**How
to Become a Millionaire**

This
section is designed to encourage those who feel confident enough with the
principles of gearing and of buy-to-let to make a major investment in the
commercial mortgage sector.

If
you would like to have a million pounds in say 25 or 30 years time, it
essentially depends on what growth rate you can achieve from a reasonably small
starting capital.

Growth Rate to
achieve £1M |
Starting capital
needed for 30 year’s growth |
Starting capital
needed for 25 year’s growth |

10% pa |
£57,309 (17.4) |
£92,296 (10.8) |

15% pa |
£15,103 (66.2) |
£30,378 (32.9) |

20% pa |
£4,213 (237) |
£10,483 (95.4) |

25% pa |
£1,238 (808) |
£3,778 (265) |

The
table above shows that it is possible with high growth rates and smallish
capital or visa versa. The longer
the term, the better: the extra 5 years makes a lot of difference.
The growth factor is shown in brackets – multiply any starting sum by
the factor to see the end result. A
million pounds may sound a tidy sum and it has that lovely sound to it, until
you look at what inflation can do: -

Inflation
rate |
Value of £1M in 25
years |
Value of £1M in 30
years |

2% pa |
£609,500 |
£552,000 |

4% pa |
£375,100 |
£308,300 |

6% pa |
£233,000 |
£174,100 |

8% pa |
£146,000 |
£99,400 |

It’s
probably safe to assume that the purchasing power of £1,000,000 might well fall
by 50% in twenty-five years time. Investing
£1M for income, a 10% annual return can then produce £100,000 gross annual
income – say £50,000 in real terms at today’s prices. But it’s possible to live quite well on that income,
regardless of any other income you might have.

We
have seen from the section on buy-to-let that it is possible to achieve good
returns on both residential and commercial property, provided you are prepared
to face up to the gearing risks. Let
me restate the argument, but now using a good quality commercial property as a
simple example, yielding say 9% pa. Suppose
you have £50,000 cash available, or you can raise it with a remortgage on your
own home.

Now
follow down the line of figures hereunder to understand how you could gear up to
achieve a return in excess of 25% pa.

Buy investment property
£200,000

With a mortgage of
£150,000
(75% LTV)

Capital investment needed
£50,000
(initial deposit)

Income from property @ 9%
£18,000
pa

Cost of mortgage @ 8%
£12,000
pa interest-only

Net Income
£6,000
pa (re-invested @ 7%)

Running yield on capital
12% pa
(6,000 x
100 / 50,000)

Property grows by 5% to
£210,000
after one year

Profit on sale
£10,000

Additional return on capital 20%
pa (10,000 x
100 / 50,000)

Total return in year one
32% pa
(12% + 20%)

Costs
and expenses are ignored although commercial leases are usually fully repairing
and insuring, and are far less trouble than residential shortholds.
But let us say the gross yield reduced to only say 25%, and you could
achieve this every year, your million pounds would be reached in less than
fourteen years. In 25 years £50,000
could then be worth £13,000,000. It
only takes seventeen years at 20% pa return to reach a million.

**Tax
**There
is also tax to consider. But
fortunately, mortgage interest and other management expenses can be offset
against rental income for income tax purposes.
Also, no capital gains tax is payable until you sell the property.
So, if you arrange for the mortgage interest plus expenses to equal the
rental income there is no income tax to pay.
You can do this by picking a lower yielding but higher growth potential
property and maximising your mortgage by raising a re-mortgage on your own
property just after you have arranged the commercial mortgage.
Although the extra mortgage is secured on a private residence, the taxman
looks at how the money was used, not where it came from: if it was a commercial
venture, it can generally be offset for tax.

Capital
gains tax now enjoys taper relief. After
10 years the tax is down to just 20%, and then only when you sell the asset and
is only payable on the gain less buying and selling expenses.
But why sell? If you have picked a good asset, you simply increase the
borrowing as it rises in value and rents are reviewed, and use such extra loans
to purchase additional property.

**Save the surplus
**Any
surplus rent, after charges, could also be saved up as deposit towards the next
purchase. The best way of doing
that is to enjoy the best short term return possible – a current account
mortgage or a flexible repayment mortgage on your own home as described earlier
is an excellent, safe short term investment, and is perfect for parking rental
income.

You
may think that using the surplus rent to repay part of capital owed on the
commercial mortgage might be as good. But
you are enjoying tax relief on that mortgage
- it is as if MIRAS applies on the full loan and at the full rate.
8% pa gross interest only actually costs 5.6% net of 30% tax, or 4.8% at
40% tax. So the commercial loan is
only worth repaying if you cannot achieve the same net interest rate return
elsewhere. A flexible residential
mortgage at say 7% offers an investment return of 7% - net of tax.

Continuing
the example, after 30% tax, the rental income surplus of £6,000 pa reduces to
£4,200. Invested over five years
at 7% pa produces £24,153.

