Property investment has had a bad rep over recent years. Landlord is a dirty word for some – but if you stick to some ethical principles, you can make great returns on your investment AND be a great landlord.
2019 has seen some radical changes to the buy-to-let market, from changes in tenant fees to increased landlord responsibilities. So, how does this affect buy-to-let as an investment – and how can you ensure you profit?
- The pros and cons of property investment
- Should you be a property investor?
- The ethical dilemma of buy-to-let landlords
- An example of the costs and returns of buy-to-let property
- How Capital Gains Tax eats profit
- What sort of lifestyle do you want from your property investment?
- Research the market
- Investment outlay
- How do you save the capital required?
- The money you earn as an investor will eventually outweigh the amount you spend and borrow – providing everything goes according to plan.
- The rental payments you receive from your tenants can go toward your mortgage payment
- If the property value rises, so does your profit.
- Longer contracts mean you can get to know your tenants.
- The demand for rented accommodation is very high and continues to increase.
- In many parts of the UK property prices will rise over time as pressure on the housing stock mounts, so when you come to sell you could possibly make a small profit.
- If there are any shortfalls between your mortgage payments and rental payments, you will have to pay.
- You will be in charge of finding tenants as well as checking their references.
- Under Right to Rent rules set in 2016, you’re responsible for checking the tenant has the right to live in the UK (and face hefty penalties if you rent to someone without that right).
- You will lose income if you run into a void period (when your property is empty).
- Maintaining the property can be costly and you will be in charge of doing so yourself or hiring someone else to do it.
- Not all of your tenants will be ideal. Some could be disruptive and destructive to the property, causing a headache for you and your other tenants.
- There are no guarantees that property will go up in price over time, even in London. It’s likely that it will in many areas but not everywhere.
- The Section 21 consultation (ending October 2019) may have an impact on contract lengths and selling before the end of a tenancy agreement.
- Current political uncertainty with Brexit means house prices may fall or additional taxes and levies could be placed on landlords, making it a more expensive venture.
You shouldn’t make the decision to invest in property on a whim. It isn’t a decision to be taken lightly. It needs careful consideration and it won’t be for everyone. Buy-to-let investors will require typically 25% of the purchase price to put down plus all the extra costs of buying property such as legal fees, survey costs and stamp duty. It’s therefore not cheap to get out of the investment, which is one reason buy-to-let should be considered as a medium to long-term proposition.
Here are some questions you should ask yourself while making your decision:
- Do I have money to invest?
- Am I willing and able to invest this money long-term?
- Do I have spare time to look after a property and the people who rent it?
- Do I have the skills and funds to maintain a property on my own, or do I have the means to hire someone to do it for me?
- Do I have a strategy in dealing with void periods?
- Do I have a plan for dealing with disruptive tenants?
- Am I willing to upgrade and furnish the property as needed to attract tenants?
If you answered “yes” to the above questions, property investment could be for you.
Before you invest in property, you should also consider the ethical dilemma you face. Some argue that buy-to-let properties are the reason house prices continue to rise and why the younger generations struggle to get on the property ladder.
To get a buy-to-let mortgage, you usually already need to be a homeowner. This means you’re buying a second property that a first-time buyer could benefit from instead. Getting a buy-to-let mortgage is not always as difficult as a first-time mortgage, because you already need to be a homeowner AND have a 25% deposit. So, it’s easier for you to buy a second property than it is for the first-time buyer to purchase the same property.
However, other socioeconomic factors, such as salaries not rising in line with inflation, also impact the difficulty of ‘Generation Rent’ to buy their first house. The mortgage crisis in the early 2000s caused by 100% and even 125% mortgages is a major factor for the very strict requirements for mortgage applications these days.
As an investor, none of these factors are your fault. Instead, you could see your rental property as providing a service to those who either can’t or don’t want to join the property ladder.
You can be an ethical landlord by following a few rules:
- Charge a reasonable rent in line with other properties in the area
- Maintain your property to a high standard
- Respond to tenant queries quickly
- Assess more than basic affordability: Right to Rent risks accidental discrimination, for example, so approach these checks without bias
- Respect the property is your tenants’ private home
These sound like simple rules but many ruthless landlords only see the profit and not the people. This type of landlord will allow their property to fall into disrepair while still charging a sky-high rent, for example.
Landlords are a necessity of the housing market. You can make a profit and maintain a reputation as a great landlord if you get to know your tenants and build a good relationship with them.
