Buying to Let

Letting property in the UK

Since the introduction of the 1988 Housing Act and the amendments in the 1996 Housing Act, landlords have had far greater security when letting their properties. These acts introduced two new kinds of tenancy, assured and assured shorthold, whereby the length of the tenancy and an open market rent are agreed at the outset, and landlords have a guaranteed right in law to possession of their property at the end of the fixed term.

Buying to Let

These acts had a positive effect on revitalising the private rental sector in the UK, which had previously been in a slump for decades.

Most people in the UK make a yield of between 5 and 10 per cent (the gross profit on your capital investment after all expenses, but before taxes) and capital growth (the value of the property) has been up to 25 per cent or more a year in many areas. It’s a win-win investment – no other comes close – and is apparently risk-free (unless there’s a property crash)! On the down side, buy-to-let investors have contributed to spiralling property prices in recent years, which has led to a dearth of first-time buyers (who cannot afford to buy) that is threatening the whole property market.

However, in late 2004 rental yields were less than 1 per cent in many areas and many landlords in London were actually losing money (along with zero capital growth). Do your sums carefully before buying and don’t believe what letting agents tell you regarding rental income, as they may exaggerate the return you can expect, in order to encourage you. With property values stagnating or even falling in some areas, many analysts advise that investors could be better off keeping their money in a savings account over the next few years. This has led to many nervous landlords selling their buy-to-let properties which it’s feared could trigger a plunge in property prices in 2005.

Tip: Although buy-to-let seems like the dream investment, don’t be tempted to dump your pension and rush into it without giving it serious thought!

Where to buy

It’s important to buy the right property in the right area to maximise both rental income and capital growth. Ask advice from letting agents, who will generally offer unbiased advice as they have no hidden agenda (unlike an estate agent trying to sell to you). When buying property to let – whether it’s a buy-to-let or a holiday home – location is critical!

Your best chance of maximising your profit is to buy a property that needs complete renovation, do it up yourself and let it for a good rent. Buying a large house and converting it to apartments can also pay handsomely. If income rather than capital growth is your major concern, you may be better off buying in an unfashionable area where prices are low and yields are high, but capital growth is relatively low.

The buy-to-let phenomenon has meant that many British towns and city suburbs have become saturated with property to let, which has put pressure on landlords to lower rents – you need to do your sums very carefully and choose the location carefully. Before buying a property to let, it’s important to identify your ideal tenant and to ensure that there’s a demand for rental properties in the area where you plan to buy. You must be emotionally detached (you won’t be living there) and not buy something that appeals to you, but to your target market. Wherever you buy, it must usually be close to public transport (e.g. a railway station or a tube station in London) and in an area of high employment.

To whom can I let?

You can get good yields letting to students sharing a property, but you will need to put up with a lot of problems; they will almost certainly ruin the decorations and may even trash the place (on the other hand, don’t assume that they will rent a dump)! Most landlords in the UK prefer to let to a business or to professionals with steady jobs.

Up-market homes near foreign and international schools command high rents from itinerant foreigners who pay vast rents (actually their employers usually pay the rent). Properties close to large office blocks, factories, hospitals and universities also have good letting potential. The corporate rental market has traditionally been a lucrative sector of the British market, particularly in London, although there has been a big turndown in the corporate rental market in the last few years. Corporate lets represent some 30 per cent of the London market, but only 6 to 12 per cent of regional markets.

Books that profess to tell you where and what to buy need to be taken with a pinch of salt, as areas change rapidly from hot to cold and no book can keep up. Plus, of course, everyone else who buys the book will also know the best areas, which means that the information will be worth little or nothing almost as soon as it’s published.

It’s probably better to keep your eyes and ears open and to follow the trends highlighted in newspaper and magazine articles, which are more up to date. Note that in late 2004, the top ten property hotspots (where property prices had risen fastest in the previous year) were all outside the south of England, i.e. in the north of England, Wales or Scotland.

