Questions and Answers on Buy-to-Let investment
Thinking of investing in rental property? Below are answers to a number of key questions people ask about buy-to-let property investment
- Why should I consider buy-to-let property?
- What type of buy-to-let properties?
- Where should I purchase investment property?
- What general trends should I consider when purchasing?
- How do most buy-to-let investors raise finance?
- Will there be a house price crash?
- Am I too late to get into property if I am about to purchase my first property?
Many people started investing in buy-to-let property because they became disillusioned with investment returns in stocks and shares, mutual funds, unit trust and private pensions. Many invest to create an income to supplement other retirement income, or even as a main source of retirement income. Other investors have been attracted by high capital value increased and potential as the housing market has strengthened slowly from 1996 and very strongly from 1999 onwards. The main attractions of investing in property are:
You can leverage your funds to 80% plus – giving greater exposure to capital value increases (unlike stocks and shares)
- It is an asset that is real – you can see it, use it, rent it, improve the value of it
- Long-term capital value has risen by 8% per year on average – this is over the last 25, 50 and 100 years (note: this does not necessarily have to continue!)
- Property can produce attractive rental income
- Property can be managed by letting agents – hence there is no critical requirement to be close to them – hence investing in property can be a “virtual” job
- Significant tax advantages are available
- There is a shortage of supply of housing, and hence with strong employment, high GDP growth and more single households will support prices and increase the likelihood of potential capital gains
The golden rule is make sure you purchase a property that has a good rental market and is not overvalued. Best to ask local letting agents what type of properties they most easily rent out. Be open minded you might find a 2 double bedroomed flat above a grocery near a station rents out far faster than a similar flat in a nice road 15 minutes walk from a station, and costs considerably less to purchase. A large 6 double bedroomed house in only fair condition with no garden, close to a University could rent out with high yield to multi-occupancy students, whereas a similar house with large garden in a leafy suburb could impossible to rent out since there are not many large families, and most people with families like properties in very good condition (new bathrooms and kitchens). Another example is, if you purchase a large house in a re-generating area with many double bedrooms, you might let the house on a room-by-room basis either to builders as weekday accommodation, or to foreign nationals seeking work in the UK .
However, if you buy good valued 1 bedroomed, or 2 double bedroomed flats close to a city centre (hospitals, universities, large offices, public sector offices) and transport/communications are very good, you will probably not have too many problems renting the property, though every city and area has its own micro-market, and asking a local letting agent is essential.
If you wish to purchase a buy-to-let property in a chosen city, the best thing to do is to make a summary map showing all the big institutions, colleges, train stations, major roads, office complexes and development areas, parks and amenities. Then check the cost of flats or houses look for value an area that is up and coming. If transport/communication links are likely to improve in the future, then all the better. If new employment centres are opening, this will also help. Then sketch out a target search area, ask the local agents about the rental market. What are the void periods? How long would it take to rent out? What is the best type of property to buy for rental purchase? Where should it be in the area? Make notes, refer back to your map and decide on the type of property and the area in which you wish to purchase. Make sure you view at least 10 properties before putting in any offer basically, the more properties you see, the better chance you will come across a bargain. Most property investors make most of their future money when they purchase a property.
Most investors tend to focus on buying investment property fairly close to where they live this is because it is easier for them to hunt down good deals and manage let property if it is close to home. That said, many investors operate remotely, flying or driving to areas for fairly short periods of time to purchase property, and having letting agents collect keys to let out and fully manage the property. The remote operation is more costly since full management is normally required. Many expatriates own multiple investment properties, so proximity is not critical by any means.
Most investors look for two key criteria potential for capital value growth, and rental yield. If a property can be found which ranks high on both criteria, with low risk, then this is the ideal investment. Areas of high yield are where prices are lower and rents are higher, with good overall letting demand (e.g. Glasgow city centre). An example of an area with lower yields but particularly high potential for capital value increase would be East London (Bow, Stratford).
Many investors target areas where there is positive change occurring new railways, roads, hospitals, sports centres, offices/jobs, re-generation, injection of public and private funding. Examples in London are: White City , Paddington Basin , Kings Cross, Stratford , Docklands, Peckham and Wembley. Examples outside London are Birmingham Bull-ring/Eastside area, Liverpool city centre, Gravesend/Ebbsfleet, Cambridge/Peterborough/Huntington corridor.
Baby-boomers. Whatever you think the baby-boomers will do next, is the market to target. These citizens are 42 to 58 years old at present, and have just started retiring, or partially retiring.
I predict there will be a shift from large suburban family houses to smaller 2 double bedroomed luxury apartments, either in central city areas (ref: London) or in holiday resorts along the English and Welsh coastal areas. Some of these people will want to live in nice cottages or farms in country areas with some land. So they will either want central city and/or country/coastal holiday home type property. Furthermore, the eco-boomers the oldest of whom are now 25 years old, will want the smart small central city apartments as well.
Because families are increasingly small, the typical 4 bedroomed 1930-70s suburban detached house will become less popular. Many will want convenience, city living, café culture and access to airports and roads for travel.