Let’s imagine a scenario for one possible investor:
Alice, a successful florist, has saved £40,000 after clearing her debts. She currently owns a one-bed flat. She has other investments in a stakeholder pension plan and share tracker funds, but has heard property is a great way to spread the risk of her investments.
She’s spotted a great two-bedroom flat for sale at £150,000. Her £40,000 savings will cover the 25% deposit and the fees for arranging a mortgage and buying the house.
The property would rent for £150 a week, meaning she’ll earn £7,800 in rental income every year. The prices of flats in the area have also been rising a steady 10% each year, so she could add £15,000 profit in just a year. Add that to the rental income and she’ll have £22,800 profit in just one year (or 15.2% on her initial £150,000 investment).
Sounds like a great investment, right?
Or is it?…
Buying and managing property can be complicated and costly. There are a few more things Alice should add to the out-goings:
- Administration (lawyers, surveyors etc) fees cost between £3,500 and £5,000 depending on the complexities of the purchase.
- Insurance for the land and/or buildings will set her back a few hundred pounds a year. The average annual expenditure on landlord insurance is £217 a year.
- Provisions for upkeep of the house. Professional landlords recommend you budget around 25% of your house’s gross rental for maintenance each year. You may not spend it all one year – but you will need a big chunk if you ever have to replace the roofing etc.
- Tenant and property management fees. Does she intend to manage the property herself or, will she pay a professional – who charge between 5% and 10% a year of the monthly rent – to do it for her?
- Leasehold fees. The property Alice buys is a flat, which often means it is leasehold, not freehold. There will be a quarterly or annual maintenance fee to cover communal areas like the roof, windows, and gardens.
- Base rental return on a 45-or 50-week period (depending on the level of rental demand in her area. Are there tube or bus stations, or schools nearby? How far is the flat from major cities for commuters?).
Alice should also reduce the expected rate of rental return to account for periods when the flat is empty.
If the flat is empty, she will also have to cover local council tax. This can vary widely throughout the country, so it’s important to thoroughly research the area where you’re buying.
Alice has also been swept up in the hype of spectacular buy-to-let returns. The real story is not nearly as rosy:
Capital growth is the term used to represent the increase in the property’s value from year-to-year. You may have heard success stories of capital growth of 30% or more. But across Britain, the average per year (over a good decade of ownership or more) is likely to be around 3%. Anything you get above that is just a lucky bonus. Especially in such an uncertain housing market thanks to Brexit (or a lack of – at time of writing, we’re still not sure what’s going to happen), house prices can go down as well as up.
Real return for Alice’s property (even if she manages it herself) is likely to be closer to:
Cost of home £150,000
Purchase fees (average) £3,250
Insurance (average) £217
Up-keep (25% x rental return) £1950
Property management (7.5%) £585
Leasehold fees (annual, average) £1,200
Two weeks of council tax £75
Rental return (£150 a week x 50 weeks) £7,500
Capital growth (increase in resale value average 3%) £4,500
REAL RETURN is 7.63%
This calculation is BEFORE taxes, too.
Any profit Alice makes on a property by selling it will be subject to Capital Gains Tax on any profit over her annual £12,000 personal allowance. Alice is a basic-rate tax payer earning £30,000 a year, so has used her allowance through her earnings.
If she sold the flat for £200,000 she’s made a £50,000 profit. The tax is paid on this £50,000, and not the full sale price.
As Alice is a basic-rate payer, but has none of her personal allowance left, she needs to work out what tax is owed on the £50,000.
Basic-rate payers pay 18% on any profit above their allowance that remains within the basic-rate band. Anything over that, or higher rate tax payers, will pay 28% tax.
Allowance left in basic-rate tax band: £16,350
£50,000 (profit) – £16,350 (basic rate allowance) = £33,650 higher rate tax
Alice pays 18% on £16,350 (which is £2,943) and 28% on £33,650 (equalling £9,422).
That means the total tax for the sale of this property would come to £12,365.
Take that out of the profit and Alice has made £37,635 – BEFORE fees for selling the house, and the costs incurred during her stint as a landlord.
So, you can see that it is possible to make money from property investments – but it’s not a short-term game to play. The longer Alice owns the property the more profit she can make. If her mortgage for the property was for 15 years, for example, and she owns the flat for 20 years, the real profit comes from those final 5 years.
If you think these numbers are a solid investment plan for you, keep reading to find out how to become a landlord.