What to Buy

One-bedroom apartments (but not studios) have the best rental prospects in cities (where most renters are singles), while large houses are best in country areas. Houses are better than apartments for long-term tenants – the average stay of a tenant in an apartment is around six months to a year, whereas in a house it’s around two and a half years.

Don’t buy a very expensive property as the rent won’t cover the costs. Buying resale rather than new usually provides better value – glossy new developments are expensive and the extra cost isn’t usually reflected in the rent you can charge (although capital growth may be higher).

If you’re buying an apartment off plan, buy one that will appeal to both owner-occupiers and renters, so that on completion you have the option to sell it at a profit or let it. Be wary of investing in a development where most owners are investors – a 60-40 ratio of owner-occupiers to tenants is considered the best split.

A good apartment in a city (where competition is usually fierce) must usually be modern (or with all mod cons), well equipped, well decorated and very well furnished to command a high rent. Rooms should be well-proportioned (big enough for ‘proper’ furniture), well-lit and preferably south facing. Low-maintenance gardens with paved surfaces or decking rather than lawns and flowerbeds are best (if you’ve got a large garden you will need to employ a gardener - never rely on tenants to look after a garden or even to water indoor plants!).

Tip: Avoid pokey apartments and houses with tiny living rooms and box rooms masquerading as bedrooms. Make sure that a property has the right attributes, such as being in a good area and close to public transport, major roads and amenities such as shops, restaurants, pubs, parks and sports facilities, and that it has off-road parking (preferably a lock-up garage) and a peaceful, secure location.

Buy (or create) a property with a killer selling point such as a vast lounge/dining room, a good-sized terrace, a garage or off-road parking (e.g. in a city where it’s expensive or non-existent!), great views, a beautiful garden (could be shared), a stunning kitchen or a fabulous bathroom with a Jacuzzi and power shower. It’s advisable to make your place look different (i.e. more desirable), as there are far too many places that look exactly the same.

Letting to Buy

In recent years an increasing number of people have been letting (rather than selling) their family home in order to fund their next move; let to buy rather than buy-to-let. If you plan to do this you must ensure that your home meets the necessary requirements for letting and that the rent you can achieve is at least 130 per cent of your mortgage payments. You should consider re-mortgaging to free equity for a deposit on your next home. Capital gains tax is payable when you sell if you’ve let a property for three years.

Yield

The yield on a property is the gross profit on your capital investment (after the deduction of expenses, but before tax), which varies depending on how much you paid for a property and the rent.

Generally the cheaper the property the higher the yield. For example, if you buy a property for £100,000 and let it for £700 per month (gross income £8,400 a year), your gross yield is 8.4 per cent (8,400 divided by 100,000 = 0.084 x 100). If you buy a property for £200,000 and let it for £1,200 a month (£14,400 a year) your gross yield is 7.2 per cent. This is a simple example to illustrate that yields are usually higher on cheaper properties and doesn’t take into account your costs.

Costs may include purchase costs, furniture and furnishings, service charges, ground rent, insurance, wear and tear, agent’s fees, cleaning, maintenance and decorating, void periods, council tax (when a property is empty), etc. – but not your mortgage payments. These must be deducted from your gross income in order to calculate your net income and net yield. For example, if you buy a £200,000 property, earn £15,000 a year in rent and have costs of £5,000, you have a net income of £10,000. Your net yield is therefore £10,000 divided by £200,000 = 0.05 x 100 = 5 per cent – but bear in mind that you still have to pay tax on your net income! Note that you should always use the current market value of a property to calculate the yield.

Tip: It’s important that you know the net yield you can expect to earn before embarking on a buy-to-let scheme.

