Should you get into the buy-to-let business?
Buy-to-let (BTL) seems like a good money-spinner for a growing number of income-seeking investors battling with low interest rates and stockmarket volatility. According to the english Housing Survey 2011/2012, there are more than 1.4 million private landlords operating in the UK.
David Hollingworth, mortgage specialist at broker london & Country, puts this down to several factors. "As many people have struggled to buy their own property in recent years, the demand for rental property has remained high, and, as a result, landlords have found rental income has held up strongly," he says.
"Meanwhile, competition in the BTL mortgage market has also been strong, so the rates on offer for property investors have been coming down," he adds.
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For example, one of the latest lenders to cut rates is BM Solutions, which has brought its two-year fix down from 3.69 to 3.49% at 60% loan-to- value (LTV,) with a fee of £995. Nottingham Building Society is another BTL lender to slash its two-year fix at 75% ltV to 3.49%, with a £1,999 fee, down from 3.65%.
But taking the BTL path in search of profit isn't without its pitfalls, so it's vital to do your research.
Bear in mind BTL lenders typically want rent to cover 125% of the mortgage repayments and demand bigger deposits than residential deals. Rates are often considerably higher, too. the most competitive BTL mortgages also come with hefty arrangement fees, so make sure to factor these into your calculations (see table on page 53).
Also remember that property prices could go either way at any time, and interest rates could suddenly rise, so you'll need to be able to afford to remortgage when the time comes. Most BTL mortgages are done on an interest-only basis, so you won't be wiping out the capital debt over time.
Essentially, by dipping a toe in the BTL market, you're starting a small business. So whether you're keen to maximise returns or simply have become an accidental landlord because you've been unable to sell up, you'll need to be cool, calm and collected – and do your sums.
Calculate the yield
With house prices generally flat, you'll need to invest for income rather than rely on short-term capital growth. you need to calculate the yield you'll get on your buy-to-let investment, which is the annual rent received as a percentage of the purchase price.
For example, a £200,000 property that offers around £10,000 a year worth of rent has a 5% gross yield, although many BTL big boys search for properties that produce at least a 6% yield. the rent is therefore crucial in your calculations as it will determine how much profit you make.
"The yield will vary from year to year," says Matt Hobbs, lettings director for Savills. "However, if the property goes up in value, bear in mind the yield will come down, and you'll need to consider any other outgoings – such as tax, mortgage repayments, maintenance, service charges and insurance – to calculate the net yield."
If you can get a rental return substantially over the mortgage payments, then, once you have built up a good emergency fund, you can start saving or investing any extra cash – for example, towards paying off the mortgage at the end of its term. Ideally, you'll want to profit from the rental income after additional costs, alongside saving to pay off the mortgage, and for the property to maintain its value. This may seem a tall order, but it is possible.
Void periods and finding tenants
You can’t rely on the property being rented out all the time – even in popular areas, property can sit empty. According to the National Landlords Association (NLA), 33% of landlords have experienced vacant periods in the past three months, so factor this into your costs to give yourself a financial buffer.
However, you can guard against long vacant periods by making sure you’ll attract tenants who will hopefully stay for the long term. So when considering buying a property, try to put yourself in prospective tenants’ shoes – who are they and what type of property are they looking for? Will your property’s layout and decor attract students, young professionals or families?
Then, you can make sure the property will appeal to the most likely tenants. For example, if they’re students, it needs to be functional and have a basic level of comfort, while if they are young professionals it should be modern and stylish.
Top five buy-to-let mortgages
|Coventy Building Society||3.39%, fixed to 30 April 2015||65%||£1,249||Yes||Free valuation and legal work for remortgages|
|Nottingham Building Society||3.49%, fixed to 1 July 2015||75%||£1,999||Yes||Free valuation and legal work for remortgages|
|Aldermore Building Society||5.38%, fixed for three years||80%||£999||Yes||Free legal work for remortgages|
|Hinckley & Rugby Building Society||3.24% (variable), 2.40% discount for two years||60%||£1,249||No||Rental income of 135% of the mortgage required|
|Skipton Building Society||3.68%, fixed for two years||70%||£995||Yes||Free valuation and legal work for remortgages|
Paperwork and agents
Once you’ve found suitable tenants, you’ll need to get an Assured Shorthold Tenancy agreement drawn up. This will include details of the tenant’s deposit, which must be protected in a government-authorised scheme. If you use a letting agency, it can help you with this,
although you can do it for yourself. The NLA, for example, offers a free best practice editable tenancy agreement for all landlords at landlords.org.uk.
When you protect your tenant’s deposit, you can deduct the cost of rectifying any damage at the end of their tenancy. However, this means having a detailed inventory in place from the outset, which outlines how the property should be returned, taking into account reasonable wear and tear.
Agents offer different levels of service, which range from just finding a tenant to rent collection and full management, for which they will charge a management fee. They can help with maintenance headaches by sorting out any issues so you don’t have the hassle, provided they’re reliable. To find a quality letting agent, look for agents who are members of the Association of Residential Letting Agents or the NLA.
There are more than 50 Acts of Parliament and more than 70 sets of regulations governing the private-rented sector, so it’s vital to do your homework before aiming to make a swift buck from buy-to-let.
When you purchase the property…
As well as paying stamp duty (on all properties over £125,000), you’ll also have to pay income tax on rent you receive through a tax return. How much you’ll pay depends on your tax band (20% for basic-rate payers, 40% for higher-rate, and 50% for additional-rate). But you can deduct certain ‘allowable expenses’ from your taxable rental income, including:
- Letting agency fees
- Maintenance costs
- Buildings and contents insurance premiums
- Council tax and utility bills (only if you pay these)
- Accountancy fees
Capital gains tax is also levied on BTL property if sold for more than it was bought for – although there is an annual tax-free allowance of £10,600. Any sale would also have to be declared on your tax return.
BTL properties will also count towards your estate for inheritance tax purposes. IHT on estates worth more than £325,000 (or £650,000 for married couples or civil partners) is charged at 40% on everything above the threshold.
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.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Does exactly what it says on the tin: covers the contents of your home for theft and damage and also may insure certain possessions (jewellery, cycles) outside of the home. Things to watch for include the excess and also the maximum payout on individual items. Another grey area is kitchen fittings, as some contents policies say these are not contents but part of the fabric of the property and covered by buildings insurance and some buildings policies don’t cover them because they regard them as contents.
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.
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.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.