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Buy to Let: A Guide

Buy to Let: Background

Born in the mid-1990s, Britain’s buy to let market has grown rapidly. Not surprisingly, this has resulted in a fundamental shift in property ownership in the private residential rented sector, which has had knock-on effects on the entire property market. Before buy to let took off, most of the sector was owned by corporate investors. Today, around 66 per cent is in private hands.

A variety of factors have contributed to this change. One is that companies have reduced their property portfolios. Another is that more of us see owning property as desirable, enticed by the prospects of extra income from rent in the short-term and healthy capital appreciation in the future. The increasing availability of buy to let mortgages has brought second (or even multiple) property ownership within the reach of increasing numbers. Add to this the continuing disillusionment with pension schemes and a perception that investing in UK property carries relatively low risks, and it is little wonder that many people regard a buy to let investment as a key financial goal.

The Buy to Let market

In 1998, there were 29,000 buy to let mortgages; today, there are 750,000. Though the phenomenal growth of the sector has led some commentators to predict a oversupply of rented property, the consensus seems to be that the rental market will continue buoyant well into the future, thanks to an influx of workers from new EU member states, high prices preventing young people from getting on the property ladder, and other factors.

Buy the right property in the right location, market it to the right people, and you too can be a successful buy to let investor. However, it’s important to remember that, despite the reassuring solidity of bricks and mortar, no property investment is without risk. Many small investors have done well, but, as those selling financial products always tell us, past performance does not guarantee future returns.

Do as much research as you can, keeping in mind that not all sources of information are unbiased. Start by asking yourself the following questions:

What are my investment objectives?

Before you go any further, decide what you want from your investment, and in what timeframe. Buy to let should only be considered as a medium- to long-term investment. Are you looking for regular income or capital growth? If income is your goal, do you want potentially high but uncertain rental yields, or more dependable but lower ones? If the worst happens – a change in your financial circumstances, for instance – can you afford to lose your investment?

It’s important to be realistic about your objectives – and about your ‘risk profile’ (that is, the level of risk you personally are comfortable with).

Can I afford to Buy to Let?

Initial and ongoing costs

You need to consider not only the purchase price and associated costs, but also the ongoing outlay involved in property ownership and your obligations as a landlord. These include maintenance costs, buildings insurance (mandatory if the property is mortgaged, but recommended even if you own it outright) and contents insurance (if you are letting the property furnished). Other costs will include, where applicable, letting agent’s commission and management fees, service charges and ground rent.

Optional extras include legal expenses insurance, which protects you in the event that a tenant defaults.

Rental returns

As a guide, gross rental returns (that is, rent received before allowing for letting costs) are generally in the region of 7 – 10 per cent of a property’s value. If you are taking out a mortgage, your lender will normally expect projected monthly gross rental returns to be around 130 per cent of the monthly mortgage payments. Mortgage lenders advise buy to let investors to deduct at least one percentage point from a property’s gross rental yield to arrive at a realistic figure for net yield.

You need to work out whether the probable rent will cover your costs, taking possible void periods (times when the property is lying vacant) into account. To be on the safe side, estimate the latter at two months in every 12, even in a popular area.

Tax

You should be able to offset certain costs against tax payable on rental income. These include maintenance (for example, cleaning and gardening), insurance, agent’s commission and other management expenses, and the cost of replacing furniture, fixtures and fittings (though not their initial purchase). Alternatively, a ‘wear and tear’ allowance (currently 10 per cent) is usually deductible.

How shall I finance my purchase?

You may be able to pay for your property from savings or investments, or you may decide to take out a buy to let mortgage. It’s important to get professional advice as to the best and most tax-efficient course of action for your circumstances.

Buy to let mortgages are offered by banks, building societies and mortgage brokers, some of whom specialise in this sector. They are available on an interest-only or repayment basis. To qualify, you will need to be able to raise a deposit (usually 15 – 20 per cent of the purchase price) and own your own home.

Choosing a location

Deciding what you can afford to spend and what return you require will help to narrow your choice of location and property. If you plan to manage the property yourself, rather than through an agent, you would probably do best to select a location relatively close to where you live.

Selecting your target area requires painstaking research. You will need to identify places where you can afford the purchase price, and where the level and reliability of rental returns you require are available. Places with good commuter services or sizeable student populations are usually a fair bet.

Television and radio programmes (particularly those dealing with current affairs), newspapers, magazines and the internet are all useful resources for further research. Talk to other buy to let investors, if you can, about their experiences, and to professional letting agents, whose knowledge of their local areas can be invaluable.

Choosing a property

Selecting a property for your own use, as a principal or second home, is easy; you need only consult your own tastes. Selecting the right buy to let property is another matter; there, you must be influenced exclusively by the tastes of your target market.

Here again, you would be wise to consult a letting agent, who will know what sort of properties are most in demand in the local rental market – flats, family houses, accommodation suitable for sharers or students, and so on – and what the key selling points are – transport links, shops, schools, large gardens, or whatever. They can also advise you whether to let furnished, part furnished or unfurnished, and on the style of decoration, furnishings, fixtures and fittings favoured by the sort of tenants you will be targeting.

Remember that you will potentially have to deal with a multitude of domestic issues, including central heating breakdowns and other plumbing problems, leaking roofs and malfunctioning appliances (if you are letting furnished). It goes without saying that if you are seeking minimal maintenance, you would probably do best to purchase a newish property, preferably without a large garden.

In conclusion

Do your sums, find the right property in the right location, and always take professional advice tailored to your particular circumstances. Don’t be in a hurry to buy; this is an important decision, and needs careful consideration.

It is always worth having a survey done, even if you are not reliant on a mortgage. A chartered surveyor can advise on the best kind of survey for the type of property you are buying, according to its age and overall condition.

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Page 1: Buy to Let: Background