MoneyMagpie

Feb 06

Property investment – should you be buying to let?

Property investment looks viable again. There are more buy-to-let mortgages on the market now than ever before after the crash in 2008. Also in many parts of the UK, property is much cheaper than it was.  Take a look at our guide to property investment to see if this is the right investment for you.

 

The pros and cons of property investment

The pros:

  • 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.
  • With the newly introduced three-year contracts you can get to know and trust your tenants.
  • The demand for rented accommodation is very high and likely 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.

The cons:

  • 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.
  • 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.

Should you be a property investor?

You shouldn’t make the decision to invest in property on a whim, according to David Hollingworth of London & Country.

“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.

An example of the costs and returns of buy-to-let property

Let’s imagine a scenario for one possible investor:

Alice, a successful florist, has managed to save £20,000 after successfully clearing all her debts. She lives with her mum and dad paying just £50 a week towards rent and would like to invest so she can grow her money towards her ultimate goal of owning her own home. Alice has started a stakeholder pension plan and has £1000 invested in a share tracker fund, but is looking to diversify – or spread the risk – of her investment. She’s heard through friends and read in the paper that property is hot.

Down the road in Bethnal Green, she’s spotted a great  little two-bedroom flat. It’s £250,000, which makes it within her price range. Her £20,000 savings represent a deposit of 8% – enough to get a basic mortgage. Alice’s flat will rent for £160 a week, making a rental income of £8,320 a year. She has also heard that the prices of flats in the area have gone up 15% in the past year. This makes Alice keen as mustard… the flat is going to make her £8,320 plus £37,500 (15% x £250,000) or £45,820 a year. That’s a whopping 18% return on her £250,000 investment.

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 complications 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 home buildings insurance is £190 a year.
  • Provisions for up-keep 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.Property investment
  • 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 property’s value – to do it for her?
  • 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 Bethnal Green from the City 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 for two weeks. This can vary widely through-out 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.

Real return for Alice’s property (even if she manages it herself) is likely to be closer to:

PAID OUT

Cost of home £250,000

Purchase fees (average) £4,250

Insurance (average) £190

Up-keep (25% x rental return) £2,080

Property management (7.5%) £18,750

Two weeks of council tax £75

TOTAL £275,345

EARNINGS

Rental return (£160 a week x 50 weeks) £8,000

Capital growth (increase in resale value) £5,850*

TOTAL £13,850

REAL RETURN is 5%

 Investing in property is a business and don’t forget that. Property, like all other investments, is subject to tax and other expenses. If you’re looking to make some money by waiting for the price to go up then selling, remember that any profit you make on the sale of your property will be subject to Capital Gains Tax which is a whopping 40%. Property also costs money to buy and sell, to maintain and to rent out. Do your sums before committing your hard-earned cash to a deposit.

If you can get your numbers to stack up – earning you a solid return each year – read on…

Research the market

The growing popularity of owning buy-to-let properties has spurned 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, and won’t be the last, 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…

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 Equifax or 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.

Investment outlay

  • Deposit

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 £180,000, you’ll need to find at least £27,000 before you even start. This is no small potatoes.

Where can you find that sort of money?

  • Cash

If you’re in the lucky position of having £27,000 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…

  • Equity

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.

  • Mortgages

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.

  • Purchase fees

Don’t forget to budget for the cost of buying a home. Buy-to-let purchases cost about the same as a standard purchase.

  • Maintenance and remodelling

Fancy yourself as a DIY expert? Those skills can come in handy when you own your own rental property – especially to keep maintenance costs down. But remember – you want to manage the property as professionally as possible.

Have you ever had the (mis)fortune of living in a house attacked by an amateur DIYer? Mismatched paint and paper, wonky tiles and leaky fittings are not pleasant, and will not encourage your tenant to hang around. One of the most important things about renting out a home is to keep it full of quality tenants. Don’t let your eagerness to complete the work (or miserliness to pay for professionals) on your rental property affect your return.