Yields in the Great Britain vary and can be less than 5 per cent and as high as 15 per cent or more. In 2004 yields were historically very low with returns in London in autumn 2004 just a few per cent, while northern cities had higher yields of up to 10 per cent (the average is around 5 per cent). Rents have fallen in the last few years while house prices have risen, although by mid-2004 rents had levelled off in most areas. (Due to the low rental returns on residential property, some professional investors were turning to commercial property in 2004.)

Buying to let isn’t a good idea if your maximum rent will barely cover your mortgage and you have little other disposable income and are relying on 100 per cent occupancy. However, if you buy off plan and rental returns aren’t sufficient to pay your mortgage, you can usually sell quickly and make a profit.

Take care – with the property market stagnating in the south of England (particularly London), many people were struggling to attract tenants in late 2004 and house prices were static or fell in most of London in 2004!

Finance

Buy-to-let mortgages are relatively easy to obtain from a large number of lenders in the UK, with interest rates typically around 1 per cent higher than standard residential loans. Fixed-rate, interest-only mortgages are favoured by many buy-to-let investors, which allows you to keep the rent competitive while watching the capital value grow.

Most lenders will lend a maximum of 75 or 80 per cent of the value of a property, although it’s advisable not to borrow more than 50 to 60 per cent. It’s important not to be too heavily geared (60 to 70 per cent is reckoned to be about right) by having too high a mortgage – you will also need a cash reserve for maintenance, repairs and void periods. Some experts recommend that you don’t buy if you need to rely solely on rental income to pay your mortgage, although this depends on your mortgage payments.

Setting the Rent

You must set a realistic rent that compares with similar properties in the area and which will also give you a decent return on your investment. You can check the rents of similar properties in local newspapers. Alternatively you can use a letting agent to calculate the right price band and find your own tenants or market a property yourself. However, you must be flexible and be prepared to lower the rent (particularly for an excellent long-term tenant) or pay higher fees to an agent when tenants are thin on the ground. Many successful landlords in the UK set their rents below the market rates and rarely increase them, thus avoiding voids and keeping their tenants longer.

Bear in mind that, in the last resort, you may have to sell if you cannot find a tenant!

If you’ve got a long let (minimum 12 months) and a desirable property in a good area, you may be able to budget for 45 to 50 weeks income a year, although in an area that’s saturated with rental properties you may have to make do with 40 weeks or less.

Note that it’s often better to lower the rent than have a property empty for a number of weeks. For example, if your rent is £800 per month and a property is empty for two months, it would have been better to reduce the rent to £700 per month for a quick let. This would bring in £8,400 for 12 months (12 x £700) compared with £8,000 for 10 months (10 x £800) – and you will have spared yourself the agony of not having a tenant! A void of one month is equivalent to a loss of 8.3 per cent of one year’s rent.

In general, your rental income should cover your mortgage repayments plus another 25 to 50 per cent. You must pay tax on your rental income, but can deduct mortgage repayments and costs before paying tax on any profit.

Tenants pay one month’s rent in advance plus a deposit equal to four to six weeks’ rent, which is held by the letting agent (if applicable) in a bonded account – not by the landlord. You can also get a solicitor to hold the deposit and have the inventory prepared by an inventory clerk and signed by the tenant, which should prevent any disputes. Wear and tear is taken into consideration, but breakages, damage and missing items are deducted from the deposit when a tenancy ends. Some landlords charge up front for wear and tear, although this simply invites tenants to trash a place.

A property must be spotless when vacated and the contract may stipulate that it must be professionally cleaned. Some landlords are prone to use tenants’ deposits to refurbish their properties, while claiming that tenants left the place in a mess – even a third party holding the deposit doesn’t protect tenants as the deposit holder simply accepts what the landlord tells him (unless you get a solicitor to hold the deposit)! Tenants usually pay for utility services such as gas, electricity, water, telephone, TV licence, cable TV service and council tax.

Expenses

When calculating your budget, don’t forget to take into account all of your costs such as mortgage repayments, agency and management fees, service charges (leasehold apartment), stamp duty, land registry fees, council tax (when a property is empty), cleaning, gas safety certificate, redecorating, repairs, replacing equipment and furniture, inventory fee, advertising and tax on any profit.

