Investing in real estate has long been regarded as a wise investment. Whilst values will rise and fall, for the most part the value of an asset will rise. It’s an investment whose returns are substantially slower than the stock market, yet at the same time, are equally less risky.
Savings accounts or even ISAs will typically offer interest rates of between 0.5 and 3%. At it’s most generous, an investment of, say, £100,000 will be worth something in the region of £135,000 in ten years’ time. Whereas a property can realistically increase by upwards of 50% in the same time frame.
With such obvious benefits, the question becomes why more people are not investing their money in buy to let property. The answer is that there is a delicate balance between the advantages and disadvantages of doing so, and in this article, we’re going to take a look at some of the more obvious, and perhaps not so obvious pros and cons of investing in buy to lets.
Advantage – The Rental Market is Booming
The credit crunch of 2008 saw an end to banks and other major lenders extending offers of 100% Loan to Value mortgages to their borrowers. Immediately after this crisis, these same lenders were loathe to offer anything in excess of 80%. Fortunately, some confidence has returned to the market and it is now possible to borrow 90, or even 95% of the purchase price.
On the surface, that sounds like good news. However, consider that the average price of a starter home in the UK. Naturally, there is a great deal of fluctuation depending on the region of the country to which you are referring.
In the North West, a one-bedroom flat will sell for around £160,000. However, a similar property in Greater London will fetch around double that – and more again if we look at Central London.
Taking an average figure of £250,000, first-time buyers will need to have a deposit of at least £12,500. On top of that, there will also be stamp duty, mortgage fees, legal fees, etc, which all adds up to an initial sum of around £18,000. For many people, this figure is unattainable, hence their only other option is to rent their home.
Rental is not just seen as a last resort though. A booming ‘gig economy’ has meant that more and more millennials are taking short term contracts. Their work takes them all over the country, and sometimes the world, hence owning a property is simply impractical for them. A short term let is their solution, and for landlords happy to offer 6-month contracts, it’s a win-win situation.
Disadvantage – The Initial Investment is Higher than you Think
On 1st April 2016, the Government increased the rate of Stamp Duty Land Tax. Not only that, but they imposed additional penalties on those people investing in second homes or buy to lets.
The current surcharge in England is 3%, rising to 4% in Scotland. The Stamp Duty itself works on a sliding scale. If we take our average property value of £250,000 – the first £125,000 is taxed at 3%, so £3,750. Were this to be a non-buy to let property, that rate would have been zero.
Thereafter, the next £125,000 is taxed at 5%, so, £6,250. This means that the total Stamp Duty on this buy to let property is £10,000. This figure can, of course, be factored into the mortgage, but this does ultimately lead to a drop in profits. For the long term investor who views their buy to let as their pension fund, this may not be a major consideration, but for those looking to build a strong portfolio, it is a major dent in the bottom line and one that cannot be overlooked.
Advantage – Creature Comforts
There is a marked difference in the emotions involved between viewing a buy to let property versus buying a home.
When looking for a home, buyers need to feel a sense of comfort and belonging when they first walk in. Many home buyers will say that it’s hard to put into words but when they finally view the home onto which they make an offer, it’s often because they “just knew”.
Buy to let is different – the creature comforts that could make a property special for the home buyer are no longer relevant, and this is a mindset that the wise buy to let investor can play to his or her advantage.
Basic décor does not sell homes. White walls, inexpensive floor coverings and unimpressive kitchens and bathrooms do very little to excite the would-be homeowner, but for the buy to let investor, they are perfect.
This is why many investors choose to look for repossessions or properties in probate. In many instances, such homes are in need of some refurbishment before they can be occupied.
A homeowner may well want to sink between £5 and £10,000 on a new kitchen, but as a buy to let landlord, such luxuries are considered just that – luxuries. A web search for the words ‘cheap kitchen’ shows that one can be purchased and installed for under £1,000. Adding in some decent appliances may well double that figure, but it’s still substantially less than the £10,000 price point mentioned earlier.
Typically, owners properties in a poor state of repair are open to negotiation. They will have been advised by their estate agents that buyers will be factoring in the price of refurbishment in their offers, and as such, vendors are prepared for this.
If they weren’t, they would have invested in the refurbishment themselves and thus boosted the value of the property to sell at a higher price. There’s clearly a reason that they don’t want to that, and whatever that reason might be, the buy to let investor should start with a low offer and ultimately settle upon a figure which works for all parties concerned.