So consider as close to city centres as possible, or right out in the country, coastal resorts or higher class market towns and University towns (e.g. Norwich , Huntingdon, Kings Lynn, Bournemouth, city centre of London say Wapping, Bow, Bethnal Green). Some of these people will want foreign retirement homes in the sun particularly all year round sunny countries close to the UK though on the coast, such as Malta , southern Spain (Andalusia, Alicante , Malaga), Cyprus.
The most common form of finance for purchase of rental property is through buy to let mortgages. Borrowing of up to 85% of the purchase prices is commonly available though most banks and building societies tend to lend 75-80% of the properties value. Criteria for lending varies banks tend to lend based on a combination of the following:
- Gross rental income commonly the gross rental income needs to be at least 125% or 130% of the yearly borrowing costs this is calculated based on the standard variable rate buy-to-let mortgage rate at the time
- Value of property the banks will value the property independently and lend either 75%, 80% or 85% of the valued price note, this may be lower than the offered sale price and/or asking price
In addition, the borrower may look at your earned income, or a combination of your earned income and the rental income of the property. If you have a large portfolio, borrowers will also be interested in your overall borrowing level and rental income level. They would commonly do multiples to check your financial situation against general banking criteria and assess the risk on a case-by-case basis. Overall gearing above 70% in total is viewed as risky for banks and building societies on investment property. Any indication of negative equity on existing property in your portfolio also increases the risk for banks.
If you have a regular earned income from a job, this will improve your ability to raise funding self-assessment is next best, followed by someone with no regular earned income. Some banks and building societies will lend on buy-to-let properties without regard for your earned income.
Most banks will lend to individuals commercial lending to individuals or companies and/or groups of individuals is also possible though it may not be possible to raise more then 60-70% of the price, financial gearing criteria is stricter and interest rates may be higher typically 0.5 to 1.5% higher than typical private individual buy-to-let mortgages.
About half of UK based banks and building societies now lend to expatriates, i.e. UK citizens resident outside the UK. If there is indication that the borrower is likely to come back to the UK in the foreseeable future, this may reduce the lending risk for the banks and make it easier to raise finance.
Most banks evaluate a purchase on a case by case basis if you are buying a property with high rental yield, at a low price, have a steady income and need borrowing of say 80%, most borrows should lend on the property. They will ask to see evidence from an independent letting agent that the rental estimate for the property covers 125% or 130% of the mortgage payments (if the property is not currently let out). If this is not the case, they would normally still agree to lend to you, but a lesser amount not up to the maximum ceiling of say 80%.
This means that you can build up a portfolio of property where you put in say only 20% of the funding gearing at 80%. This is known as leverage. If prices go up 20%, you have doubled your equity. However, please note that if prices come down by 20%, conversely you have lost all your equity.
I use the following banks that I can recommend:
- Birmingham & Midshires - offer 85% lending on buy-to-let mortgages a mainstream bank, part of Halifax , will lend on ex-council, no multi-occupancy, will consider buy-to-let properties above commercial premises, also lend to Expats.
- Skipton offer 80% lending, with focus on rental income of property fast and efficient valuation, multi-occupancy okay (no DHSS), lending to Expats.
- Chelsea Building Society offer 80%, fast and efficient, will not lend on ex-council properties, multi-occupancy okay (no DHSS), lending to Expats.
There have been many scare stories about an impending UK house price crash for the last 5 years. Every year, prices have slowed then sped up again. I think of this as being an overall market price correction, though this is huge, to a new lower interest rate world. Most forecasts do not expect interest rates to rise again above 5.5% - this is three times less than the 15% peak of 1990. Inflation is not expected to rise above 2.5% - mainly due to efficiency in the global economy, IT and technology advance and worker productivity improvements. So essentially, mortgage payment affordability is still quite reasonable for the average person. Distressed cases are small. One consideration I have never seen mentioned though is how UK property price growth relates to European prices, our immediate neighbours. Ireland has experienced a four fold increase in prices in the last 10 years their interest rates at about 3.2% are far lower than ours since they are in the Euro. This makes me believe that if the UK starts to Euro-converge, interest rates will have to drop and this will prolong the market correction (or as some people call it, the market boom). As long as prices rise at a steady 20% per year and earnings by say 3-4%, and unemployment stays healthy, inflation under control and interest rates at or below 5%, I do not see any need to panic about a crash. Indeed, in Holland in 2003, GDP went down 3%, unemployment rose significantly yet house prices still rose by 5%, despite the fact that they have gone up three fold in the last 10 years. In a healthy and relatively well managed economy such as the UK, I would only expect a sharp correction if price rises became unsustainable at say +25% over the whole country for a year whilst interest rates rose significantly.
Be careful. The first property is the most important to get right and because of the learning curve, it's also the most difficult to get right. My advice is simple ask loads of people loads of questions and find what you consider to be the best place for capital appreciation potential in the short-medium term. Scan 100 properties, look at 30, get serious about 10, offer low-ball on five and hope one accepts. If you are not in a chain, have ready finance lined up and can prove this, your chances of getting a low offer accepted are reasonable. The estate agent and vendor need to trust you. Any evidence that you have the money and can be trusted will help your case. Do not follow your emotions instead follow the numbers. Make sure the economics are attractive. If you buy at say 10% below true market value this is the safety margin you need, in case prices drop. If you can quickly fix up a property to increase its value, your safety margin will improve further. Always be prepared to walk from a deal. If you pay over the odds this is commonly referred to as the winners curse.