These acts had a positive effect on revitalising the private rental sector in the UK, which had previously been in a slump for decades.

Most people in the UK make a yield of between 5 and 10 per cent (the gross profit on your capital investment after all expenses, but before taxes) and capital growth (the value of the property) has been up to 25 per cent or more a year in many areas. It’s a win-win investment – no other comes close – and is apparently risk-free (unless there’s a property crash)! On the down side, buy-to-let investors have contributed to spiralling property prices in recent years, which has led to a dearth of first-time buyers (who cannot afford to buy) that is threatening the whole property market.

However, in late 2004 rental yields were less than 1 per cent in many areas and many landlords in London were actually losing money (along with zero capital growth). Do your sums carefully before buying and don’t believe what letting agents tell you regarding rental income, as they may exaggerate the return you can expect, in order to encourage you. With property values stagnating or even falling in some areas, many analysts advise that investors could be better off keeping their money in a savings account over the next few years. This has led to many nervous landlords selling their buy-to-let properties which it’s feared could trigger a plunge in property prices in 2005.

Tip: Although buy-to-let seems like the dream investment, don’t be tempted to dump your pension and rush into it without giving it serious thought!

Where to buy

It’s important to buy the right property in the right area to maximise both rental income and capital growth. Ask advice from letting agents, who will generally offer unbiased advice as they have no hidden agenda (unlike an estate agent trying to sell to you). When buying property to let – whether it’s a buy-to-let or a holiday home – location is critical!

Your best chance of maximising your profit is to buy a property that needs complete renovation, do it up yourself and let it for a good rent. Buying a large house and converting it to apartments can also pay handsomely. If income rather than capital growth is your major concern, you may be better off buying in an unfashionable area where prices are low and yields are high, but capital growth is relatively low.

The buy-to-let phenomenon has meant that many British towns and city suburbs have become saturated with property to let, which has put pressure on landlords to lower rents – you need to do your sums very carefully and choose the location carefully. Before buying a property to let, it’s important to identify your ideal tenant and to ensure that there’s a demand for rental properties in the area where you plan to buy. You must be emotionally detached (you won’t be living there) and not buy something that appeals to you, but to your target market. Wherever you buy, it must usually be close to public transport (e.g. a railway station or a tube station in London) and in an area of high employment.

To whom can I let?

You can get good yields letting to students sharing a property, but you will need to put up with a lot of problems; they will almost certainly ruin the decorations and may even trash the place (on the other hand, don’t assume that they will rent a dump)! Most landlords in the UK prefer to let to a business or to professionals with steady jobs.

Up-market homes near foreign and international schools command high rents from itinerant foreigners who pay vast rents (actually their employers usually pay the rent). Properties close to large office blocks, factories, hospitals and universities also have good letting potential. The corporate rental market has traditionally been a lucrative sector of the British market, particularly in London, although there has been a big turndown in the corporate rental market in the last few years. Corporate lets represent some 30 per cent of the London market, but only 6 to 12 per cent of regional markets.

Books that profess to tell you where and what to buy need to be taken with a pinch of salt, as areas change rapidly from hot to cold and no book can keep up. Plus, of course, everyone else who buys the book will also know the best areas, which means that the information will be worth little or nothing almost as soon as it’s published.

It’s probably better to keep your eyes and ears open and to follow the trends highlighted in newspaper and magazine articles, which are more up to date. Note that in late 2004, the top ten property hotspots (where property prices had risen fastest in the previous year) were all outside the south of England, i.e. in the north of England, Wales or Scotland.

What to Buy

One-bedroom apartments (but not studios) have the best rental prospects in cities (where most renters are singles), while large houses are best in country areas. Houses are better than apartments for long-term tenants – the average stay of a tenant in an apartment is around six months to a year, whereas in a house it’s around two and a half years.

