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Let it be
February 2004
Should buy-to let landlords
wait out the flat growth in house prices, or is there a case for getting out of
the market?
Over the last three months, according to a report from RICS, the bad news for
tenants is that average rent payments have been increasing at their fastest rate
for over three years.
But bad news for tenants, in this case, is good news for landlords, especially
those with properties for rent in London, which has seen the most significant
rent increases. And, a bit like America and the rest of the global economy, when
London catches a cold the rest of the country sneezes. Or, in other words,
whatever happens in London happens shortly afterwards across the rest of the UK.
What happened in 2004
Well, throughout the year, buy-to-let properties in the North experienced
significant returns due to leaping house prices, with more subdued growth in the
South.
Specialist lender Paragon Mortgages describes the national pick-up in rental
income, which began in August, as steady and modest. Paragon believes that this
increase in rental demand directly resulted from interest rate rises.
“Uncertainty in the residential housing owner-occupier market has helped
strengthen tenant demand as prospective buyers, many of whom are would-be
first-time buyers, are unable or unwilling to make the initial leap on to the
housing ladder,” says Paragon’s managing director John Heron.
According to the managing director of specialist broker Landlord Mortgages, Lee
Grandin, rent levels have risen as demand for rented properties began to
outstrip supply. However, he sees a rebalancing rather than a boom period ahead.
BTL mortgages
versus standard loans The main difference between buy-to-let and residential
mortgages is the lending criteria. Aside from the valuation of the property,
lenders base the size of the loan on the potential rental income in contrast
with income multiples as with standard residential mortgages. Generally
speaking, the rental income from the property you wish to buy must equate to a
minimum of 130 per cent of the mortgage payment.
For example, if you borrow £68,000 to buy a property worth £80,000 at an
interest rate of 6.5 per cent, you would have to earn a minimum of £482.25 in
rent each month, which is 130 per cent of the £370.96 mortgage payment.
“Lenders always look for security in some manner, and as the income for
buy-to-let is subjective, they need more security from other means,” says
Grandin. Lenders get this security by demanding a higher deposit or charging a
slightly higher interest rate. Also, the maximum amount you can borrow as a
percentage of the property value is lower than the amounts offered for
residential properties. Where residential
mortgage
lenders will offer 95, 100 or in one case up to 125 per cent of the property
value, buy-to-let mortgage lenders offer between 60 and 85 per cent.
Lenders such as Bristol & West, Birmingham Midshires, GMAC RFC and The Mortgage
Works have recently lowered the rental cover required from 130 to 125 per cent,
because property prices have risen at a higher rate than rents. Hillier
explains: “People have had to borrow more to buy property because the rental
income doesn’t cover the margin required above the mortgage payments.”
Other lenders cut interest rates on their loans as conditions for the BTL market
improved. Grayson adds: “The industry nips and tucks rates based on what the
potential interest rate cycle is.”
Remember when shopping around for a mortgage that buy-to-let mortgages are
unregulated. But make sure you pick a regulated broker to help you, because then
you can be sure they are actually qualified to give you advice.
Do your homework
As with any other investment, before you part with any money, you need to do
some research. Take a detailed look at the area you plan to buy in. Find out
what the infrastructure is like, which amenities are nearby and, most
importantly, whether you are likely to get a regular supply of tenants.
On the financial side, ensure you are not paying over the odds for your property
and be prepared for void periods between tenants by putting money aside. To do
this you could choose a mortgage with the facility to overpay.
Some agents even offer a rent guarantee if you pay them a higher monthly fee or
take out insurance. Also think about whether you’ll be able to afford the
mortgage payments not only if interest rates rise, but also when the
introductory rate ends. An alternative is to choose a loan that reverts to a
tracker rate after the initial period, such as the 5.59 per cent three-year
fixed rate from Bristol & West. This reverts to the Bank of England base rate +
1.75 per cent for the remainder of the loan.
Using an agent
There are arguments for and against using a letting agent to manage your
property. Fees range from 5 to 15 per cent of the rent depending on the level of
service you want. If you decide to manage the property yourself, you will save
money, but you must be prepared. If you’re a novice you may feel more
comfortable with an agent until you gain more experience. Consult the
Association of Residential Letting Agents (see contacts) for members in your
property’s area.
Top buy-to-let tips
1 Choose the right property. Ensure the location attracts a steady flow of
tenants.
2 Get the right financing. Speak to lenders to establish how much you can
borrow.
3 Take a long-term view. Always treat entry into this market as a medium to
long-term investment.
4 Consider the hidden costs. Ensure the rent covers not only the mortgage but
the ‘hidden costs’ of maintenance and insurance as well.
5 Think about a contingency fund. Ensure you have the equivalent of three
months’ rental income put aside to cover mortgage payments during void periods
between tenants.
6 Choose a letting agent. For a fee of around 15 per cent of the gross rental
income, a letting agent will take care of tasks such as finding tenants, getting
the necessary references and collecting rent.
7 Put the right tenancy agreement in place. Always have a tenancy agreement in
place before a tenant occupies your property.
8 Ensure you have the right insurance. As the owner, you are responsible for
insuring the structure of your property, which will include any permanent
fixtures and fittings.
9 Comply with fire regulations. Local authorities require you to comply with
fire regulations. This could mean putting in fire doors and smoke detectors.
Ring your local authority for advice and a factsheet.
10 Sort out your tax position. Rental income is taxable but the mortgage
payments are tax-deductible. Any profit you make when you sell the property will
be liable to capital gains tax charged at the highest rate of income tax.
11 Before tenants move in, produce a detailed inventory. Include all the
contents in a furnished property to safeguard against any missing or damaged
items.
12 Always get a deposit. This will protect you against any damage caused by the
tenants or default on the rental payments.
Source: UCB Home Loans
Case study
Karl Bennett (34) from Dereham in Norfolk began investing in property three and
a half years ago. He has always looked at ways to invest and prepare financially
for his future and decided that investing in property was the safest option. In
addition, running a grounds and property maintenance business means his
contracted plumbers and electricians are available for any work required.
Karl now owns 20 properties and puts his success down to a few factors. Firstly,
he has bought locally, with his furthest property only 30 miles away from home.
“I’m Norfolk born and bred, so I know the county like the back of my hand, for
example where labour is needed. It’s better to buy in an area you know well.” As
a local you’re already at an advantage when it comes to doing your research.
Secondly, he sticks to one property type. “I buy only one or two-bedroom flats
or houses for professional couples or singles. I calculated that the margin
between letting a family house and one for professionals is not that great.
The return is just as good with smaller properties.” Karl’s third rule is to buy
only new properties. “Properties under 15 years old either have a builder’s
warranty or if not are in fair structural order. This means less work.”
He adds: “You need to monitor your properties constantly to ensure rental
payments have been made, when buildings’
insurance
policies are due for renewal and when tenancy agreements expire. If you don’t
keep on top of this, things could run away with you.”
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