A poster on a property forum said: ‘I currently own two BTL properties and for some time now been thinking about my next property strategy. I’ve decided joint ventures, specifically becoming a private/silent investor, is the way I really wish to go. However, having read many related articles and case studies, I can’t seem to find what the potential or average net returns could be. In short then, what sort of returns should I expect to make through property and in JVs in particular?’ Let’s address this one head on then and outline the sorts of return generally available through property investment projects. However, upside rarely comes without downside, so we consider the risks as well as the rewards today too.
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Have a realistic view of property returns for different types of property project. Always remember to quantify the trade-off between risk & reward, especially in JV projects.
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Transcription of the show
Hello and welcome to another edition of The Property Voice Podcast, my name is Richard Brown and as always it is a pleasure to have you join me again on the show today.
Today’s show is inspired by an exchange I recently had on a property forum relating to typical property investment returns. In fact, the poster was specifically interested in joint ventures, as a passive or finance partner, and whether he could expect to achieve returns of something like 20% per project in such a situation.
What do you reckon, does that sound realistic to you and if so, what could be the potential downside?
Let’s dive into the meat of the subject to find out.
As I mentioned, I recently came across a forum thread, where the poster said something like this:
“I currently own two BTL properties and for some time now been thinking about my next (and future) property strategy.
I’ve decided JV’ing, specifically becoming a ‘private/silent investor’, is the way I really wish to go. However, having read many related articles and case studies, I can’t seem to find what the potential or average net returns could be.
You see, a wealth management company currently invests a considerable amount of my spare cash in shares. Before surrendering some of that cash into property (as a private investor) I need to be sure it’s going to be worthwhile.....I mean could I make 20%+ profit on each property investment?
For example, if I provided £100K as a private investor to a property development project, could I then realistically receive back somewhere like £120K?”
In short then, what sort of returns should I expect to make through property and in JVs in particular?
First of all, I will share a link in the show notes that sets out some of the top long-term performing fund managers performance listed on Trustnet. In summary, the BEST performing fund manager over a 10-year period averaged an annual compound growth rate of 10.4% over 16 years. The fund here relates to stock market returns. Therefore, I would be sceptical about someone generating returns of 20% per year or so on a consistent basis through the stock market without taking on significant risk or fully understanding what they are doing. There are always exceptions of course...
Speaking of risk, again I share an article in the show notes that compares performance and risk between equities and property, along with a couple of other asset classes. Whilst residential property and equities have similar returns, equities carry far higher risk. The principal explanation for this, from my point of view, is that obviously property comes with an underlying asset that has a realisable value if it needs to be called in and disposed of. In businesses, this is not always the case and even where there are assets, they may have little residual value in a break up situation.
Specifically, in terms of property, there is a risk / reward trade-off as well. There are different types of property strategy that can generate different types of return. It is difficult to fully predict the total returns available, but here are a couple of very general guidelines, which are based on my own and others' experience. The following examples, assume no leverage or debt is used and the values provided are typical ranges, with higher and lower results also possible in individual cases:
- Long-term buy-to-let in residential property is probably IRO 10% to 12% on average nationally, which combines both rental returns and capital growth over an extended period.
- Flip projects, which here is buying and selling a single dwelling for profit, should generate anything from 5% to 25% as a general rule
- Conversion types of project, if then sold on, should generate anything between 10% and 30%, again as a general rule
- Development projects, if then then sold, should generate anything between 15% and 40%...on average
Remember that these returns would be gross returns before the JV divides up the spoils...so for a 50/50 JV...halve these numbers for each party’s resulting profit. The results, aside from BTL, are by project, so there could be a rounding up or down to calculate annual returns based on whether a project completes in less than or more than a year.
Is it possible to get better returns? The short answer is yes, of course, it is possible. Taking on more risk should, in theory, generate more rewards. For example, gaining planning permission in the green belt or a conservation area. Equally, it can also go against us. For example, if that planning application is declined leaving us with a bunch of abortive costs. In other words, there is a reason why the potential returns need to be higher with some of these project types, as not all work out as planned. Developer margins tend to be higher as they have to carry more risk, heavier costs and several less known issues.
Another way to improve the returns is to use leverage or borrowing, which could see some of these results potentially improve significantly. A simple example will help illustrate this.
Let’s say we have a flip project with the following outline numbers with a cash sale:
- Purchase price £120,000
- Total costs and fees £40,000
- Total cash investment £160,000
- Selling price £190,000
We can see the profit figure is £30,000, which would result in an ROI of almost 19%.
If it took 9 months to complete, the annual equivalent return here would be 25%
Now, if we took this same example and this time used bridging finance at 75% LTV with an interest rate of 10% per annum plus finance related costs of say £2,500, the result for this same project would then be as follows, simple speaking:
- Purchase price £120,000
- Total costs & fees excluding finance £40,000
- Finance charges £9,250
- Total project costs £169,250
- Total cash investment £79,250
- Selling price £190,000
This time, we can see the profit figure is £20,750, which would result in an ROI of over 26%.
