A friend of mine has been messaging me over the last few days asking for advice and information about buying a property to rent out. I’ve done my best to answer his questions, but ended my reply by saying that I don’t think he should go with a buy-to-let (BTL) if he wants to make money. There are other ways for people to make money with less risk and greater return.
Before going any further however, a few points.
First, I am not a qualified financial advisor. What follows is my opinion, rather than advice.
Second, I am a qualified mortgage advisor so I think I have a decent understanding of what it takes to obtain a mortgage.
Third, the following article is aimed at a particular audience. It is not aimed at those who are experienced in property and investing. It is not aimed at those who are wealthy with lots of disposable income and can afford to take risks. It is not aimed at those buying property under the umbrella of a Limited Company.
This article is aimed at those who may not be financially confident or experienced, and who believe that buying a BTL is a safe, guaranteed way to make money.
For the sake of clarity, I will use an example property based on research and experience. This property will be a two-bedroom apartment in Sheffield city centre. The property is on the market for £120,000.
How does BTL work?
With a BTL mortgage the deposit requirements are normally higher than for a property you are going to live in yourself. For a residential mortgage you can normally put down as little as 10% subject to lending criteria and credit scoring. For a BTL it is normally expected that you will put down a minimum of 25% and often you need to put down at least 40% of the purchase price to obtain good interest rates. In our example, assuming my friend goes ahead he will have to put down £30,000 as a deposit as a minimum.
Running Upfront Expense Total: £30,000.
The deposit is not the only one-off cost to be paid however. For a BTL, Stamp Duty will also be payable at a rate of 3% of the purchase price up to £125,000. Beyond this Stamp Duty rises to 5% and then 8%. So, in addition to the £30,000 deposit, my friend will have to pay £3,600 in Stamp Duty.
Running Upfront Expense Total: £33,600.
There will also be valuation fees and legal fees to consider. Some lenders will offer a basic valuation service which checks that the property is basically in liveable condition. It will not be a full and thorough survey. The costs for these can easily range up to £1,000, although the less detailed surveys can cost just a few hundred. The question is how much of a risk are you willing to take? You could spend tens of thousands in deposit and fees and then scrimp on your survey and find the property needs thousands of pounds worth of repairs. None of this accounts for the legal fees which can easily account for £500-£1,000 as well. Assuming that my friend went for a comprehensive survey and found a reasonably priced solicitor the total fees here could come in at around £1,500.
Running Upfront Expense Total: £35,100.
Is the property going to be furnished or unfurnished? If furnished, then this can easily add on a few hundred to a few thousand more depending on how far you want to go. I’m not going to get side tracked too much here except to point out that this is just another expense to consider. Let us assume my friend goes the unfurnished route.
So far I have described some of the upfront costs that will need to be considered. This list is by no means exhaustive and there are always going to be unexpected expenses when buying a property. If you are going to rent out the property there are also health and safety checks to be carried out for the gas, electric and so on. I don’t have experience in arranging these, as anytime I look at investing in BTL I add up the costs to this point (as well as the ongoing costs) and usually decide to invest elsewhere.
Another consideration is whether my friend will manage the property himself. Will he draw up the contract or use an off-the-shelf contract? Will he collect rent himself? Will he organise any repairs and maintenance that will come up from time to time? Will he deal with the inventory at the start and end of the tenancy? Will he advertise and market the property himself? Complete referencing and vetting of prospective tenants?
Renting a property out and managing it yourself can become a full-time job. I know a lot of people who have dabbled in BTL, managing the property on their own, and not a single one of them has found it rewarding either personally or financially. So the other option is engaging a management company or letting agent.
I’ve googled a reputable letting agent and calculated their fees based on this information. The property my friend is looking at should rent for £600-£650 per month. I’ll go with £650.
Arranging Viewings and General Marketing: One month rent + VAT.
Tenancy Set Up: £300.
Rent Collection Only: 10% of rent payable.
Full Management (Rent Collection in addition to maintenance and other related services): 13%.
Extend Tenancy: £150.
This does include fees for statements, billing, key-cutting, extra property visits and so on.
