The UK are big fans of property ownership, approximately seventy percent of property is owned with thirty percent rented, a ratio well above the average in Europe. Although the bulk of the drive for ownership about owning your own home, there’s also a growing popularity in buying property to rent out as an investment. Buy-to-let is a well marketed industry and is presented as an easy access opportunity to the general public. Letting out property as an investment can be lucrative in the right circumstances, however it is still a form of “business”, which has specific rules and requirements to be successful. Many people step into property investment without a full understanding of the many aspects that need appraising. Below are five key considerations, however please note the list is not exhaustive and all investors should do their own research before making their commitment.
For the investor usually there are two main methods to raise finance:
Equity release from your own property.
Buy-to-let mortgages are specifically marketed by the financial sector for this type of business. The rates of interest are usually higher than a mortgage taken against your own home. This is because there is a higher perceived risk to the lender in that the loan is usually covered by the rental income from a 3rd party who in this case is not the named borrower. This risk usually also translates into the need for a larger deposit to be put down against the purchase price, for example a 20-25% deposit requirement is typical. In calculating that risk affordability is given extra scrutiny so any applicant may need to evidence a higher degree of affordability at the underwriting process then with a residential mortgage. The buy-to-let mortgage is specific in that it treats your investment as a business case in its own right.
Equity release mortgages allow the investor to borrow against the equity in their own home and then use that cash to purchase the investment property. In this situation the interest rate is more favorable, the lender considers the risk lower as the affordability and means to pay the loan is directly attributable to the borrower directly. The level of borrowing in this situation is determined primarily by two aspects. Firstly the level of loan-to-value, LTV requested, i.e. what percentage of the equity in your home’s value you wish to borrow against and secondly affordability criteria to service that loan. In terms of affordability any potential rental income from this equity release is not considered, so unlike the buy-to-let mortgage you are assessed for affordability based on your current situation only.
Buy-to-let – Pros – Takes into account potential rental income in affordability criteria
Buy-to-let – Cons – Typically higher interest rate & setup cost, higher deposit required than most residential mortgages
Equity release – Pros – Lower interest rate, typically lower setup costs
Equity release – Cons – Affordability criteria usually excludes potential rental income
Often people move out of their main residence, with the intention of keeping the property to rent out and mistakenly assume they can continue to run their residential mortgage on the property. However the risk levels and the terms that the residential mortgage was taken out against have changed, therefore the mortgage lender will require you to change your mortgage to a buy-to-let product or return to residency in the property.
Especially with buy-to-let mortages there may be other criteria on which properties a company will and will not lend on. For example, some companies will not lend on apartments above the 2nd floor etc. It’s recommended to check this against the property type being considered.
Overall seek professional advice before making any financial commitment.
Potential Rental Market Returns
It helps to know in advance what your economic conditions are, i.e. potential access to loans, available deposit, budget if no finance needed etc… This may help to clarify the amount of monthly rental return you are looking for to both meet expectations of the lender (where finance is needed) and yourself in terms of a given return for your invested money. Surprisingly the reverse often happens, a property is found, committed to and then at that late stage the financials are considered!
Potential rental returns can vary greatly; aspects such as location, property type, property condition, supply and demand are just a few variables so it’s essential to gauge the market correctly. Using a property letting agent is a smart way to get a feeling for what is obtainable. A good lettings agency will provide guidance and advice without obligation.
Bear in mind that when a figure is established for rental return some consideration should be given to “voids”, periods of time where the property is not rented. Voids are obviously undesirable but always possible due to the nature of tenants moving in and out. On average a figure of fifteen percent is sensible to account for, as the future is unknown. However, using a good property management agency can help reduce the void percentage through efficient organisation and by leveraging their tenant client base and marketing reach.
There are several variables in costs and also some common costs to account for and find out ahead:
Property Type – For example an apartment will typically come with service charges, find out what these are ahead
Furnished or Unfurnished? – If furnishing enhances the rental return or ability to let the property then account for the setup costs of furnishing and also the replacement costs over the years. Again a local lettings agent could advise on the pros and cons of this choice
Repairs / incidental maintenance – Some upfront accountancy needs to be made for maintenance whether internal or external. Level of cost should be judged on state/condition of property.
Property Management & Marketing – What are the annual costs, both one-off and ongoing?
Ground rent – Payable annually for all leasehold ownership where applicable
Buildings Insurance – Leaseholds, properties with communal aspects the insurance costs are dictated to you. Freehold you choose, check market rates
Landlords Liability Insurance – Optional but recommended
Contents Insurance – Optional but recommended
Other Legal Requirements – Several additional costs to account for see next section.
All in all once a full financial appraisal has been made of both costs and returns it’s probably a good time to start looking for the right property.
The property rental sector is not as heavily regulated as the property sales and estate agency market. However there are several Acts of Parliament which govern generally and regulate residential property lettings, such as the Housing Act. These laws are typically broad and all encompassing, certain aspects of them do apply to the property lettings industry whilst many do not.
It’s also true to say that in recent years the letting industry has become more formalized and there is an increasing quantity of lettings specific legislation being introduced. This is in many ways a positive thing as helps to bring higher standards and professionalism to the sector; it’s also worth noting that some of the compliancy comes with a financial cost. For an up to date list of legal and safety regulations that any prospective landlord must be compliant with, consider talking with a letting agent, who will by up to date by default and should provide free no obligation advice.
Managing your Property
There are 3 principle methods landlords usually consider:
Management via an agency – Tenants are both found and managed as a complete outsourced process. The cost is usually expressed as a percentage of the monthly rent received.
Self-Management with Marketing via 3rd party – Landlord chooses to manage the property but uses an agent to find and vet potential tenants; the landlord may also use the agent to be compliant with the legal tenancy contract. The cost here is usually expressed as an upfront one-off fee.
Complete self-management – Landlord manages the full scope of activity, markets their own property plus finds and manages their own tenant. The cost here is whatever the independent costs are the landlord incurs themselves.
Pros & Cons
Agency Management – Pros – Experienced management of all tenant and property related issues, financially simple – all monies managed for you, potential to negotiate best market rental rate, increasingly cost effective for landlords with multiple properties
Agency Management – Cons – Cost is perceived higher than self-managed. However the long term earnings may be greater as a function of agent experience.
Self-Managed, with 3rd party marketing – Pros – Lower cost option, allows landlords with enough time and confidence in their own management to save money
Self-Managed, with 3rd party marketing – Cons – New landlords in particular stand a higher risk of error or mismanagement and usually gaining experience comes with a cost.
Complete self-management – Pros – All costs under control of the landlord and if all the work is done by the landlord probably will provide the highest return on paper.
Complete self-management – Cons – New landlords in particular stand a higher risk of error or mismanagement and usually gaining experience comes with a cost. They also don’t have access to the marketing tools or are able to leverage the economies of scale that a lettings agency can, which may mean the economics behind this choice need to be carefully weighed.
Overall each scenario should be considered in its own right, the property and person involved, attitudes to risk versus reward and the amount of available spare time are big factors in making the decision. A local letting agent will be able to advise on their service offerings which should help determine the economics of this choice. Note that performance and service levels are likely to vary between agents.
In conclusion these are five key aspects to consider before you consider investing in property to let. Each person’s motivations, personal feelings and situation will be different but generically addressing these five considerations will help provide an informed methodology to take the next step forward.