This is particularly pertinent when buying a home to remodel. Common remodelling mistakes:

  • Hiring the wrong contractor. Don’t fall into the trap of getting your neighbour’s cousin Fred, or anyone else who happens to cross your path. If you’re clear about the job you want done, you can get recommendations for friends for someone who knows what they’re doing and will give you value for money.
  • Allowing someone to work without a contract or insurance is asking for trouble. Any contractor worth their salt should be happy to sign a quote and contract detailing estimated time to completion and so on.
  • Under-estimating the cost. Don’t touch DIY with a barge-pole if you’re not willing to research the cost of the work. Property investmentYou should know things like the cost of any materials, the cost of workmanship, and the cost of delays from weather etc. You should budget for these and get any finance sorted in advance.
  • Not completing the right paperwork. Believe it or not, it’s important you get on with your local council. They are the ones that get to say ‘yay’ or ‘nay’ to all your remodelling fantasies.
  • Over-improving. Regardless of the work you do, the rent and sale price of a house will only be affected by one thing – demand. Forget your desires for acres of peach pastel; unless you’re an interior designer, your tastes should never be reflected in a rental property. Instead, opt for neutral colours throughout and tidy, understated yet hard-wearing chattels. Focus on a clean, functional kitchen and bathroom and easy-to-maintain landscaping.Money well-spent will be directly reflected in the rent, tenure of tenants and, if applicable, the sale price.

As a landlord, your best friend will be insurance. But by nature, it only helps after the fact. In an ideal world, you could prevent the problems occurring full stop. The way to do this is to make sure you have proper ownership and management policies from the start.

Essentials

  • Have water-tight contracts with tenants before they move in. Click here for an example of a tenant contract.
  • Personally check tenants references, including making sure that the referees are bona-fide. You can’t do this any other way than ringing them personally.
  • Make sure you maintain the big stuff. This includes things like boilers, washing machines and roofs.
  • Try to keep a good working relationship with your tenants so that they tell you early on if something looks like it’s cracked or old and about to blow. They’re the ones living there and they will know if something doesn’t look right before it gets so bad that it’s an insurance job.

All these are important things to remember, but you can still have accidents that no one could have foreseen. For that reason, insurance is a must have.

Insurance

So you’ve got your property, you’ve done it up nicely and even got some nice tenants in. Well done! But there are a lot of things that could go wrong: the place could go up in smoke, the pipes could burst and flood the kitchen or the tenants could refuse to pay their rent… and that’s just for starters.

Consider insurance, or you could see all your profit go out of the window with any one of these situations.

What sort of lifestyle do you want from your property investment?

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.

Think about the lifestyle you want; time off, holidays, more freedom, more choices, a shorter working week, or perhaps you want to continue in your current career and property is a side-line, or maybe you see it as a full time job and something you want to develop and focus on every day. Be clear.

Once you know approximately the sort of lifestyle you want to live you can budget for this and work out how many properties you’ll need and which strategy will get you the lifestyle you are looking for.

For example if you are looking for straight forward cashflow with very little of your own time – then buying three bed houses and letting them to families can help you attract tenants that will want to stay as their children are in local schools.

If you can find properties that give you a great return near to where you live and you have a lot of spare time then consider letting to professionals in houses of multiple occupancy. But this strategy will require a lot more of your time.

Once you’ve chosen the strategy for you, focus on it. Don’t play around with a few different approaches. Choose what will work for your goal and commit to it. Get help if you need to – but find the right strategy for you first and then take action.

If you chose to work with a sourcing agent then ensure they help you recognise your financial goals and identify your financial assets, and then help you create a plan to reach your personal investment targets. If they don’t, then the chances are they are just after your money! Also check out how long they have been investing, what their portfolio is like, what their clients say about them, and what their business model is.

A common mistake is to hand over responsibility to someone else. Never do this. Take responsibility for your own financial future. Employ all the professionals you need but retain control over your cash pot. Make sure you understand how and why the money is being used, what you want from your property and how a particular purchase is going to help you achieve that.

Always leverage your resources. For example using a builder, solicitor, broker and letting agent leverages your time and their knowledge. Every successful property entrepreneur knows how to leverage their time, their money and their staff. Calculate the value of your own time so you can make new judgements about where your time is well spent.

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