Are you ready to start building your property portfolio? The very first step is to work out where your goldmine area will be. In this post I go through a step by step process to help you find your goldmine area.
Your motives
What are your motives for getting into the property market? Is it to move some of your existing cash pile into another asset class, to gain better returns? Is it to spread risk? Or if like me, you may wish to set up a base of financial independence by having enough cashflow to cover your living expenses?
It is important to clarify your motive from the outset as this will determine how much cashflow you will need. This in turn will influence the type of property and therefore help you pinpoint the goldmine area you should be looking at. It will also give you focus when it comes to what deals you will put offers into and what deals you will pass on.
How much cashflow do you need?
Once you’ve clarified your motives, you should find it easier to specify how much cashflow you will need. From now on we will express this number as monthly cashflow or more specifically the profits you receive per month before taxes.
Let’s surmise that you want to buy your first property so that you can start a small portfolio, which will pay you a monthly income such that you can retire from paid employment (if you wish). Define your monthly cashflow number now. Write this number down, so that you are reminded of it all the time. I will assume that you have already defined what your monthly expenses are. If not please do this exercise first. I show you exactly how to do this in my book How Do I Retire Early.
Going forward we will use an example of someone who needs a monthly cashflow of £2,000 from their property portfolio. Now we will start to look at the geographical area you will search for properties in.
Yields and financials what you will look out for
Before we establish where your goldmine area is, we need to spend a little time thinking about the key financial indicator – yield.
Yield
Yield is simply the amount of annual income you will achieve on a single property, expressed as a percentage of the price of the property. The formula to work this out is annual rent divided by the price of the property multiplied by 100.
(Rent/price x 100)
For example, if a particular investment property can be purchased for £100,000 and the rent is £900 per month, then the yield will be:
£900×12 / £100,000 x 100 = 10.8%
A yield of 10.8% would be very good, as ideally you want to be looking at properties that yield more than 7%.
Although the yield isn’t what your eventual profits will be, as it doesn’t take into account running costs, void periods and of course mortgage repayments, it is still a valuable indicator as to whether you should be looking at a particular property as an potential investment. If you work out the potential yield on a property and it works out less than 7%, I would pass on it straightaway.
Finding Your Goldmine Area
Now we have established what your target rental yield is, your next task will be to establish your goldmine area, using yield as a guide. Establishing your goldmine area takes some groundwork but it is well worth it. After all that’s why it’s called a goldmine. Your goldmine area is an area in which you’ve already worked out that the average yields are optimal and the other criteria are a fit for you.
Geography should be your first criteria. In what location do you want to own property? Ideally it should be within 30 minutes commute, as you will need to visit the properties before making offers. It is also an area that you can get expert knowledge in quickly. Having that expert knowledge of your local area can help you to find better deals and also to understand where the potential pitfalls are.
You will be doing some analysis on the financials of the properties in your goldmine area and I can recommend setting up a spreadsheet to do the donkey work for you.
Download a free copy my Goldmine Area spreadsheet in the Free Stuff page. You can also see a screen shot below.
First go online to www.rightmove.co.uk and search properties for sale in a small geographical area within your 30-minute catchment area. Rightmove allows you to search in specific locations such as Town, County, Postcode. I would advise searching postcode sub-sections e.g. M25, M45, BL8. These are also called the outward code. Specific postcodes, for example M16 0RA which includes the inward code, will be too small to gain a good sample area.
Filter Your Search Results
Next, filter your search by numbers of bedrooms, separately. I.e. first look at 1 bedroom, then 2, then 3. If you already know you are only looking at 2 or 3 bedrooms, then you only need to search for these. You might also have already decided you don’t want to look at flats or bungalows. If so you can filter these out too.
Sort by price lowest to highest. What you are looking for here is the average price for a property with that specific number of bedrooms. Use the median price for a quick and dirty average. This is the middle price, so if your search comes back with eleven pages of results, for instance, go to page 6 and choose the middle-of-the-page price. Enter this into your spreadsheet. Repeat this for each number of bedrooms.
Repeat with For Rent
Now you want to repeat this exercise for rental prices. Go to the For Rent tab on Rightmove and find the average rental price for each number of bedrooms, using the same method as above. Enter these into the next column on your spreadsheet. Use the following formula to work out the average yield for each number of bedrooms:
Av. Monthly rental x 12/ Av price x 100. Enter this into your spreadsheet. (If you use my spreadsheet, Excel will work this out for you).
Repeat this for every sub-area in your catchment area. Once you have done this you will have a breakdown of yields per no. of bedrooms per sub area.
Go through your spreadsheet and delete any areas/bedroom numbers that come in with an average yield of less than 7%. Now it should be easy to choose the highest yielding sub-area as your Goldmine area.
Yes, I know this will be a laborious task at first, but believe me, once you have found your Goldmine area, you will have struck gold.
How much have you got for a deposit?
Once you have chosen your initial Goldmine Area, we will assess whether this is a viable option for you, in respect of your personal circumstances.
Firstly, we will now start to look at how much liquid cash you have available for your first deposit. Assuming you have this number to hand, you will be able to see how realistic this goldmine area is for you. If you don’t have this number to hand then please go ahead and work this out.
Let’s say that you have a cash deposit of £25,000 which you can get your hands on within the next few months. Now have look at your Goldmine Area prospecting spreadsheet. Look at your chosen Goldmine Area and look across to the row of your chosen number of bedrooms. For instance, in the example screenshot above, you can see the following are yielding above 7%.
- Camberwick Green – 2 beds
- Chigley – 2 beds
- Royston Vasey – 1 bed
- Hobbiton – 2 bed
But as we look down the deposit required columns, we only have enough average deposit for Camberwick Green – 2 bed and Royston Vasey – 1 bed.
You may decide not to consider 1 bedroom properties, therefore 2 bedroom properties in Camberwick Green would be you Goldmine Area.
How many properties will you need to get your target cashflow?
The second sense-check, when choosing your goldmine area, after the amount of deposit required, is how many properties will you need to purchase to reach your Financial Independence target? Again, there is no right or wrong answer to this, your number will be personal to you and is a factor of how long it may take.
Let’s use simple figures to illustrate. Say your financial independence target is £2,000 per month. Look at your goldmine area on the prospecting spreadsheet, in this case Camberwick Green – 2 beds. On average we will need to borrow £75,000. At today’s rates of 4.89% interest on an interest only mortgage your mortgage would be £3,668 or £306 per month.
If the average rent is £800, this will give you an average gross profit of £494.
Remember this is an average and doesn’t include costs such as repairs, insurance and void periods etc.
So, dividing £494 into £2,000 means you will need to purchase around 4 properties of similar profitability. Is four properties acceptable to you? How long will this take, given your circumstances?
To summarise, then, your choice of goldmine area will come from working out how much cashflow you need. You will need to bear in mind what the yield is and what minimum yield you are prepared to look at. Ideally this should be more than 7%. Then figure out how much cash you have available for a deposit. Does it cover the average deposit needed in your proposed goldmine area? Finally, how many of the average properties in your goldmine area will you need to purchase? Is this acceptable to you? Remember also that your motives for investing in property will under-pin all of this. Be clear on your motives.