Don’t buy a very expensive property as the rent won’t cover the costs. Buying resale rather than new usually provides better value – glossy new developments are expensive and the extra cost isn’t usually reflected in the rent you can charge (although capital growth may be higher).

If you’re buying an apartment off plan, buy one that will appeal to both owner-occupiers and renters, so that on completion you have the option to sell it at a profit or let it. Be wary of investing in a development where most owners are investors – a 60-40 ratio of owner-occupiers to tenants is considered the best split.

A good apartment in a city (where competition is usually fierce) must usually be modern (or with all mod cons), well equipped, well decorated and very well furnished to command a high rent. Rooms should be well-proportioned (big enough for ‘proper’ furniture), well-lit and preferably south facing. Low-maintenance gardens with paved surfaces or decking rather than lawns and flowerbeds are best (if you’ve got a large garden you will need to employ a gardener - never rely on tenants to look after a garden or even to water indoor plants!).

Tip: Avoid pokey apartments and houses with tiny living rooms and box rooms masquerading as bedrooms. Make sure that a property has the right attributes, such as being in a good area and close to public transport, major roads and amenities such as shops, restaurants, pubs, parks and sports facilities, and that it has off-road parking (preferably a lock-up garage) and a peaceful, secure location.

Buy (or create) a property with a killer selling point such as a vast lounge/dining room, a good-sized terrace, a garage or off-road parking (e.g. in a city where it’s expensive or non-existent!), great views, a beautiful garden (could be shared), a stunning kitchen or a fabulous bathroom with a Jacuzzi and power shower. It’s advisable to make your place look different (i.e. more desirable), as there are far too many places that look exactly the same.

Letting to Buy

In recent years an increasing number of people have been letting (rather than selling) their family home in order to fund their next move; let to buy rather than buy-to-let. If you plan to do this you must ensure that your home meets the necessary requirements for letting and that the rent you can achieve is at least 130 per cent of your mortgage payments. You should consider re-mortgaging to free equity for a deposit on your next home. Capital gains tax is payable when you sell if you’ve let a property for three years.

Yield

The yield on a property is the gross profit on your capital investment (after the deduction of expenses, but before tax), which varies depending on how much you paid for a property and the rent.

Generally the cheaper the property the higher the yield. For example, if you buy a property for £100,000 and let it for £700 per month (gross income £8,400 a year), your gross yield is 8.4 per cent (8,400 divided by 100,000 = 0.084 x 100). If you buy a property for £200,000 and let it for £1,200 a month (£14,400 a year) your gross yield is 7.2 per cent. This is a simple example to illustrate that yields are usually higher on cheaper properties and doesn’t take into account your costs.

Costs may include purchase costs, furniture and furnishings, service charges, ground rent, insurance, wear and tear, agent’s fees, cleaning, maintenance and decorating, void periods, council tax (when a property is empty), etc. – but not your mortgage payments. These must be deducted from your gross income in order to calculate your net income and net yield. For example, if you buy a £200,000 property, earn £15,000 a year in rent and have costs of £5,000, you have a net income of £10,000. Your net yield is therefore £10,000 divided by £200,000 = 0.05 x 100 = 5 per cent – but bear in mind that you still have to pay tax on your net income! Note that you should always use the current market value of a property to calculate the yield.

Tip: It’s important that you know the net yield you can expect to earn before embarking on a buy-to-let scheme.

Yields in the Great Britain vary and can be less than 5 per cent and as high as 15 per cent or more. In 2004 yields were historically very low with returns in London in autumn 2004 just a few per cent, while northern cities had higher yields of up to 10 per cent (the average is around 5 per cent). Rents have fallen in the last few years while house prices have risen, although by mid-2004 rents had levelled off in most areas. (Due to the low rental returns on residential property, some professional investors were turning to commercial property in 2004.)