The growing popularity of owning buy-to-let properties has spawned a whole new range of finance products. Getting the best value mortgage for your money requires some research and thinking.
- Seek out advice from professionals and other experienced investors. You’re not the first person to look into buying a rental property. Sieve out the drivel and you can learn something listening to other people’s experiences. What kind of mortgage did they favour? How much did they budget for annual home maintenance?
- Work out what suits you. As with most investing, the idea is to narrow down hundreds of choices to a small number best suited to your needs. For example, are you a single buyer? Looking to buy abroad? and so on…
- Use the internet to compare, compare, compare. The internet is a great tool for pulling together a large number of options for consideration. A good place to start is the Moneymagpie online mortgage advice service, provided by independent mortgage specialists London & Country. They cover the whole of the mortgage market and give you advice for free, so try them out – you have nothing to lose!
Make sure you check your credit record before applying for a mortgage. You can do this for free by using a credit checking agency like Experian. It’s an easy thing to do and you can take action to remove any black marks from your record (should you have any) before applying. You don’t want a needlessly bad credit record to wreck your chances of getting another mortgage approved.
According to Vicki Wusche, successful property investor and author of ‘Property for the Next Generation’, it’s not enough to want to make money from property (although that is very important!) You also need to understand the “life” that you want property to give you – the lifestyle – and therefore how you will engage and interact with the properties that you invest in.
To be a successful property entrepreneur you need to be clear about what role property investment plays in the grand scheme of your life. Not understanding this is the single biggest reason people fail as property investors.
What you want your property to provide will determine the type of house – and tenant – you should focus on.
A long-term investment that provides regular income and means the rent pays off the buy-to-let mortgage in full is a great pension plan for some. Others prefer the idea of quick-sale, riskier investments to scale their profit faster.
A long-term plan means you should look at investing in a family-size home that’ll appeal to tenants with children. They’ll want to stay in the area if there are good local schools for their children to grow up in. A quick plan means cheap-but-volume-based student rentals or up-and-coming areas that are the centre of ‘gentrification’ trends. These are riskier projects but, as is always the case, the higher the risk, the more attractive the potential rewards.
Finding a deposit for a buy-to-let property is a big ask because most mortgage lenders want you to put down at least 20% of the value of the property. Some are asking for as much as 30%, but helpfully, there are more and more who will take just 15%.
With the average price of a property in Britain being around £232,574, you’ll need to find at least £47,000 for a 20% deposit before you even start. That’s no small potatoes!
Where can you find that sort of money?
If you’re in the lucky position of having £47,000 knocking about, then great – put that down as a deposit. Or you can aim for that amount in savings – see here. We’ve also got plenty of ideas on how you can invest your money. Or…
If you already own a property where you’ve paid off some of the mortgage, you can use that to help you buy a second one. Some of the equity – or the percentage ownership – you have in the first property can be released by re-mortgaging.
Re-mortgaging in its simplest form is changing or re-negotiating your mortgage to borrow extra money. (To read more about it, click here). Say, for example, you have paid £80,000 into your current mortgage. You could re-mortgage to let you spend £40,000 on a new property, while leaving £40,000 in the original one.
Normally, re-mortgaging to free up cash from your home is a bad idea at all costs. But if your mortgage isn’t hiked to the sky (i.e, you have a little leeway left for rising interest rates), it’s worth considering for a second sensible investment.
In an ideal scenario, you would have paid off more than 50% of your home before you re-mortgage to get into a second one. It’s no good bankrupting yourself just so that you can invest in something else.
Crafty mortgage lenders have cottoned onto the booming buy-to-let market and there’s a whole range of products for you to choose from. Learn more here.
Don’t Forget Purchase and Insurance Fees
Don’t forget you’ll also need a buffer to account for purchase and insurance fees. Your mortgage provider will require you to have buildings insurance cover from the date of exchange of contracts (and not, as is commonly misunderstood, the date of completion). Without this, your mortgage may not be granted.
Purchase fees often amount to several thousand pounds, as you’ll need to pay a conveyancing solicitor as well as for surveys and searches.
Need to save more before you can afford to invest?
As you can see, buy-to-let investments can be a great way to make a long-term return on your money. However, it requires a lot of capital outlay and runs a financial risk when you own the property, too.
If you need to save a bit more before you can become a landlord, check out our money saving (and money making!) tips across the Moneymagpie blogs.