A Guide To Buy-To-Let Investments
More and more people are looking towards the property market for a way to diversify their investment portfolios, and for many buy-to-let is the obvious choice. If you are someone who is thinking about investing in a buy-to-let property then you’re in the right place.
Our guide aims to explain all you need to know about creating your own property portfolio and give you the advice you need to get things right first time. So, without further ado, let’s get started:
What is buy-to-let?
Firstly, it’s important to understand exactly what buy-to-let means. Buy-to-let is a type of property investment where an individual purchases a residential property not to live in, but to rent out to others. By undertaking this investment, the purchaser becomes a landlord and they collect rent from their tenants for the duration of their contract.
Who are buy-to-let investments suitable for?
Investing in property may seem like the easy way to untold riches but the truth is it’s not always that simple. Buy-to-let investments are not for everyone, and the main issue that you must address is whether or not you can afford to take the risks associated with dabbling in the property market. Despite the media hype surrounding buy-to-let investments, the risks are very real and you should only take on a BTL mortgage if you can manage those risks sufficiently.
You must also have a decent credit record in place before attempting to get a mortgage for a buy-to-let property and it is highly likely that the lender will only consider you if you already own your own home. This can either be held outright or with an existing mortgage, but it is very rare that mortgage providers will supply a buy-to-let mortgage to someone who doesn’t already have a property in their name.
Your age will also be taken into consideration and this can potentially be a stumbling block for those looking to take on a BTL mortgage for retirement. Many people leave the decision too late only to find that lenders are reluctant to take them on if they are over a certain age.
While there has been a recent discriminatory court hearing on this very subject, it will still be more difficult to get a BTL mortgage if that loan is set to end after you are 75. So, if you are looking to get a 25-year mortgage, the latest you should apply for one is 50-years of age.
Where do the profits come from?
As with any investment, the main aim is to make money and the way that this happens with buy-to-let is twofold. In the short-term, money can be accrued from the rent received from the tenant. This is sometimes referred to as rental yield.
The rent you charge should always cover your mortgage payments and more, so that you can build up a reserve fund just in case any repairs or maintenance needs to be undertaken on the property.
The second way that profit can be made is when the property is sold. After holding the property for a period of time the hope is that the market will have moved upwards and the property can then be sold at a profit. This profit is commonly referred to as capital growth.
When considering a buy-to-let investment it is important to look toward the medium to long-term as opposed to hoping for any short-term gains.
Selecting a property
The key to a successful property portfolio is in the selection of the properties that you place within it. Making the right choices at the start will stand you in good stead for the future. But how do you make the right choices? Following these key points will get you off on the right foot:
- Research – Ask around your local estate agents about the types of property that are hot at the moment. Find out the areas that are mentioned frequently and look for a pattern. Enquire about what kind of rent these properties are fetching and who the tenants are; i.e. young professionals, students, retired etc.
Once you have this information you can then research the specific area further. Find out about the local amenities such as transport links and schools to see how they fit in with your prospective tenants.
- Target – Make a list of the types of properties you wish to target. Bear in mind all that you have found out and work this into your equation. Location, tenant and property type should all fit together.
- Calculate – Now you can start to work out the financial aspect of your investment. Look at the property types that you are targeting in the area you wish to make your purchase, and begin to calculate yields and whether or not you can obtain a mortgage for these properties.
Calculating rental yields
Rental yields can be calculated to give you an idea of your returns over the course of a year. This is important to know, as a cheaper property may not always be the best investment.
Thankfully, the equation is simple and you only need to have two figures to hand – your projected monthly rental return and the amount of money spent on the property. Let’s take a look at a couple of examples:
Monthly rent = £1050
Investment made = £250,000
£1,050 * 12 = £12,600
£12,600 / £250,000 = 0.0504
0.0504 * 100 = 5.04% yield
Monthly rent = £900
Investment made = £225,000
£900 * 12 = £10,800
£10800 / £225,000 = 0.048
0.048 * 100 = 4.8% yield
As you can see, Property B cost £25,000 less than Property A, but Property A has a higher yield than Property B. This makes Property A the better investment of the two in the medium/long-term.
Financing your investment
Buy-to-let mortgages differ somewhat from normal residential mortgages. With a residential mortgage, the amount that you can borrow is normally calculated based on your income and outgoings. Buy-to-let mortgages, however, are worked out by taking into account the amount of rental income your property is likely to generate.
The base figure for most lenders is 125% of the mortgage payments that you will make each month. So, if your mortgage repayments are £950, your prospective rental income will need to be at least £1,187.50 for the mortgage provider to consider lending.
