Five rules before joining the buy-to-let market
"How's your buy-to-let portfolio performing, Deidre? Any rental voids?"
"Superbly, Cedric. In point of fact, I'm thinking of buying another couple of properties.There are some super buy-to- let mortgage deals doing the rounds. Dipped your toe in yet? Or are you still squirrelling vast sums into that company pension of yours? Remember, diversification, my dear, is the key to financial success. Pass me the port, darling."
Poor interest rates on savings, a young generation forced to rent rather than buy (despite the launch of help-to-buy), and widespread disappointment with the performance of many pension funds are all persuading more people like Deidre to turn to buy-to-let as a provider of income – and long-term capital gain.
Last year, I wanted to get an idea of the nation's appetite for buy-to-let by conducting a reader survey in the money pages of The Mail on Sunday.The results were fascinating.
Some 65% of respondents said they were using or planning to use buy-to-let as an alternative to a pension fund; 60% said they were using buy to let as an alternative to low-return cash deposits; and 69% said it was less risky than equity investments. Of existing buy-to-let investors surveyed, 60% said they were either planning to buy to let or considering adding to their portfolios in the next year.
The findings pretty much confirmed what I thought: that buy-to-let is now a crucial component in many investors' portfolios – an acceptable complement to tax-friendly Isas and pensions. It's not a passing fad and is here to stay, as evidenced by the fact that buy-to-let loans now account for 13% of all mortgages in Britain. And in the second quarter of this year, lenders advanced more buy-to-let loans than since the heady days of 2008 – before the financial crisis truly gripped the country and all mortgage lending dried up.
With gross yields on a typical rental property in the order of 5%, and average rents both growing and at near all-time records, it's not surprising that buy-to-let remains attractive.
But investing in property remains a risky business. House prices can crash, tenants can cause trouble and rental void periods, combined with maintenance costs and high management fees, can quickly eat into profits.
Also, entry costs for investors remain high, with most buy-to-let lenders insisting on minimum deposits of 20% – and the best loan rates are really only available to those with deposits of 40%-plus. High mortgage application fees, stamp duty and other set-up charges all have to be factored in – as well as the possibility of future rate hikes.
There are five golden rules I think wannabe buy-to-let investors should observe.
Rule one is to get the choice of property right – and that means looking at a buy-to-let purchase purely as an investment. Work out your target market – students or professionals, for example – and then select a property that will appeal to that sector. Preferably, buy a property in an area that you know.
Rule two is to ensure you take all costs into account. That means building into your buy- to-let business plan the cost of maintenance, insurance, protecting deposits, letting and management agents, legal services, accountants, mortgage brokers, stamp duty and advertising.
Rule three is not to over-borrow. A 60% loan is a good ceiling, otherwise it is unlikely that the rental income will support the borrowing costs and other overheads. Rental voids are inevitable. Most experts say investors should work on the basis of no fewer than four weeks in each year.
Rule four is to have a financial buffer for unexpected eventualities – such as a dishwasher breaking down.
Rule five is to get professional advice. Buy-to-let is awash with regulations. Getting advice can alert investors to some of these potential traps.
So, by all means, join the Deidre buy-to-let jet set. But don't think it's a one-way ticket to financial riches. Like all investing, there will be many bumps along the way.
Jeff Prestridge is the personal finance editor of the Mail on Sunday. Email him at email@example.com
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
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.