The Buy To Let Myth and Why You’ll Never Make Money.
Robin G Smith
Copyright 2011 Robin G Smith
Smashwords Edition
The Buy To Let Myth and Why You’ll Never Make Money.
Controversial title I know but it’s time the truth were told, that it’s virtually impossible for the small Landlord and indeed even some of the larger ones to make a decent return from the Buy To Let market.
So why is this myth continued, well of course it’s those in the property business who benefit from a thriving market in investment properties, Estate Agents, TV presenters and those selling courses or books on how to get rich in the letting market, frankly I think they are the only ones getting a decent return!
The problem is that the maths just doesn’t work, and those pushing these investment opportunities just conveniently forget to explain the costings and day to day downside of residential tenancies.
Just so you understand that I do know what I am talking about I have been a Chartered Surveyor for very many years and have owned a number of residential investments in my time, most of which I have now sold. When I purchased my investments some ten years ago I was able to secure some bargains so started at a relatively low cost base but even so struggled to get a satisfactory return.
So let’s start with some simple facts before we tackle some of the more insidious problems and the mathematics.
To be brutally honest half the problem is dealing with human beings! Some I know are sweet as pie and treat the place as their own, others are caring but perhaps not quite so fastidious, whilst others have no respect for the property and its fixtures and fittings and finally there are the ‘professional’ rip off merchants who know every way to ensure that they pay as little as possible for their stay.
Don’t be fooled into thinking that the tenant will be responsible for maintaining the property, sure they should treat it with respect and would be responsible for spilling red wine on the carpet, but not for fair wear and tear on that carpet. Of course if you are providing facilities, a washing machine for example or central heating system, if it goes wrong, you will be the one to shell out not the tenant.
If you’re handy with a tool kit this will be very useful to you and save you a bundle, if not you might as well have a tap on your wallet, of course it’s not always as bad as that, sometimes it’s worse!!!!
So I’m going to tell you all the pitfalls and how to mitigate the problems. Also this book should not be seen as a way of avoiding paying for professional advice, whilst I believe all the information in this book is correct it is only provided as background and you should always take professional advice, this is a complicated business and full of traps for the unwary. A few true stories are included too !
But we’re jumping ahead here, lets back track a little and start with your decision making.
PROPERTY VALUES
In times of property inflation the picture is rosy, you may not be making much of a return on your investment but if the place is increasing in value daily and the rent covers your mortgage then you are indeed creating an asset, albeit illiquid ( remember you won’t be able to sell quickly with vacant possession and if you try to sell by auction will get far less than the market value ). Unfortunately any sale profitwill attract Capital Gains Tax, they get you every which way.
If you buy at the top of the market there is no growth to cushion you, you may even be looking at negative equity now, prudence is the key to this and spotting a bargain.
On the plus side, yes there is a plus side, in times of recession, when few properties are available rental levels increase.
THE DREAM
So you have a little nest egg tucked away in the Bank and a long lost relative has left you a small amount in a will, not quite enough to buy something outright but good enough for a deposit on a property. You’ve already looked in horror at the paltry interest from the bank and a quick bit of mental arithmetic seems to show that you can make a decent return on your investment, maybe even 10% that’s what the Estate agent reckons and you can go and look at it, on the downside you may be visiting it more than you expect, but hey let’s keep upbeat and trust that it will all work out perfectly.
WHAT THE LANDLORD THINKS
If I provide a really lovely home I will be able to find a great tenant who will treat the place as their own, pay the rent on time and be grateful for all the effort I have put into it and will probably become a friend eventually and ask me to be God-parent to their children when they have some. As responsible adults they will let me know the moment something goes wrong and will treat their neighbours with respect.
Actually sometimes it does work out like that but as you will find as you delve deeper into this book that is not always the case.
I would recommend that you keep the relationship with the tenant on a business basis at all times, however keen you are to be a God parent, but bear in mind that you should treat them in a way that you would like to be treated.
WHAT THE TENANT THINKS
Anyone who owns property to let must be loaded, they’re taking money from me but doing nothing. The place is not mine therefore I don’t care if there’s a funny noise in the washing machine, if it breaks the landlord can fix it or give me a new one and if I get fed up with this place I can always move on. I don’t need to comply with all those silly rules and regulations in the contract who’s going to know if I smoke in the property or keep pets or sublet a room to my mate for an office ?
IDEAL TENANTS
Ah, if only we could come up with the answer to this thorny question we'd all be happier however my researches have given me some ideas which I will impart, you'll understand that even these ideals can go awry.
Couples, in a relationship, on average, look after property better than two sharers, and tend to stay longer and gay couples whether in a relationship or not, will generally take pride in their home.
Single parents are popular particularly if there is a guarantor, usually they stay for quite a while as they probably have family nearby and want to keep the continuity of schooling.
There is also financial support available should they need it and as they are making a home will usually keep the place in good condition.
Housing Associations, Special Needs Agencies and Local Authorities as will be discussed are a popular option with some people.
COMPANY LETS
Corporate lets are of course the most attractive as they are always for an agreed period, certainly a year but often more and the Co. guarantee or pay the rental, often for a year in advance. The requirements for such tenants tend to be high end, some want property they can move straight into and in consequence the fixtures and fittings and furnishings need to be excellent quality, however others will come with their own furniture and so that element is not an issue. If one is aiming for that market detailed discussions with the letting agents is a must and even the brand of the fixtures and fittings could be relevant. Letting to Embassies sounds great but remember they do have diplomatic immunity if it should all go horribly wrong. Another variation on the same theme is the SHORT LET, great if you can get it because you will get more rental income because the tenant will leave after a guaranteed time span, usually a few months these arrangements work well for both sides as they are usually business people who are in the location for a specific period but don’t want the cost and soulessness of a hotel of course you don’t want to be caught out with too many voids. HOWEVER a short let property must be kitted out like an hotel with towels, bed linen and indeed all the facilities one would expect in a hotel including changing sheets and towels and cleaning.
