest rates and oversupply. One company I know of actually sells these properties and bases the sales pitch on "treat it like your pension which you pay money into each month and you will see the return in years to come!" Well if you don't have the cash to pay out and the time to wait for capital growth, you will be in trouble (not forgetting opportunity cost). As a result, Investor A is a prime candidate for a forced sale as he has no other portfolio income to help him out.

Investor B, on the other hand, is an experienced investor who fully understands the concept of negative cash flow investing. His current portfolio has a positive cashflow per annum of £50,000 / £75,000 / £100,000 and the subsidy of £9000 for these new investments can be met from his existing portfolio, regardless of any change in circumstances. He will not become a forced seller and can take a solid 10 year view of this investment opportunity and the risks associated with it.

Risk and Return

In the scenario above we have two investors making the same investment but having a completely different and opposite risk profile. Investor A has a high risk strategy whilst Investor B in my view carries a low to low medium risk.

Investing in property is not a game, it needs to be treated like any other business. When you invest in property, particularly overseas, risk has to be at the top of your list of considerations.

Two quotes from the great man himself:

“Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.”

The first rule is not to lose. The second rule is not to forget the first rule.”

Warren Buffet

If you are a novice investor I would avoid negative cashflow investing and cut your teeth in more traditional markets where there are good solid returns in the form of income and capital growth. Build equity and income and then think about higher risk cashflow negative emerging markets. Avoid crazy investment logic.

Experienced investors can make their own mind up and have the resources to reduce the risk significantly and prosper from the long-term gains offered in the less traditional markets.

Interest rates were left unchanged at 5.25 per cent on Thursday, but the city remains convinced that further increases in the cost of borrowing are just around the corner.

The Bank of England's decision to stay its hand suggests that the majority on its monetary policy committee (MPC) were prepared to wait to see what effect the three 0.25 per cent percentage point increases since August will have on demand in coming months.

It also may point to a fall back in the consumer price index measure of inflation for January, on which the official report will have been given to the MPC prior to their vote.

The jump in CPI inflation to 3 per cent in December, a full 1 percentage point above the Bank's 2 per cent target, is one of the main reasons for the rate increase in January.

A majority of economists had expected no change in monetary policy on Thursday, but markets were nervous after last month's surprise quarter point hike.

A survey by Bloomberg showed only 8 out of 50, or 16 per cent, of analysts thought the monetary policy committee would vote to raise rates for the second consecutive month, to 5.5 per cent.

However, 43 per cent of respondents see interest rates at 5.5 per cent or higher by March, and this rises to 74 per cent for rates to be at that level or higher in May.

Investors' attention will now turn to the publication on February 14 of the Bank of England's latest quarterly inflation report for a guide to the Bank's thinking. A week after that the minutes of Thursday's MPC meeting will be released.

The minutes of the January meeting showed a committee more deeply split about whether to tighten monetary policy than had been expected.

However, for many in the 4 to 5 minority who wanted to keep rates unchanged, their decision was based on a matter of timing rather than direction.

Because of this, a tightening bias is likely to persist within the MPC. And recent data may have only marginally tempered this view.

Surveys of the service sector show continued robust, though slightly slower, growth, while manufacturers appear to be coping, so far, with the strong pound. Significantly, both sectors are showing evidence that companies are enjoying a bit more pricing power.

Retailers, in contrast, still need to offer discounts to entice buyers, but not to the same extent as in the recent past. Consumer spending also remains relatively robust, and a better than expected Christmas has not been followed by a weak new year according to industry data.

Anecdotal evidence of pay negotiations suggest workers are prepared to ask for inflation-beating wages in order to compensate for higher living costs, an area of particular concern for the MPC.

Finally, asset prices continue to rise. The Bank of England says it does not directly target asset prices, but it has made clear that they can add to inflationary pressures as households can feel wealthier and increase spending accordingly.

The Halifax said on Thursday that house prices are rising at an annual rate of 9.9 per cent - though it did warn that recent volatility in prices on a month-on-month basis suggested a cooling market. Weaker mortgage approvals data appear to support this view.

In addition, equities are at fresh six-year highs, buoyed by merger activity.

Though borrowers may have welcomed Thursday's decision by the Bank, a respected economic think-tank will have been disappointed by the MPC's reticence.

The National Institute of Economic and Social Research (Niesr) on Thursday called for "at least one further interest rate increase in order to keep inflationary pressures in check".

Publishing its projection that the economy grew by 0.8 per cent in the three months ending in January, Niesr reiterated its belief that monetary policy should be used to influence expectations.

It went on to say: "For this reason and bearing in mind the recent pattern of pay settlements, we think that the Bank of England should err on the side of caution and raise the interest rate again this month."

Niesr may get its wish in March.

Source: Financial Times