Disadvantage – Property Management
As a landlord, the buy to let investor has two choices when it comes to the management of the property. He or she can hand over the entire affair to a management agent. The advantage here is that the agent will have a network of tradespeople to assist whenever a problem arises – and it will.
Appliances stop working, boilers break down, and the lights fail to come on. Assigning a management contract over to an agent with ties to local electricians, plumbers and repair people can prove a valuable way to save time and stress – though not necessarily money.
Unsurprisingly, management agents charge a fee for their services, and this will once again eat into the profits of the buy to let investor. For many, this is a calculated expense. The majority of owners of buy to let properties actually live within a 10-mile journey of the property that they are renting out.
Should the need arise, they can visit the property themselves and then assign a local tradesperson to take care of the repairs. Such proximity also gives them more of an opportunity to be a truly ‘hands-on’ landlord – available whenever the tenant calls.
Regrettably, one can never be sure what sort of tenant will move in. Granted, there is a screening process, although this usually covers the basic financial and lifestyle profile that helps the landlord to decide whether or not that tenant is a good fit.
There’s simply no way to know if that same tenant is going to call at unreasonable hours for a simple repair which could wait until the morning. Or if, after a certain period within the property, they feel ‘entitled’ to new furniture or new carpets.
For these people, a property management agent can act as a very useful buffer between landlord and tenant. Many landlords live much further away or have simply decided that they have no desire to be a ‘hands-on’ landlord. They have made an investment, and the tenants are purely there to cover the mortgage expenses. So whilst the monthly profit may be lower, it can be considered by many as a small price to pay for having all of the admin of the property handled by a professional.
Advantage – A Source of Income
Many landlords throughout the UK are what are referred to as ‘accidental landlords’. When they were ready to move to their next property, they saw that they had enough saved to be able to move without the need to sell their property first.
As a result, they presented it to the rental market, safe in the knowledge that the monthly rent would comfortably pay their monthly mortgage payments. They’ll keep the property for as long as it appears economically viable. Many will end up using the equity on that property to clear the mortgage on their current property.
For others, this is the beginning of their build of a property portfolio, and so they choose to buy more properties on a buy to let scheme and enjoy an income from each one.
The maths is fairly simple too. Most Buy to Let mortgages are interest-only mortgages, and that’s good news because the monthly repayments will be substantially less than those of a repayment mortgage.
Let’s take a two-bedroom flat with a value of £250,000. On a mortgage of £200,000, the monthly repayments will be in the region of £500. The average rent on a property of this type is in the region of £1,100 per month. Now if our buy to let investor chooses to be a hands-on landlord and does not need to spend anything on management fees, they’re looking at a monthly profit of £600, and for many people, an additional £600 per month in the bank account is not to be sniffed at, and remember, this is based on owning only one buy to let property and at the lower end of the market.
House rentals are much higher than flats, and of course, by spreading one’s portfolio throughout the country (although granted, at that stage a management agent would be a good idea) means that an investor’s rental income could equal that of a full-time salary.
Disadvantage – Empty Property
Fully vetting the right tenants takes time, and this time very quickly turns into money, as – tenant or not – the monthly mortgage payments are due, and it will be the responsibility of the investor to cover these whilst the property is unoccupied.
It’s important that the buy to let investor knows his target market before investing. The needs of the university student requiring accommodation are going to be very different to the needs of a young professional couple who aren’t quite in a position to own their own home just yet.
Once identified, the property will need to be advertised. Tenants will then need to be vetted and qualified and agreements drawn up and signed. Whilst it is possible for a buy to let investor do this all on their own, it is more than likely that they will employ the services of a local estate agent that specialises in lettings.
Despite the fact that the rental market is booming, this does not necessarily mean that the investor will find his or her ideal tenant quickly. In addition, if the property does require some renovation before it is put onto the market, then those months’ mortgage payments will need to be factored into the equation too.
Investors may find tenants quickly, but they may only be interested in a short term let, and this means going through the advertising and vetting process all over again in a short space of time – sometimes as little as a few months.
If the investor doesn’t live close enough to the property, the issues that come with administering everything remotely quickly add up – in financial terms certainly, but one cannot put a price on the stress that comes along with it all.
So Is Buy to Let a Good Option?
It’s clear that for every advantage that can be proposed for the buy to let investor, there’s an equal and opposite disadvantage that could shut the whole idea down. Like any investment, one must weigh up the risks and the returns to see if it’s right for them.