HOLIDAY LETS.
These are also short term lets and do require extra management but premium rents can be achieved in tourist hot spots.
MORTAGAGES
A necessary fact of life for most and at one time an easy way into the residential letting market, lenders were falling over themselves to hand out wads of cash with a somewhat cavalier approach to the mathematics, not that they weren't paying some attention. Rent generally had to cover 125% of monthly mortgage payments and it was virtually impossible to get a loan over 90% of the capital value of the property, however well the figures worked out.
Now all is changed and a good thing to I say, we all know that the financial markets were brought to their metaphorical knees by aggressive lending techniques to those who could not afford the repayments, particularly prevalent in the USA, but crazy lending went on in Europe too. Yes there was fraud, or certainly a lack of understanding of what the long term consequences could be but this lending was based on an assumption that property prices would continue to rise. At it's simplest the lenders were of the opinion that even if the borrower reneged on the deal after a year or so then any loss would be covered by the increase in value of the building, so the risk was underwritten by a belief in the continuing, inexorable rise in property prices and continuing demand by homeowners, and we all know what happened there.
We all need somewhere to live so the demise of the residential property market has certainly led to an increase in demand for rental property and in some cases an increase in rental.
The biggest change I suspect is in youngsters refusing, or being unable to leave home, this is the law of unforeseen circumstances. How many parents would believe that there sibling could still be occupying the bathroom at thirty!
We love our children but hey, isn't this taking parental responsibility too far?
Following the collapse of the financial markets, virtually every lender retreated from the market to lick their wounds and work out how best to pay their staff bonuses, the good news is many organisations are back, some a little coyly, others more enthusiastically. If the maths is right some mortgage lenders are happy to have a proportion of their loans tied to residential lets, afterall they can charge set up fees ( usually 1% ) and much more importantly a higher rate of interest.
At the time of writing the loan to value rates are around 75% so the deposit will be 25% and rental cover has to be 125%. In other words the annual rental has to be 25% more than the mortgage repayments. Most lenders also want you to own your own home already and have a certain level of income, so not exactly perfect terms for the aspiring property tycoon, on the other hand it's a system designed to ensure nobody and in particular the lender is over exposed, well until the next time. It is difficult being too precise as terms and conditions change all the time.
Although you may consider that this is a purely business related transaction, be assured you will still be personally liable for every penny you borrow.
If you have any queries these can be addressed to The Council of Mortgage Lenders and I’m sure your friendly I.F.A will give you help too.
PURCHASER ??
If you are a purchaser there are also all those extra costs, that you have to build into your calculations, legal fees, stamp duty, surveyors fees, vat on all those costs admin fees to the building society and valuation fee. As you will be aware the stamp duty rates increase substantial at different thresholds and significant savings can be made by buying at just below these levels.
The costs of the purchase can be deducted from any profit you make when you resell ( if capital gains tax is an issue, but not the VAT, sorry that’s just gone ).
LIMITED COMPANIES
Many years ago I purchased three floors of run down offices, obtained planning consent and converted them into three flats, my accountant persuaded me to hold them in a limited company. I guess that there was a sound reason at the time but to be honest all that has meant is that I have to file annual accounts, which is a significant burden and quite an unnecessary cost in fees
( ah.....perhaps that was the attraction for my accountant ) and completely unnecessary for a few flats and incidentally has caused all sorts of complications when trying to sell. Also be assured any lender will make you sign a personal guarantee so there is no hope of hiding behind the Limited Company legislation if it all goes wrong.
The key point is be sure that you know the full details, requirements and on going costs if you do go the limited co. route.
WOULD YOU LIVE HERE ??
As you know location is everything, the big question you should ask yourself, if I were a tenant would I live here ?? if you’re unsure then you can be certain someone else will feel the same. Spooky dark alleys at night might not be noticeable during the day and those cars whizzing past might not seem so noisy in the daytime but will certainly affect lettability and of course the rent. Research is everything and don’t be tempted to buy a property because it is cheap if it’s not easy for you to visit at short notice, I suggest a one hour car journey should be the limit, but maybe you like long car journeys and the cost of petrol.
SERVICE CHARGES
If you are buying a flat you must ascertain the level of service charge for the last few years, and whether there is a service charge fund already established and whether any major works are needed or planned which you will have to contribute to. Blocks with lots of facilities will have much higher service charge bills and you may end up supporting that swimming pool you never get to enjoy!
There will also be an annual ground rent to pay, it all chips away at your return.
In the event of a dispute that can’t be settled by sensible negotiation either party can apply to the Leasehold Valuation Tribunal to help settle the matter, there is a charge of course but a quite cost effective way if sensible negotiation fails. With there advice and support you can even change the managing agents and they are the final arbiter in value if you are trying to purchase the freehold from a Landlord.
LEASEHOLD PROPERTY
Most flats and indeed occasionally the odd house are leasehold
( some flats have a share of freehold ) it is imperative that you do not get seduced into buying a property with a short lease because it is cheap. I would not consider anything with a lease of less than 90 years, as time passes they get harder and harder to sell. There are sometimes options to buy extensions to the term but you should not rely on these and in any event still cost you money.
MANSION BLOCKS
Beware, before to rush into buying that flat in a mansion block do get your Solicitor to check the lease, some have very restrictive covenants regarding sub letting and you may find you are actually not permitted to sublet. Indeed it is paramount that you check with any freeholder whether you have the right to sublet and the conditions that might pertain to that letting.