Making Money Tristan on 14 Dec 2008 01:22 pm
How buy-to-let can work for you
I have recently become a property investor – not entirely by design, my wife and I split, neither of us wanted to live in the marital home, so we have rented it out – and I think now is the time to make a killing.
Interest rates are dropping, house prices are dropping and rents are increasing – could there be a better time to invest? Yes, wait six months and prices could be lower, as could interest rates, but even now it makes sense. I’ll give you a real world example to demonstrate the point.
My property is a regular three bedroom semi detached in Bristol. It’s probably worth about £150,000. The mortgage is currently on the lender’s standard variable rate (1.75% over base) and we are paying about £500 a month for the mortgage and buildings insurance. The rent is £795 a month, leaving us a nice little profit of around £300 a month.
I did a quick scout around to see what sort of rates would be available for buy-to-let mortgages and found that on MoneySuperMarket there were no rates available (I searched for £150,000 property purchase, 3 year deals with an income of £50,000 and no adverse credit). I found this strange considering I found deals on other websites.
I suspect this is because they make more money by getting you to complete an enquiry form, which is then sold off as a lead to a mortgage broker than they would if they allowed you to source your own product (likelihood is not many searches would result in any revenue for them).
I eventually found some useful information on the Cheltenham & Gloucester website, a lender that I put a number of deals through when I was a mortgage broker, and a lender that on the whole I found to be quite good.
Their buy-to-let range has products for 2, 3 and 5 year fixed rates, nothing else. The max loan-to-value is 75%, but if you can find a 40% deposit, they will shave 0.3% off the rate they offer you.
Let’s consider my investment property on the most expensive deal they offer, currently a five year fixed rate, max loan-to-value of 75%, 2.5% arrangement fee and a rate payable of 5.69%.
Assume a purchase price of £150,000, requiring a deposit of £37,500, stamp duty of £1,500, survey fees of £1,000 and legal fees of £1,000 (rough figures only). For a total of £41,000 you could acquire an asset that pays you a rental yield of 6.4%.
The actual return you would receive is £228.23 per calendar month. Over a year, this would be £2,738.76 or 6.7% return on your capital. I’m sure there are better mortgage rates out there, and I’m sure when the govt and the lenders stop arguing over passing the base rate cuts onto the borrowers, the rates will come down even more so, which is good news as it will make this deal stack up even more.
The best bit is that in ten years time, the property will most likely have doubled in value, so you will have had money in your pocket each month and a nice capital gain too.
Calculations
£150,000 purchase price
1% stamp duty: £150,000 x 1% = £1,500
25% deposit: £150,000 x 25% = £37,500
75% loan-to-value: £150,000 x 75% = £112,500
2.5% arrangement fee: £112,500 x 2.5% = £2,812.50
Total borrowing: £112,500 + £2,812.50 = £115,312.50
Monthly interest: (£115,312.50 x 5.69%) / 12 = £546.77
Monthly costs (interest + buildings insurance): £546.77 + £20 = £566.77
Monthly profit (rent less costs): £795 – £566.77 = 228.23
Yearly profit (assume 12 months profit): £2,738.76
Return on capital: (£2,738.76 / £41,000) x 100 = 6.7%
on 16 Dec 2008 at 6:56 pm 1.Moments of Fame « Funny about Money said …
[...] and cons of paying off your mortgage early. Across the Pond, Find Financial Freedom realizes that buying a rental property could now be a profitable move; don’t know how that would apply in other countries, but note [...]
on 16 Dec 2008 at 8:37 pm 2.Andy @ Retire at 40 said …
This post has been featured on the 89th Carnival of Money Stories at Retire at 40.
Great detailed post. I hope it all goes well for you.
on 18 Dec 2008 at 1:18 pm 3.stevetodd said …
I have been a landlord for over 17 years now and I would say that although it can be a good long term investment. The above figures are very optimistic. The calculation makes no allowance for:
£180 Rental voids say 1 weeks per year (ave)
£950 letting agents fees (in some areas there is no real market place without using an agent)
£250 sinking fund to allow for redecoration every 4-5 years
£720 maintenance and repairs.
