This piece first appeared in Reader's Digest in April 2001
The text here may not be identical to the published text
The stock market performed dismally last year. The average price of shares in the 900 firms that make up the all-share index of the London stock market fell by 6 per cent in 2000. The biggest 100 companies did even worse – 8 per cent down on the year. With hindsight, your money would have been better off in a brown paper bag under the bed. The market is still both flat – going nowhere – and volatile – doing it very energetically. I still believe that for the long term the stock market is the best place for your money. But more and more people are looking at other ways to get a return. One is buying a property and letting it out.
Many people who go into buy-to-let are cautious investors. They want to know where their money is, and there is nothing like walking by a property and feeling that sense of ownership! Apart from the profit you make from the rent, you can probably look forward to owning an appreciating asset. Unlike the stock market, house prices rose in 2000 though only by around 3 per cent. And they are forecast to rise by 4 per cent this year.
Buying to let is more like trading than investing – you have to buy the capital asset and pay the expenses of running it and collecting the income. But professionals in the field estimate that you can make a return of up to 10 per cent a year – more in some areas and on some types of property. Of course you can make less or even lose money. So it is important that you take care of all the details first. And it is a long-term investment – ten years is a sensible time-scale.
Normal residential mortgages do not let you rent out the property, but many major lenders now offer mortgages specifically for buying to let. Normally you will take out an interest-only mortgage and repay the capital when you sell the property in the future. The big difference with buy-to-let mortgages is that you have to find a big deposit. Typically you can only borrow up to 75 per cent of the purchase price, though some will go as high as 85 per cent. That means you have to find the balance yourself from savings or other resources. You will also have to pay a percentage commission to the agent that arranges it – many buy-to-let deals are only available through brokers. That fee can be as high as 0.5 per cent of the advance – so £500 on a £100,000 loan. But a broker can often find you a better deal than you could get yourself.
Interest rates are slightly higher than the best you can get for buying a home you will live in. But you can find very reasonable rates of less than 7 per cent. Fixed rate mortgages are attractive for buy-to-let because your costs are fixed and that means you know they will be covered by the rent. You can find a fixed rate of 6.5 per cent to 7 per cent for between two and five years. But look carefully at what rate you will be charged after that. Some fixed rate deals charge a penalty if you change your mortgage company within the fixed rate period. Others keep the penalty for longer. The lender will insist that the property can be rented out for around 125 or 130 per cent of the mortgage payments. And when they do that calculation they may ignore the discount. So a £100,000 property will have to bring in a rent of around £800 a month.
You should make sure the mortgage is flexible– in other words you can pay more or less each month if you want. With buy-to-let it is a good idea to make sure you can miss a payment occasionally when the property is empty and no rent is coming in. But always try to pay more in subsequent months – or in advance – to make up the difference.
Apart from the deposit you will also need money to furnish the property. Even ‘unfurnished’ lettings may need decorating and you will have to provide carpets, curtains, light bulbs and a fully equipped kitchen and bathroom. Any fitted gas appliances, such as fires and boilers, will have to comply with stringent safety regulations. Electrical fittings and appliances will have to be properly installed and safe. Smoke and carbon monoxide detectors are a good idea. If you decide to furnish the property fully then you will have to make sure that all soft furnishings comply with modern safety standards.
In the past, properties that were let ‘unfurnished’ gave tenants more rights. That is no longer true. Nowadays lettings are for a period of six months and can be terminated by either side at that date so there should be no fears about getting rid of tenants.
You should also set something aside for the inevitable repairs, renewals and decorations. A good looking home will be let more quickly, and it is very important to keep the home occupied, too many blank months – ‘voids’ is the jargon – and you will find the year’s profit disappearing very rapidly.
Many people consider buying-to-let in an area where they would like to live – possibly retire to or keep as a second home. But that is not a good idea. An area where you many want to retire is not necessarily a good area for buy-to-let. It should be looked on as a business deal, an investment, and that means choosing a place where your money will produce a good return. If your own area or somewhere nearby is good for letting, then that may be a good place to start. Remember that you may have to travel there a lot – to see tenants, deal with emergencies or meet your local agent, if you have one.
Of course, not all areas of the country are suitable for letting. But most of Greater London, many other cities, and areas that are handy for motorway travel or commuting, places where companies have their headquarters, and university towns, all have good potential for letting. A quick trip round local estate agents will tell you if there is a market in that area.
You can get help from a local residential letting agent. These are not necessarily the same as estate agents. Many of them belong to the Association of Residential Letting Agents (ARLA), which ensures its members are competent to manage rented property. They also make sure that your rent and deposit money is safe. Most important, they can give you advice about the local market – what kind of property is in demand and what kind is not. Most do not charge for advice, but they will charge if you use their services. They will find tenants, take up references and organise all the details of the letting including the tenancy agreement, and changing the details registered with gas, electricity and water. They will also hold the deposit and check the property at the end of the tenancy before handing it back. To do all this, they will charge around 10 per cent of the rent during the period of the let. If you want them to manage the property fully, which means they will act in your place and deal with problems and repairs then they will charge another 5 per cent or so of the rent. Some charge more; others may charge less. Doing it without an agent is possible, but I do not recommend it.
No investment is completely free of risk. But buying to let can be a lot more enjoyable than poring over share prices. And it is the origin of the eighteenth century phrase ‘safe as houses’.
John Charcol mortgage brokers 0800 718191 or www.charcolonline.co.uk
Association of Residential Letting Agents 01923 896 555 or www.arla.co.uk