Landlords have been doing well with letting for years, but can novices to buy to let still benefit from those opportunities for profit?
With buy to lets, investors buy properties with the intention of making a profit on (i) the rent received over their mortgage, costs and tax payable and (ii) the capital appreciation of the property.
Most lenders offer separate buy to let mortgages in addition to their residential mortgage products. The interest rates for buy to let are almost always higher though and the fees tend to be far greater.
Additionally, lenders are a bit more stringent with buy to let investors versus the typical residential mortgage application process. For instance, residential mortgage deposits can be as low as just 5%. Conversely, for buy to let properties lenders ask for a higher deposits, invariably between 20% and 40% of the property’s value. Also lenders generally ask buy to let applicants to hold a more impressive credit score when compared to residential mortgage applications.
To obtain sufficient size mortgage to purchase a buy to let, the lender’s valuation needs to be satisfactory in two different criteria.
Firstly, as with a residential mortgages, the value of the property as whole must come out at a certain amount so that the mortgage amount equates to a certain loan to value. Secondly, unlike a residential mortgage, the valuer will also give an estimate on the likely rent per month for the property. Usually this needs to come in around 120% to 130% of the total rent per month, but can be more. If the valuer comes in lower than hoped for either of these numbers, the buy to let mortgage amount can be reduced or refused altogether.
With the exception of city centre flats, rents are the highest they have ever been thanks to a widespread shortage of affordable properties for first-time home buyers. This fact alone would seem to make buy-to-let a no-brainer. Coupled with historically low interest rates, it would seem that profit margins are currently high.
It is not so straightforward though, as the location of a prospective buy to let investment has a heavy influence on profit margin. Yields in certain regions can be very low if the initial cost of the purchase was high or if rental demand and therefore rents in the area are low. Where margins are tight, if interest rates were to shoot up or if there was ever an extended period of the property being vacant, this could put the landlords into trouble.
The answer to this depends on how familiar the landlord is with personal finance strategies - for example, landlords with minimal financial knowledge may sometimes purchase property and end up failing to find a tenant. In these cases, those mortgage repayments often cannot be paid off. As a result, a repossession may occur and the landlord will lose their deposit.
Furthermore, buy to let landlords have found themselves in the cross hairs of the government tax legislation in recent years making the investment much less profitable. At the outset, investors have to pay far more stamp duty to acquire the property compared to residential purchasers. In addition, landlords can set off a decreasing amount of their mortgage against their tax bills which has resulted in some landlords actually paying more tax to HMRC than the profit they receive. Also in respect of tax, the 10% wear and tear relief has been scrapped, further increasing landlord tax bills.
Another negative is the increasing level of regulation which therefore more costs to get properties up to a legally required standard. Certainly landlord of HMO’s need to now obtain a licence (which is not cheap) which usually involves a lot of work to be done on the properties as required by the local councils.
Furthermore., tenants are certainly more law savvy nowadays, with information readily available on the internet and dare I say they are more litigious. In many situations, it is certainly easier to simply concede points rather than take on the fight.
Lastly, a crucial aspect of buy to let is that investors are not really able to sell the property quickly for the purpose of paying off the mortgage. This is especially so during the present Covid period, where notice to tenants is now a minimum of 6 months. Hi An example is a situation where housing values are on the decline, and the investor goes negative on their equity. The investor still needs to pay their lender any outstanding dues after paying off debts with profits from the property sale.
There are many smaller buy to let investors today who are selling up and pulling out of the market. One prediction is that there are now 110,000 less landlords than there were 10 years ago. We believe it is fair to say the returns on buy to let are not as great as they have been previously because of the changes in tax laws, the rise in stamp duty, the increase in regulation and the costs of acquiring the mortgages.
Further many landlords have found themselves burnt by savvy tenants who decided to stop paying their rents and played the court system to stop being evicted. Indeed the law often seems to be more on the side of tenants rather than landlords in this area.
That stated, profit still can be made on buy to let properties, especially if you choose the right property in the right location. Just make sure you choose the property and your tenants carefully and assess the numbers realistically and in detail.