I travelled up to Manchester and Liverpool last week, to explore some buy-to-let property investment opportunities.
Building up a portfolio of buy-to-let properties can be an effective strategy to create long term financial independence. But if the opportunities are not adequately investigated and through diligence is not carried out, they may turn out to be poor investments.
In this piece, I consider some of the major factors to be aware of when choosing to invest in a buy-to-let property.
1. Understand what price you are actually paying for the property – say a one bed apartment is listed at GBP 195,000. What you will actually pay will be quite a bit north of this, when all the various taxes and costs are added up. For a UK resident, who is buying a buy-to-let property, that is not a first-time buyer, stamp duty of 3% will apply, and 5% for non-UK residents, since there is an additional 2% surcharge. This adds on 5,850 for the UK resident investor, and 9,750 to non-UK resident investors. Once a property value goes above 250,000, the stamp duties further increase. Then on top of this, you will have to pay conveyancing fees and other fees relating to the purchase price of about 1,500 pounds. Using these assumptions, the cost of the property for an international investor has now increased from 195,000 to 206,250.
2. Understand your gross versus net rental income – gross rent is what the tenant pays you every month, net rent is what you actually get to keep after costs, but before any mortgage related payments. The house which sells for GBP 195k may generate a monthly rental of say GBP 950 per month, but after operating costs (most usually service charges and estate agent management fees) this may drop to GBP 750. The gross yield on the marketed sales price of GBP 195,000 is 5.8%, however this drops to 5.5% on the all-in purchase cost. The net yield respectively is 4.6% and 4.4%.
3. Understand the monthly operating costs – following on from point 2, the costs usually for the landlord’s pocket include service charges and management fees. Service charges are usually expressed as an amount per square foot, payable annually. The properties I looked at in Manchester and Liverpool ranged from between GBP 3.10 and GBP3.90 per square foot, although this depends on the range of amenities available. The more luxurious the property, the higher the service charge will be, as we all know there is no such thing as a free lunch. So whilst having an indoor swimming pool and gym sounds attractive for the tenant, this will cost the landlord more money,. And then unless you live in the vicinity, you are going to need someone to manage the property for you. Typically management fees are 8% of gross rent.
4. Is your deposit protected? Most new builds that are bought off-plan require a payment of 30% deposit upon exchange of contracts, with the balance payable upon completion of the build, which may be up to a year after the deposit is paid. As a buyer, you want some comfort that your deposit is protected in case the development goes wrong. You should definitely check with your developer whether your deposit is protected. Some of the developers I met did fully protect their deposits, some didn’t. The more reputable the developers, the longer they have been around for and the better their track records, the more comfort you can get from not having the whole, or only part of the deposit protected.
5. Proportion of owner occupied versus buy-to-let properties and long versus short term lease policy – good developers will try to strike a balance between owner occupied and buy-to-let tenants. This ensures quality standards are maintained since there is a sense of ownership from the people that live there. This may be a 50/50, or 60/40 split. In addition to this, some property associations ban short-term lettings, such as registering your property on air bnb. This is an important consideration if you are looking to amplify yield with short term, higher rentals.
6. Prospects for capital appreciation – return on a property investment includes both the rental return, and capital appreciation, i.e. the extent to which a property goes up, or down, in value. Most property in the UK has generally gone up for several decades now, although this has been supported by a tailwind of declining interest rates. Rental yields tend to be 4%-5% per annum on purchase cost, and capital appreciation may be 3-5% per year, bringing total return on property investment to 8-10% per year. A function of capital appreciation is the supply/demand dynamics relating to area in which the property is located. How much of a housing shortage is there currently? What are the demographic trends driving relocation to a particular town or city? Are companies moving their headquarters to or away from a city? What proportion of students choose to stay in the city after graduating? Some of these trends will be explored in a separate blog post. If there is a lot of construction happening without a corresponding increase in demand for the properties, there is a high probability of a housing glut, falling rents and property values.
7. Is the property freehold or leasehold? Freehold means you own the property and the land it’s built on, whilst leasehold means you own the property, but lease the land it’s built on. A large proportion of properties in the UK are leasehold, with leases running into the hundreds of years. The properties I looked at in Manchester and Liverpool were either 250 years or 999 years. Generally, any lease below 80 years can be a problem when trying to secure a mortgage from a bank. As a basic rule of thumb, i’d say investors should be wary of any lease with less than 100 years remaining.
8. Understand the debt service coverage ratio – this is the ratio of a property’s monthly cash flow to its monthly debt obligation, including both principal and interest repayment. This assumes the property purchase is funded with debt. If this ratio is more than 1, it means the property income more than covers the loan repayment obligation. If the ratio is less than 1, it means the owner of the property will have to fork out extra cash every month to cover the obligation. Most mortgages will require a 15-25% down payment, with a 85%/75% loan to cover the purchase price.
9. Condition of the house – a lot of properties sought after by international buy-to-let investors tend to be newbuilds, where the property is in good condition, and shouldn’t require maintenance for several years, but for older properties, extra diligence would be required such as getting an engineer to do a structural survey.
10. Selling costs – finally, at some point in the future, you may like to sell your property, either to reinvest the proceeds into a different property or to repatriate the funds back home. This will include estate agent fees which can range from between 0.75% – 3.5% of the sale price, plus VAT, legal fees of 500-1500 pounds plus VAT, an Energy Performance Certificate of about 100 pounds, Capital Gain Tax of either 18% or 28% depending on your income levels, and potentially mortgage redemption fees, if you are redeeming or transforming a mortgage prematurely.
In summary, before choosing to invest in buy-to-let properties in foreign countries, it is wise to spend some time investigating and doing due diligence to make sure you know what you are getting in to, and avoiding problems down the line.