**Five years later
**Let
us continue with the example above and look at the position five years later.
If the property grows at say 5% pa it will have increased from £200,000
to £255,000, a £55,000 increase. The
more valuable property is now eligible for an increase in mortgage.
The reviewed rent could now be increased to say £22,000 pa , so the
situation after five years is as follows:

New
mortgage now
£191,250
(75% of new value)

Mortgage
costs @ 8%
£15,300
pa

New rental income
£22,000
pa (<9% pa)

New net income
£6,700
pa

Cash from new mortgage
£41,250

Cash from saved rent surplus
£24,153
(after 30% income tax)

Total cash available
£65,403
deposit - next property

£65,000
is now a sufficient deposit to purchase another £260,000 property, assuming
another 75% mortgage, and you double your assets.

Assuming
yields were roughly the same, in another five years the exercise can be repeated
again, only you can now buy two more new properties bringing the total to four.

**In Ten Years Time
**If
you sold up all four properties after ten years you could have about £328,000
after repaying the loans and before capital gains: all from an initial
investment of £50,000. This
represents a return of about 20% pa

**In Twenty Years time**

Repeating this exercise for another five years gives you eight properties in
total, and sixteen properties in another five years.
Ten more years in total at 20% pa would bring up the free capital in now
sixteen properties to about £2M. It
has taken just twenty years in total to do it.
The rental income less the mortgage interest, if now simply taken as
income, would be around £250,000 pa before income tax, assuming the 12% pa
running investment yield is sustained.
Again there is no need to sell the property: one could happily live on that income thereafter, enjoying
regular rent reviews to combat inflation. If
your children inherit the portfolio on your death there is no capital gains tax
to pay. As a business asset there
are also opportunities to mitigate inheritance tax, but you need separate advice
for that.

I
have not included several important items for the sake of simplicity, but they
must be included in a real scenario. There
is the question of stamp duty on a purchase, which can take as much as 3.5% of
the property value, and also legal and mortgage valuation fees which can take
another 2%. This could take out the
entire first year’s growth of the property, so one should allow for that in
growth projections. One way is to
simply knock one year off the growth term and project at the expected growth
full rate. Another way is to
project at a lower growth rate. For
example, 5% pa over four years produces roughly the same end value as 4% pa over
five years.

**Interest-only, fixed rate mortgage
**The
mortgages have each been assumed to be interest only to enhance the yield.
Lenders are usually quite happy to do this provided there is a sufficient
term left on the lease. There is no
point in repaying any capital while the gearing is making money – indeed, in
theory, there is never any need to repay any loan whilst the overall growth
(running income plus capital growth) exceeds the mortgage interest.

A
fixed interest loan is quite appropriate for a portfolio of this nature to at
least minimise the downside risks. Commercial
rents are usually pretty stable and so an equally stable mortgage payment
produces a stable surplus.

**Remember the risks
**Now
while all the above has been very simplified, the object is to hint at what is
possible. An 8% mortgage rate may
be a bit on the high side, but then I have ignored buying costs. I
have ignored time differences when gross income is invested and tax is actually
paid a year or more later. Obviously
the property could grow faster or slower than 5%; it could even fall leaving you
with a net loss. But
these are the inevitable risks that need to be taken to achieve rewards of this
magnitude. There is safety in
numbers – better a larger number of smaller properties than the other way
round, unless a really solid covenant is available from a larger property.

**Spreadsheet tool
**A
spreadsheet is included called “Property Portfolio” and will enable you to
play with various scenarios. The
aim is more to develop the principles of the business model, rather than as an
accurate plan. The end result is
very sensitive to the LTV selected, and the property growth rate is important
too. In real life, yields and
growth rates vary from year to year: but
since property is a real asset, it is linked to the inflationary process and
therefore compensates to an extent for unpredicted inflation.

I
also suggest you become familiar with the “Investment Property Return”
spreadsheet, which enables all the costs to be entered for a specific property
transaction in order to calculate the possible return on capital (expressed as
an IRR).

**Summary
**In
short, a carefully selected, geared portfolio of good quality commercial
property, such as warehouses could produce a sizable profit over the medium to
long term, and provide a good source of income thereafter.
£1M is fairly easily possible before you retire provided you get
cracking in your early 40’s at the latest.

I
have used an example of £50,000 to achieve £2M in twenty years. In theory you could scale down with a lower starting capital,
but good commercial property requires a sizable commitment and even a £200,000
property is somewhat light. One way
to build up to this deposit is your own home and a remortgage at the right time.
A house costing just £100,000 today would grow to about £160,000 in ten
years at 5% per annum. That’s a
£60,000 increase for a start.

Finding
and selecting the commercial properties themselves is clearly crucial.
You will need to bone up on the intricacies of commercial property and
perhaps take on a professional commercial mortgage broker and a buying agent to
guide you. It is worth explaining
your amateur status to start with since on the whole, people in the professional
sector are very helpful to beginners who may become substantial clients in the
future.