What is buy to let?
Buy to let involves purchasing property with the specific intention of renting it out to tenants. The UK buy to let property market is booming – worth at least £30bn – and this form of property investment is an increasingly popular alternative to more traditional pension schemes.
Buy to let landlords own an average of 7 properties but don't let that put you off – if you already own your house and provided you do your homework carefully, there's no reason why you can't join the growing band of buy to let property owners.
Do your homework
If you're keen to maximise profits, it's tempting to join the thousands of landlords letting properties in London and the South East. But before you jump on the bandwagon, consider the following:
- Buy to let investors who purchase property locally tend to prosper. By buying close to where you live, you benefit from local knowledge and can be on hand to keep an eye on the property and deal with any tenancy issues personally.
- London and the South East have high demand for housing so yields are attractive, but the property is much more expensive to begin with.
- Plenty of towns outside the Home Counties offer reliable rental returns. Birmingham is one such example - with only 11% of housing being privately rented yet with 23% of the workforce aged 18-30, it's an ideal spot for buy to let. What you're looking for is a large, young working population and a shortage of rental accommodation.
Once you've chosen your area, get help from a letting agent who knows the area – they will be aware of current demand, and the likely pitfalls of certain properties or areas. A good tactic is to approach agents as a potential tenant to get a less biased view of local market conditions.
Keep tabs on the local media – finding that there has been a spate of burglaries will explain why sellers are keen to hand you a “bargain”, and plans to build a bypass or an airport nearby can adversely affect property values too.
More specific publications like Residential Property Investor can keep you up to date with what's hot in your local property market – you can get a free copy by requesting an information pack from the Residential Landlords Association.
A few more tips for picking a good investment property:
- Look for a property which requires little maintenance. A big garden might seem attractive but it's unlikely to increase the rental value.
- Focus on the needs of your target market, but also look out for benefits that will appeal to all tenants, like nearby shops and easy access to public transport.
- Naff décor can give you bargaining power when it comes to buying a property, and it often costs relatively little to put right.
- When it comes to major, structural issues, however, stay well clear, and always get a full survey before you buy.
Working out what you can afford
Although house prices in Britain rose by an astonishing 15% per annum between 1999 and 2004, the long-term trend is unlikely to provide such a good rate of return on your investment. If you decide on a buy to let investment, you must be realistic about long-term price rises – bear in mind that housing markets can bust as well as boom, potentially leaving you with negative equity.
At it's simplest, the yield is the rate of return that you earn on an investment. In the case of buy to let, this is calculated by taking total annual income (rent paid per week multiplied by number of weeks occupied) and dividing by the cost of the property. The yield is expressed as a percentage, this being the the percentage of the property's value made annually in rent.
Here are a couple of worked examples:3-bed house in Tower Hamlets, London Purchase price: £240,000. Let's assume there is a tenant in the property for the full 52 weeks of the year: Weekly Rental Income x 52 / Property Value = Yield £250 x 52 / £240,000 = 0.0542 So the yield would be 5.42%. 2-bed house in Bradford Purchase price: £50,000. Again assuming year-round occupancy: £120 x 52 / £50,000 = 0.1248 So the yield is 12.48%
What could reduce my yield?
Factors which adversely affect the yield (and therefore things to avoid or minimise) include:
- Void periods, i.e. intervals between tenants when no rent is paid. The UK average is two months per year. Try to minimise the length and impact of void periods, and/or take out insurance which covers you for non-occupancy. In the two examples above, a void period of 10 weeks per year would see the yield of the London house plummet from 5.42% to 4.33% and the yield on the Bradford property would drop from 12.48% to 9.98%. Make use of an on-line Property Yield Calculator to determine the yield of a property you might be considering, and the impact of non-occupancy.
Long-term investment versus short-term gains
A property in London, for example, is likely to have a lot of capital tied up in it as equity. The yield is low in the first example above, but while the housing market in London continues to boom, it represents a good investment even though the rental income is very low. Conversely, equity will be low on the terraced house in Bradford with a price tag of £50,000.
For this property, the benefit is the high positive monthly cash flow – useful if you need money now rather than just to boost your pension fund. Your circumstances will determine whether you should focus on investment potential or cash flow.
Financing the property purchase
There are plenty of finance packages on the market designed specifically for buy to let – usually requiring at least a 15% deposit. Most lenders expect you to already own at least one property, and place as much importance on the likely rental income of the buy to let property as the income of the applicant, so make sure you've calculated the potential yield accurately (see above). An annual yield of more than 8% of the mortgage would be expected.