You will also need to be able to put down a fair size deposit on the property you wish to buy, typically around 25%. Some lenders may accept lower but this is a good guide figure to make your calculations around. It will also be expected that you have a personal income of £20,000pa or more on top of what you anticipate you will earn from the rent that you will receive.
What are the risks?
No investment is entirely without risk and buy-to-let is no different. Property markets can fluctuate and this can affect both the amount of rent that you can command and the overall value of the property should you wish to sell.
Structural problems too can take their toll on investors. If you are sailing close to wind in terms of what you are receiving in rent compared to what your mortgage repayments are you could find yourself having to delve into your own savings to repair a roof or deal with burst pipes.
Smaller problems such as broken appliances also cost money to repair and replace, and general wear and tear will eventually have to be taken care of too. As a landlord you have a duty of care to your tenants so you will need to fix any problems that may arise while they are renting your property.
Unsurprisingly, these issues never happen at a good time, and they can catch you unawares if you haven’t made the necessary provisions to deal with them.
Can you insure against the risk?
There are certain things that you can insure yourself for, but not all. Things like moves in the property market are not insurable but damage to your property can be safeguarded against. Similarly, you should have insurance for public liability too. This will cover you should a tenant or service provider be injured in your property.
Loss of rent can also be insured and there are other elements that can be protected as well depending on how much you wish to spend on insurance each month. Do your research and make an informed decision upon the level of cover you wish to take out.
As for contents insurance, tenants should be encouraged to take out their own contents insurance should they wish to cover their own personal belongings while they are renting your property.
How about tax?
When you take on a buy-to-let investment you are effectively running a business as a landlord. Therefore there are tax implications to take into account. These include:
- Stamp duty land tax (SDLT) – Charged when you first buy the property
- Income tax – Charged against the rental income
- Inheritance tax – Charged if you should die whilst holding property
- Capital gains tax – Charged when you sell the property
- VAT – Charged whenever you make purchases or pay for services related to the property
Are there any additional fees to pay?
Other than your insurance costs and the expense of maintaining the property to a standard fit for someone to live in, there can be other costs associated with owning a buy-to-let property.
The main one would be if you choose to have a letting agent manage your property for you. Doing so can relieve a lot of the headaches that come with being a landlord, but that stress relief doesn’t come for free.
Ask around your local letting agents to see what sort of charges they make for managing the type of property you are looking to rent out.
Interviewing prospective tenants
If you are not using a letting agent you will need to interview and assess your prospective tenants yourself. In order to avoid future problems, you will need to find out as much as you can about them before you rent your property out.
The five main things you must obtain are:
- Proof of identity
- Proof of credit rating
- Proof of current address
- Employer’s reference
- Reference from their previous landlord
Are there any other obligations?
As a landlord you will need to meet certain obligations in order to legally rent out your property. These are:
- Mortgage consent to let – You must have permission from the mortgage lender to rent out your property. For the majority of buy-to-let investors this will not be a problem, as you will probably have a specific mortgage for the purpose. However, if you already own a property and are considering renting it out you must inform your mortgage provider and obtain consent to do so.
- Hold an up-to-date gas safety certificate – If you have gas appliances fitted in your property it is part of your duty of care to have a current gas safety certificate. These need to be carried out annually and by a Gas Safe registered engineer.
- Have a current electrical safety check – Although it is not a legal requirement to have annual checks performed like the above gas safety check, you will need to comply with the Electrical Equipment (Safety) Regulations 1994 and the Plugs and Sockets etc. (Safety) Regulations 1994. This is an obligation of all landlords and the Health and Safety Executive enforce these regulations.
- If you are supplying furnishings for your property they must comply with the Furniture and Furnishings (Fire) (Safety) Regulations 1988 which extends the scope of the Consumer Protection Act 1987 (CPA).
- Energy performance certificate – Failing to produce a valid energy performance certificate can result in a £200 fine from your local TSO (Trading Standards Officer).
- Fire safety measure need to be put in place too. Any building built after 1992 must have a mains operated interconnected smoke alarm fitted on the entry level to the property. Older properties should have battery operated smoke alarms fitted.
- General safety is also an obligation that must be fulfilled by the landlord. Renting out a property that is hazardous could result in a £5000.00 fine, 6 month’s imprisonment, and it could invalidate your insurance policy.
Becoming a landlord involves a great deal of work and it is not an entirely hands-off investment. However, the rewards can be great, so if you feel you have what it takes to go through with purchasing a buy-to-let property why not begin your journey today – it could be the best investment you’ll ever make.
Feature image credit: Ken Dodds via Flickr
If you enjoyed this blog post then perhaps you’d like to read “Ways to Increase Buy-To-Let Profits“?