The annual equivalent return would be almost 35%, which compares to 25% without using leverage.
In effect, by using a lender’s cash instead of our own, despite it eating into the profit margin by over £9k, we can increase our overall return percentage.
However, funding carries its own risks and complexities and with lower value projects the fixed transaction costs often drag the net profit figure down as well. In a similar way that a hedge fund or venture capitalist may use debt to gear up their returns, so too can a property investor / developer, often in return for giving up some security. This is fine as long as the market does not turn against us mid-project...or there is a global financial crisis!
To illustrate this, imagine that same project but instead of taking 9 months to complete it takes 18 months instead. If everything else stays the same, the only change is the cost of finance, which would increase from £9,250 to £16,000 instead.
That would increase the cash requirement to £86,000 and reduce the profit to £14,000.
The ROI would fall from 26% to a little over 16% or just under 11% on an annualised basis.
This illustrates some of the downsides of leverage quite well, which we will come on to in a moment.
Bearing in mind the original question posed on that thread was essentially: can I expect to return 20% as a JV partner, then I would say this. If you have a modest to high appetite for risk and can set aside sums that you can either afford to lose, not gain that much or at least wait to get back, then more adventurous development projects could deliver the desired target returns. If using leverage, it could potentially be achieved on flips, conversions and development type projects.
However, if you are more cautious and wish to protect your capital a little more, then perhaps it would be wise to set the bar a little lower, avoid over-leveraging and accept more modest levels of return instead.
Understanding some of the potential risks
In order to realise higher returns, we often have to trade off with higher risk. So, let’s consider some of the main risks that could be involved in some of these types of project.
- Project-related risks
- Project delays
- Unexpected costs and cost overruns
- Quality issues
- Approvals & permissions-related risks
- Council departments issues: planning, licensing & building control requirements
- Freeholder & managing agent approvals
- Utility providers
- Market-related risks
- A drop off in demand that pulls down exit values or slows down our sales
- Economic factors such as recession and other general economic shocks can happen, particularly with a longer project duration, such as a new build development
- Finance & legal-related risks
- Problems and delays securing finance
- Lender policy & criteria that impact the project
- Costs of finance: fixed transaction costs, re-inspection fees & penalties being incurred for extending the facility
- Legal barriers, irregularities & disputes, watered down or demoted security interests
- Partner-related risks
- JV partner or other key stakeholders not doing what they say they will or being obstructive, conflicting objectives and lack of clear roles or even skills & experience
- Trades & professionals’ mishaps, disputes & errors
- Materials or labour shortages
- False assumptions and poor due diligence
- Can feed into any of the above factors
- Too optimistic, failing to have contingencies / plan B
- Errors in the research phase
- Force majeure
- Acts of God, strikes, war, terrorism, etc.
- Theft, loss & damage
- Personal issues such as health, holiday or competing calls on time (e.g. a job or other business / project)
These are the common risks that we have to factor in. It’s not just a case of looking for the best returns as we have heard.
There we have it then. I wanted to share a quick set of guidelines of what sort of returns to expect from different types of property project using some typical ranges. These can range from 5% to 40% in total before dividing them out between the JV partnership.
We have seen that we can target the upper end of this range, either by accepting greater risk and / or by using leverage or debt to reduce our personal cash investment. Leverage can help us to make more with less so to speak.
We have then also considered some of the main risks that we need to look out for, manage and then get comfortable with if that is the path we would like to take. These risks will not be acceptable to everyone that’s for sure.
JVs are a very interesting aspect of investing in property projects and have a lot of potential benefits. I undertake joint venture projects myself and so speak from experience here. However, we should always equally consider the downside as well as the upside in any property investment opportunity. This means carefully evaluating the risks, understanding what they are and then being ready to accept the good with the bad at times too.
That is what I wanted to cover this week, I hope that’s been helpful. I have tried to be realistic during this episode as far as possible. Do always keep in mind that a project has both a risk element as well as reward one. With that in mind, we should be well placed to make a good judgement as to whether it suits our return expectations, within our personal risk tolerance, before leaping into any particular property project, be that in a JV or on our own.
We haven’t had a shout out for a little while now, so just before I leave, I have a small update on a new property book that has just been released. It is a collection of tips from experienced property investors, which also happens to include a contribution from Yours Truly J
The book is called: The No.1 Property Investing Tips From Top UK Property Experts. It is available from the Amazon Kindle store for the princely sum of £0.99. I am not on a royalty or anything like that, but there will be something in there for everyone I am sure.
There we go then, that’s me for another week. As always, thank you very much for joining me on the show today and until next time on The Property Voice Podcast…it’s ciao ciao!