Growth vs income

Without the merest shadow of a doubt, the greatest property-related TV show of all time was Property Ladder.
In every episode we’d see a couple of utter pillocks buy a property at an over-inflated price, then undertake some kind of bonkers conversion or refurbishment. They’d be watched over by the permapregnant Sarah Beeny, who did her utmost to gently suggest that converting a two-bedroom semi in Grimsby into four high-end luxury shoeboxes might not be the best move, or that hot-pink textured
walls aren’t everyone’s ideal decor.
Inevitably, after overrunning by six months and adding very little value, the pillocks would then sell their hot-pink high-end shoeboxes for a handsome profit – purely because the whole market had risen by about 40% in the time it took them to rip out a historic original fireplace.
Unfortunately, many viewers were interpreting it as a how-to guide: hey, if those idiots can do it, then I can too!

In retrospect, the whole show was the surest sign we had of the coming apocalypse: when total amateurs are diving into an unfamiliar industry, screwing everything up and still walking away with
double-digit profits, it’s high time for a serious market correction.
(When the correction came, a follow-up series called Property Snakes and Ladders showed what happened to the people who were still gaily ripping out load-bearing walls when the economic system collapsed. For some reason, Beeny wasn’t knighted for her restraint in never once laughing in their faces. )

Too much growth, not enough income
Anyway! The point is that during this boom/bubble, everyone was fixated on growth. In a market that’s rising 25% every quarter, I suppose that’s understandable.
But while growth is great, you can never be totally sure when (or to what extent) it will happen. If you’re buying purely with growth in mind and the property isn’t making you any money month on month, you’re gambling that the capital value will rise before your monthly expenses increase and push you into a loss.
Rental income, on the other hand, isn’t a gamble: you can pretty much lock it in when you buy, and collect it forever.
Say you put down £25,000 to buy a house worth £100,000. You then rent it out for £700 per month. An interest-only mortgage at 5% will cost you £312.50 per month. Let’s budget £100 per month for repairs. What does that leave?
Two hundred and eighty seven pounds and fifty pence per month in pre-tax profit. Every month.Forever!
Of course, we’ve forgotten management fees. And any periods where you don’t have a tenant. And the fact that your mortgage rate might go up. And that rents might go down. And tax. But you can build all that into your calculations.
The point is that if the property doesn’t go up in value for a number of years – and even if it goes down for a bit – you’ve still got £287.50 dropping into your bank account every month.
Naturally, nobody wants the value of their property to go down – and historically, the gains investors have made from capital growth have dwarfed their rental returns. But given that you have no control over growth, you’d better make sure that the property is making you money every month.

Re-enter our old friend leverage
The use of leverage is, of course, a factor in whether or not the property makes you money every month – because the bigger the mortgage you take on, the more the interest payments are going to take a bite out of your monthly income. (And depending on your circumstances, the new tax treatment of mortgage interest might make that bite even bigger.)
During the last boom, people were taking on such massive mortgages that the property would actually cost them every month – and they didn’t care, because its value was going up faster than they were having to put in money to pay the bills. I even know some landlords who didn’t bother putting tenants into their properties, because it was less effort to just shovel in the cash while they watched the value rocket.
Clearly, this is madness.
Leverage, in short, is a great tool to help you benefit from rising prices – because at its simplest, it means you can buy (for example) four properties instead of one and therefore expose yourself to more capital growth. But at the same time, the interest payments make it harder for you to make a monthly profit.