So, my friend would have to sacrifice his first month’s rent and pay VAT (20% of £650 = £130) on top to just arrange viewings and market the property. Then an extra £300 to set up a tenancy.
Running Upfront Expense Total: £35,530.
Net rent received after letting agent cut (full management): £520
The main ongoing cost is going to be the mortgage. Assuming a 25% deposit, you can probably expect a rate of between 1.5%-2.5% depending on lender and whether you will opt to pay a fee. Many BTL deals will come with a fee. Assuming a modest fee of £500 for the interest rate, which comes in at 2.0 % and assuming the mortgage will be interest only the monthly payment would be around £150.
Running Upfront Expense Total: £36,030.
Net Rent after mortgage: £370.
It can be time consuming to calculate all the costs as a landlord.
It’s important to remember that on an interest only mortgage none of the debt is being repaid. At the end of the mortgage term, the debt will need to be paid back in full. It’s also important to remember that once the initial interest rate ends, the rate will likely jump up and it can easily revert to a rate double that of the initial rate. The alternative is to switch to a new deal (likely coming with product fees again) or even switch lender (product, legal and valuation fees to be paid).
For this property there are other costs to consider. A city centre apartment will come with service charges and ground rent. I see these costs regularly through my job and this sort of property will easily have a minimum ground rent of £100 per year and almost certainly service charges that amount to over £75 per month.
Net Rent after service charge: £295.
Tax is another expense. I’m not a tax expert, but when I’ve looked into this for myself the information seems to suggest that you are allowed some reasonable expenses to be removed from the tax calculation but this does not amount to much. My friend is a basic rate tax-payer and will pay 20% tax in this band on income received.
I’m not sure if my friend would be taxed on the rent before agents’ fees are deducted or after. To load the case in my friend’s favour I will assume it is taxed on the amount received after the agent takes their cut; so 20% of £520 which comes to £104
Net Rent after all previous charges and rent: £191.
As I’ve mentioned, I’m not a tax expert or a financial advisor and some of this information may not be entirely accurate. Please do the research and feel free to comment with any corrections.
In addition to what has already been covered, there are other costs to take into account. The first to mention is “void periods”, which are the periods of time in which the property may be vacant. Although your property may be between tenants the utility companies will still expect to be paid, and so will the mortgage lender. A good rule of thumb is to account for one month “void” per year.
Net Rent (accounting for a 1/12 reduction of gross rent annually): £136.
Landlord’s insurance is another cost that is often overlooked. Some google-fu suggests policies can range from £15-£25 per month depending on how much cover you want.
Net Rent assuming basic cover: £121.
In summary, my friend will have “paid” upfront £36,030 to achieve a potential return of £1,452 per annum. This assumes only one month “void” per year, and that the tenant does not keep changing (as would cost more with agent to draw up additional tenancy agreements). It also assumes the tenant will actually pay their rent. I know two people who have had BTL with tenants that refused to pay rent. It is remarkably difficult to legally evict a tenant that is not paying rent.
£1,452 / £36,030 = 4.03%.
For all the above stress, effort and uncertainty the best my friend can hope for is a return of 4.03%.
Becoming a landlord is hard work. It’s stressful. There are no guarantees that money will be made. Many properties can become a black hole into which money disappears. It is difficult to get your money back. In my opinion, BTL should not be considered by those who are not financially literate or experienced. Don’t misunderstand me, I am not anti-property. I invest in several properties through other channels and receive my own rental income but this is all passive income with no day-to-day involvement from me. My return ranges from 4%-7% across the six properties I receive income from. I also invest in the stock market with companies that have a track record of paying dividends. I’m earning between 5% and 7% on these investments with no day-to-day involvement from myself. It’s completely passive income.
If my friend has £36,030 to invest there are plenty of other options other than BTL, and many other options for someone that is starting their financial journey. My opinion is that a BTL should not be a person’s first investment. The first investment should be improving one’s own financial education. From that point on, the mysteries of the stock market and beyond will become clear.
Thanks for reading. If you have any thoughts on this blog, please leave a comment.
Critic. Writer. Thinker. Observer. Creator of nowwelive.com.