Low interest rates, rising rents and recovering house prices have made the last few years very pr...
Low interest rates, rising rents and recovering house prices have made the last few years very profitable indeed for many landlords. Although times haven't always been this good!
1) Manage your borrowing
Part of the lure of buy-to-let is the borrowing. This magnifies the returns on your cash or gives “leverage” but it also adds risk: If you put down a £110,000 deposit, borrow £165,000 and buy a property for £275,000 which you rent for £1,250 per month. Before mortgage costs, that’s a yearly income of £15,000 on your £110,000 down payment – or a massive 14%. Assume mortgage costs of 4% (£550 per month), meaning your net rental income drops to £700. That’s still a handsome return of nearly 8% on your down payment, all thanks to the effect of the borrowing.
None of the above takes into account capital growth. If your property rises in value, on top of your rental income, the total return on your original £110,000 looks even more mouth-watering.
The graph here illustrates the effect of borrowing on total returns from buy-to-let, including the real growth in property prices. Between 1996 (the year buy-to-let loans first became available) and the end of 2013 the per-year returns for a buy-to-let investor who simply purchased their property with cash averaged 10%. An extremely healthy annual return.
But where the buy-to-let investor made their cash work harder with the help of a mortgage of 75% of their property’s value, the per-year return over the period came in at a far higher 16%.
To put those returns into perspective, an investment in commercial property delivered returns of 8% per year over the period. The stock market, as measured by the performance of the FTSE All Share Index, delivered 7%.
(The graph here illustrates these returns by showing how much an original £1,000 investment would have been worth at the end of the period).
But borrowing is risky. Mortgage rates are at an all-time low and will rise within the coming years, even if they are not predicted to rise very far or fast. Rents are already very high relative to incomes, suggesting that landlords might not be able to push up rents just because their mortgage costs start to climb.
If you are letting a property for a long period of time you will need a specialist landlord mortgage. These were freely available before the financial crisis but landlords’ loans dried up after that and have only in the past two years become readily available again and increasingly competitively priced.
2) Know your customer when you buy your properties
Since the onset of the financial crisis in 2008-09 there has been a growth in “accidental” landlords. These are people who opted to let a property perhaps because they couldn’t sell it in a weak market. It was a property they probably had lived in themselves, rather than one chosen deliberately for the purpose of letting.
But landlords who set out specifically to maximise returns can be more discriminating. Experienced landlords, who may own multiple properties, stick broadly with newly built 2 bedroom houses and flats. Their maintenance costs are lower, and they suit the profile of young, professional and reliable tenants who are renting while they save to buy.
You need an area where there is strong tenant demand. Some experienced property investors take a more scientific approach, using Office for National Statistics data they identify areas where there are populations of at least 20,000 working-age people. They then marry this against information about property prices and rents - higher than average rents indicate stronger demand in an area. Other investors prefer letting out individual rooms within larger homes. So they seek out larger, sometimes older, properties which could be converted from family use into multiple rooms with five or six tenants. Called HMOs or “Houses in Multiple Occupation”, this type of buy-to-let requires more work from landlords. There is also the issue of planning. Some local authorities are much less likely than others to grant planning consent.
3) Don’t count heavily on property price rises
You could gamble on rising house prices and, if that’s the case you needn’t ever let your investment property: just buy it, hang on to it and sell for a profit in the future. At least that would be your hope. But that capital-growth-only strategy has burned many investors, notably those in 2006-07 who were trying to “flip” properties before they were even built.
The ruse there involved signing up to an unbuilt flat costing, for example, £200,000. All you’d put down was a deposit of say £20,000. A year later, once the flat was complete – possibly even before – you sell it for 10pc more, at £220,000, and that’s a £20,000 profit or 100pc return on your stake.
While that trick may have worked for a few lucky gamblers whose timing was just right, it was a disaster for others – who found themselves in 2007 and 2008 lumped with unlettable properties worth less than the price they’d promised to pay.
The lesson? Don’t depend, at least in the short term, on rising prices. You are almost certainly going to have to pay capital gains tax in any case. Now read tip number four . . .
4) Make rental income a big part of your total return
While capital growth will be what you hope for over the longer term – and while history suggests you will get it – in the short term most experienced landlords focus on cashflow. In particular make sure your mortgage repayments and other costs will be covered.
Most people think their biggest asset is their home, but in many cases they’re wrong. A property is only a true asset if it’s servicing its own debt. If you have a mortgage and use part of your salary to pay it every month, then the uncomfortable reality is that your home is probably your biggest liability. Many buy-to-let investors made similar mistakes, buying properties where the rents only just or don’t quite cover the costs. It’s better to make sure every buy-to-let you buy not only services its own debt but brings in a high enough level of profit to make an income. This layer of profit should also be robust enough to insulate against market fluctuations and interest rate rises.
Because if it doesn’t and interest rates rise, an investor could be in the uncomfortable position of having to “sub” their properties out of other income or sell them – worst-case-scenario would be selling at a bad time and for a loss.
5) Boost returns in other ways
A few successful property investors realise that for yields to be maximised it helped to convert property, refurbish it or otherwise add value. But that involves work – and is far from the easy, “armchair” investor’s idea of buying-to-let.
These investors generally buy large, family homes and then convert them into multiple-bedroom properties with an average of four bathrooms. Perhaps a Victorian terraced, a semi or a 1930s property, and typically spend 10% of the purchase price converting or updating the property, and borrow about 75% of their value.
Whatever they do by way of conversion, they generally ensure the property could still be restored to single-family use. That way they’re not limiting their future value (tenants typically include both young professionals in work and students).
6) Use a Letting Agency for tenant checks, inventories and other risk-cutting measures
Using a lettings agency cuts out the work of both finding tenants and screening them – for this service investors only pay around 10% per year of their income. Most landlords use agencies to save them doing the donkey work themselves, such as credit searches, referencing services and access to tenant deposit schemes. Letting Agents also provide very careful inventories before tenancies begins – even down to toilet roll holders and the make, model and serial number of appliances such as washing machines! This ensures tenants cannot dispute valid reasons for deducting money from their deposits at the end of the tenancy.
7) Be properly insured
Landlord insurance is a growing area, with an increasing number of specialist policies covering everything from standard buildings and contents risks to loss of rent, boilers, heating and other appliances. Not having the right insurance can be disastrous, as a few landlords discovered when their properties were trashed.
8) Consider specialising in one area of buy-to-let
Many professional landlords consider that the most attractive form of buy-to-let is HMOs, where multiple tenants are housed within one building, often on separate tenancies. Other landlords have targeted niches such as student properties, properties for those in receipt of housing benefit, or upmarket, luxury properties for executives whose rent is typically paid by an employer. Most successful landlords say they enjoy dealing with tenants, so that is likely to play a part in their choice of investment.
But deciding to pursue one type of investing could limit, among other things, your ability to raise mortgages. Many lenders will not lend against HMO properties or those requiring major refurbishment.
9) Use the internet, chat forums, landlord organisations and books to glean experience and confidence
There are two major organisations representing private landlords: the Residential Landlords Association and the National Landlords Association, both of which offer information and services.
10) Keep meticulous records - to help reduce your tax bill
There are numerous book-keeping software packages for landlords, but many choose to develop their own systems. Not only does disciplined record-keeping help avoid problems with inventories and potential disputes, it also helps ensure you meet changing regulations, including requirements from local authorites.
Detailed record-keeping is also essential to benefit from landlord tax breaks. A vast range of costs can be offset against profits for tax purposes, but they'll need to be documented. The growth in private landlords has resulted in crackdowns by the taxman – all the more reason for assiduous record-keeping!