The above adds up to an additional £2,100 per year and reduces that yield (return on capital) from 6.7% to 1.55%
on 18 Dec 2008 at 2:13 pm 4.Tristan said …
Hi Steve
I just put the numbers down as an example of what I’m achieving right now by accident, I hadn’t intended on becoming a landlord just yet!
All good points though, especially the accrual for maintenance / redecoration / void periods.
For my property, I’m paying significantly less than the 5.69% mortgage used in the post, so there is a much better return. We will be using this profit to create a “reserve” to be used for void periods / maintenance / redecoration.
One thing I perhaps disagree with is the need to pay an agent, we managed to let the property through advertising for free on various websites. I did all the background checks (credit check, employment history) on the tennants myself, and we are managing the property ourselves - we didn’t want to pay an agent a monthly fee.
on 18 Dec 2008 at 2:20 pm 5.stevetodd said …
Hi Tristan,
I too manage my properties myself (I am a chartered surveyor so it’s second nature anyway) if you read my comment again you will see that I say in some areas you cannot do this. This is because websites like Gumtree are not widely used in certain areas and therefore tenants tend to go via agents to find properties. I only rent out properties in London so this does not apply to me, but it would to people in SOME other areas and that’s why I said it, to flag it up to potential landlords in such areas.
on 18 Dec 2008 at 2:24 pm 6.stevetodd said …
By the way it is extremely unlikley that property prices will be double in 10 years time. The spread markets (which I agree with) asume in 3 years time they will be about another 20% down. So a property costing 150k now would have to rise from 120k to 300k in 7 years to achieve that. It just won’t happen. I wish it would as my wife and I own 9 properties and we would welcome such a rise, but trust me it will not happen, it won’t even come close.
on 18 Dec 2008 at 3:57 pm 7.Tristan said …
Good point, a rise of £180,000 on a property worth £120,000 in seven years is pretty phenomenal, however it all depends on what lenders do.
If libor comes down, which it should do, then the recent BOEBR cuts will be passed onto new borrowers (rather than just existing borrowers) which will start to give the housing market a kick up the backside.
From my experience arranging mortgages over the past few years I can see that a lot of the current housing market problems have been caused by the lenders, as a result of the credit crunch.
I had plenty of customers that could afford a mortgage, but were not granted one from the lenders, or were offered terms that were so marginally better than staying on SVR that they decided to wait it out. There are a lot of people just sitting tight, waiting for the price of money to come down.
on 19 Dec 2008 at 12:46 pm 8.Same Day Loans said …
Great post, I like all the ideas you suggested here and I appreciate the things that has upgraded my knowledge…
on 20 Dec 2008 at 3:35 pm 9.Do you begin a property business - now? | Dalton's RTFM said …
[...] Now is a great time to start a property business because property is cheap and getting cheaper. Some would argue that you’d be better waiting until the prices bottom first, but your chances of predicting the bottom of the market are incredibly low - better to buy when the fundamentals of the business work rather than waiting for the bottom and then missing it. For an explanation of the fundamentals of buy-to-let see how buy-to-let can work for you. [...]
on 26 Dec 2008 at 5:18 pm 10.Genevieve said …
I found the information very useful.
I would like to start my own property business but with no initial capital to invest, I do not know how to get started.
I have my own property (on a fixed mortgage and ending next year) and I am in full time work. I would appreciate some ideas to get it going or pointers?
on 27 Dec 2008 at 2:08 pm 11.Tristan said …
Hi Genevieve
If you have no capital at the moment then you have have few options, however, you do have some options.
The hardest is probably going to be saving some money up, but this will depend on your income and other financial circumstances.
You say you own your own property, how much equity do you have? If you have sufficient equity, you can remortgage, thereby releasing some capital that can be used to fund your deposits. Only do this if you are comfortable with the risks and are sure you know what you are doing!
Another strategy you can pursue is to bootstrap the deposit through other unsecured borrowings, however this is going to be very expensive. I wouldn’t consider this option myself as it can leave you too heavily geared with the cost of the debts being greater than the rent received on the property.
Another idea is to negotiate a “gifted deposit”, whereby the vendor agrees to sell the property to you with, for example, a 10% gifted deposit, meaning you can buy it “no money down”. Lots of lenders won’t allow this with new properties, but with a good solicitor and the right lender, you may be able to do this on a 2nd hand property where the values are more settled.