Buying to let isn’t a good idea if your maximum rent will barely cover your mortgage and you have little other disposable income and are relying on 100 per cent occupancy. However, if you buy off plan and rental returns aren’t sufficient to pay your mortgage, you can usually sell quickly and make a profit.

Take care – with the property market stagnating in the south of England (particularly London), many people were struggling to attract tenants in late 2004 and house prices were static or fell in most of London in 2004!

Finance

Buy-to-let mortgages are relatively easy to obtain from a large number of lenders in the UK, with interest rates typically around 1 per cent higher than standard residential loans. Fixed-rate, interest-only mortgages are favoured by many buy-to-let investors, which allows you to keep the rent competitive while watching the capital value grow.

Most lenders will lend a maximum of 75 or 80 per cent of the value of a property, although it’s advisable not to borrow more than 50 to 60 per cent. It’s important not to be too heavily geared (60 to 70 per cent is reckoned to be about right) by having too high a mortgage – you will also need a cash reserve for maintenance, repairs and void periods. Some experts recommend that you don’t buy if you need to rely solely on rental income to pay your mortgage, although this depends on your mortgage payments.

Setting the Rent

You must set a realistic rent that compares with similar properties in the area and which will also give you a decent return on your investment. You can check the rents of similar properties in local newspapers. Alternatively you can use a letting agent to calculate the right price band and find your own tenants or market a property yourself. However, you must be flexible and be prepared to lower the rent (particularly for an excellent long-term tenant) or pay higher fees to an agent when tenants are thin on the ground. Many successful landlords in the UK set their rents below the market rates and rarely increase them, thus avoiding voids and keeping their tenants longer.

Bear in mind that, in the last resort, you may have to sell if you cannot find a tenant!

If you’ve got a long let (minimum 12 months) and a desirable property in a good area, you may be able to budget for 45 to 50 weeks income a year, although in an area that’s saturated with rental properties you may have to make do with 40 weeks or less.

Note that it’s often better to lower the rent than have a property empty for a number of weeks. For example, if your rent is £800 per month and a property is empty for two months, it would have been better to reduce the rent to £700 per month for a quick let. This would bring in £8,400 for 12 months (12 x £700) compared with £8,000 for 10 months (10 x £800) – and you will have spared yourself the agony of not having a tenant! A void of one month is equivalent to a loss of 8.3 per cent of one year’s rent.

In general, your rental income should cover your mortgage repayments plus another 25 to 50 per cent. You must pay tax on your rental income, but can deduct mortgage repayments and costs before paying tax on any profit.

Tenants pay one month’s rent in advance plus a deposit equal to four to six weeks’ rent, which is held by the letting agent (if applicable) in a bonded account – not by the landlord. You can also get a solicitor to hold the deposit and have the inventory prepared by an inventory clerk and signed by the tenant, which should prevent any disputes. Wear and tear is taken into consideration, but breakages, damage and missing items are deducted from the deposit when a tenancy ends. Some landlords charge up front for wear and tear, although this simply invites tenants to trash a place.

A property must be spotless when vacated and the contract may stipulate that it must be professionally cleaned. Some landlords are prone to use tenants’ deposits to refurbish their properties, while claiming that tenants left the place in a mess – even a third party holding the deposit doesn’t protect tenants as the deposit holder simply accepts what the landlord tells him (unless you get a solicitor to hold the deposit)! Tenants usually pay for utility services such as gas, electricity, water, telephone, TV licence, cable TV service and council tax.

Expenses

When calculating your budget, don’t forget to take into account all of your costs such as mortgage repayments, agency and management fees, service charges (leasehold apartment), stamp duty, land registry fees, council tax (when a property is empty), cleaning, gas safety certificate, redecorating, repairs, replacing equipment and furniture, inventory fee, advertising and tax on any profit.

This article is an extract from Buying, selling & letting property (UK). Click here to get a copy now.

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