For more advice on how to go about finding and using a professional company that provides buy to let finance, see this guide to Commercial & Buy to Let Finance.
What costs and responsibilities will I incur as a landlord?
As well as the mortgage/loan repayments, you may need to pay a letting agent to manage the property for you. Agents will charge between 5% and 15% of rental income depending on the comprehensiveness of their service – some offer income protection and specialist legal advice as well as the usual services of rent collection and client liaison.
If you manage the property yourself you must factor in the cost of legal advice, for the drawing up of contracts or tenancy agreement, and maintenance and repair costs.
Insurance is paramount – check that you are covered for high-risk tenants if you plan to let the property to students, multiple occupants or tenants in receipt of state benefit. These groups are often excluded by insurers.
Also check that your buildings insurance covers damage due to fire, lightning, explosion, smoke, burst pipes, flooding, subsidence as well as theft and malicious damage. A particularly unlucky week could see the boiler pack up, the electrics need rewiring and the discovery of dry rot in the loft – by taking out comprehensive insurance you'll reduce those risks and enjoy more peace of mind.Responsibilities
You should also be aware of legislation relating to Health & Safety provision – check out The National Landlords' Association, a non-profit organisation with a nationwide membership of landlords which can offer advice.
Membership benefits and services include a telephone advice line, information sheets on special topics, standard tenancy documentation and advantageous property insurance.
Some special buy to let cases
Buying a property before it has been built is known as buying off-plan, and it's often marketed as being an easy route into the buy to let market. But there are potential costs:
- Properties built at the same time reach completion simultaneously – in the case of a large estate or apartment block, this can mean a previously high-demand area is flooded with available accommodation. Rental prices drop as a result and yields are driven down.
- Initial prices may be inflated by property developers. Before opting for off-plan, you must ask yourself how much capital you are willing to have tied up in property which has been valued only on paper.
Acquiring property in order to let it on a short-term basis is becoming increasingly popular with UK buyers. Whether it's a seaside cottage in Pembrokeshire or a ski chalet in Bulgaria, holiday lets can definitely be a good investment. In fact, in 2005 figures indicated that self-catering was the fastest-growing sector of the UK holiday market. Annually, there are over 4 million short-term rentals of cottages and holiday apartments in the UK.
So what are the benefits of short-term rental?
- The opportunity to maximise revenue from seasonal attractions or local events. A typical two-bedroom house in the welsh village of Hay-on-Wye, for example, might cost £500 per month as a standard residential rental. Yet the same property could command a rent of £1000 per week during late May - simply because the town hosts the annual Hay Festival of Literature. Demand for holiday lets at this time is consequently very high.
- Greater flexibility - using the property as a base for your own holidays, for example, is easier if your tenants aren't permanently resident.
So what's the downside? Short-term rentals require a major commitment in terms of marketing and property maintenance. To ensure a good return, you'll want to have tenants in week after week and that means continuous involvement. Don't underestimate the cost and time involved in cleaning the property and washing bed linen, towels etc.
You'll need to prepare a letting "pack" to give holidaymakers information about the property and its facilities, as well as local attractions, and keep on top of invoicing and client correspondence.
Holidaymakers can be much more demanding than "ordinary" tenants, so it helps to have good social and problem solving skills. If the idea of being an absentee landlord appeals or you simply don't have much free time, holiday letting may not be for you!
An excellent factsheet is available from www.scavenger.net, which examines in more detail the financial potential of holiday lets, and the current market opportunities.
Owning a property abroad is as popular as ever for us Brits. The high cost of UK houses, lower international travel costs and affordable borrowing options are major reasons for this trend. Think carefully before buying, however, and consider:
- The complexities of negotiating and buying a house in a foreign country and/or language.
- The legal framework – do you fully understand how estate agents, contracts etc. work in the country of your choice?
- The fees and costs involved – these can be far higher than in the UK.
- Factors outside your control such as political stability and environmental hazards.
If you intend to rent the property as a “holiday let” and enjoy the property yourself for at least part of the year, you should ask yourself some questions before going ahead:
- Are you buying the property because you like it rather than because it will appeal to others?
- Are you staying within your budget? A cheaper property might free up capital to spend on development and renovation.
- Will you really want to spend your “holiday” time repairing and maintaining the property?
- How will you ensure security and adequate maintenance of the building when you are absent – do you need to factor in the extra cost of employing a caretaker or property manager?
- Are local healthcare facilities adequate?