Is the buy-to-let market bouncing back?
In the years leading up to the credit crunch, the buy-to-let market was booming. Credit was easy to come by, and the deluge of property programmes on TV encouraged everyone to believe that building a successful property empire was within their reach.
Then the bubble burst, the credit crunch went global, and lenders figuratively (and in some cases, literally) shut up shop.
But as the UK moves out of recession and funding makes a slow return, it seems the devastation left behind by the credit crunch has presented the buy-to-let sector with an opportunity. The fact that house prices have fallen and the number of repossessed properties has increased means there are property bargains to be found.
Meanwhile, the unfeasibly high deposits required by cautious lenders from prospective first-time buyers means the demand for rental properties is soaring.
"As would-be first-time buyers are forced to rent for longer - until they can raise the necessary deposit - the rental market is booming," says Melanie Bien, director at brokerage Private Finance.
"Rising tenant demand is pushing up rents, while investors increasingly view the market as an attractive alternative to keeping savings in cash or investing in a volatile stockmarket.
"At the same time, buy-to-let lenders are recognising the growing opportunity to make money and are returning to the market, introducing new products, reducing rates and relaxing criteria."
However, a buy-to-let mortgage is very different from a residential mortgage.
"A buy-to-let mortgage is a commercial loan," explains Paul Rockett, managing director of online buy-to-let brokers Landlord Centre. "They tend to be repaid on an interest-only basis, with landlords generating income from rent and a return on investment from the capital appreciation of the property."
Lenders calculate how much they are willing to lend for buy-to-let mortgages based on expected rents, rather than earned income.
So Bien warns that new landlords have to make sure the numbers add up in order to satisfy the lenders. The rent should cover the mortgage interest plus a healthy margin for other costs - 125% or 130% of the monthly mortgage cost is typical.
Buy-to-let mortgages are generally more expensive than residential mortgages, due to the perceived increase in risk caused by having tenants living in the property.
For example, Yorkshire Bank currently offers a variable offset rate of 5.3% for the term of the mortgage at 80% loan to value, with a £999 arrangement fee. Or those with a larger deposit, Skipton offers a fixed rate of 3.99% until July 2013 at 70% LTV, with a completion fee of £2,495.
However, becoming a successful landlord requires careful planning and research. "When you start out, research the area in which you plan to invest, as well as your target tenant group and the demand for accommodation," says Chris Norris, policy manager at the National Landlords Association.
Another consideration should be whether you are better off using a letting agent to find tenants and collect the rent, rather than doing it yourself. "Some people are not best suited to these tasks," warns Bien. "Be honest with yourself regarding your strengths and weaknesses."
Landlord Andrew Baker from Neath in south Wales suggests that when it comes to finding a tenant it's better to wait for two or three weeks rather than rush into signing one up. "Try to pick tenants who seem more settled," he advises.
"If they've had two or three addresses in the last few years, chances are they're not going to stay long at your property. A high turnover of tenants can mean a lot of extra cost."
It's also important to understand the tax implications of owning a buy-to-let property. Rent is treated as taxable income; however, you can offset the costs associated with each buy-to-let property, including mortgage interest payments, maintenance costs and letting agency fees.
Capital gains tax is currently charged at a flat rate of 18% or 28% (depending on your total taxable income) on any profits gained that are above the CGT threshold (currently £10,600) when you sell up.
There's also a 10% annual wear and tear allowance if you let furnished property, whereby you can deduct 10% of the annual rent from your tax bill. Both rental income and profits must be declared in an annual self-assessment form; always get advice from a qualified accountant.
Once you've bought the property and you have tenants in place, you'll need to maintain the property to a decent standard and get landlord insurance if you want to make a success of your venture.
While the current economic climate means it could be a good time to get involved in buy-to-let, anyone considering doing so needs to be aware of the potential pitfalls. One of the main ones is the risk of being over-exposed to a single sector. If you own your home and a couple of buy-to-lets and there's a property crash, you could be horribly exposed.
"Investing in other asset classes such as shares and cash can mitigate this risk," says Bien.
It's also important to recognise that property is also a very illiquid investment: "If you need to get your hands on the equity, you have to find a buyer, which could take some time," she adds.
Bad tenants can also be an issue, as can rental voids and the amount of time needed to manage your property.
"Buy-to-let is not a get-rich-quick scheme," concludes Rockett. "You need to seriously consider its pros and cons first before you decide to invest."
Loan to value
The LTV shows how much of a property is being financed and is also a way to tell how much equity you have in a property. The higher the LTV ratio the greater the risk for the lender, so borrowers with small deposits or not much equity in the property will be charged higher interest rates than borrowers with large deposits. The LTV ratio is calculated by dividing the loan value by the property value and then multiplying by 100. For example, a £140,000 loan on a £200,000 property is a LTV of 70%.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
A charge some brokers (and, increasingly, lenders) make for arranging your loan or mortgage, either as a flat fee or a percentage of the amount you wish to borrow. In order to look ultra-competitive in the best-buy tables, some mortgage lenders will offer mortgages with an attractive low rate and recoup any losses with a hefty arrangement fee.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.