FSA Warns of Dangers of BTL

Thrugelmir

KKevin wrote: »

Its has worked in Reverse for me

I bought an ex-council flat this time last year for £80k, i put down a 15% deposit which left me with a mortgage of £68k which was on a tracker interest only mortgage.

As i got a tenant in straight away i was getting £400 per month and my interest only mortgage was £300, due to the interest rates falling, my mortgage is now just over £100 which is therefore giving me a profit of £300 a month which isnt bad for a £12k investment.

Aren't you concerned that if interest rates rise to say 6% plus that you'd be making a loss? With no capital gain to offset the trading loss either.

Thrugelmir

HelpWhereIcan wrote: »

I would only use 3 for the reasons iveseenthelight states. As s/he says it can be useful in the decision making process for when/if to sell a property - especially when taking into account the risk it offers compared to other asset classes as dunstonh points out.

BTL is risky because of the gearing and the fact that your eggs are in one basket (a single property) which is pretty illiquid.

However, I don't think the traditional yield calculations provide the full picture when looking at a property that is mortgaged (as most are).

I use return on capital employed - in other words the return I am getting on the money I have spent.

Recent Example:

Property Value: £125000

Price Paid : £88000

Mortgage amount: £66000 (now £158.95 pm)

Rental Income : £450 pm (£5400)


The capital employed is £22000 deposit, approx £2000 purchase costs plus about £3000 refurb costs: total is about £27000

Property is self managed so return allowing for 1 mth per year void (ARLA Average) is £ 4950

Less Mortgage: 1907.40
Less Insurance: 380

Costs: £2287.40

profit = 4675 - 1907.40 = 2662.60

The property stands at £27000 capital employed so 2662.60/27000 * 100 = 9.86% (11.52% if you assume no voids)

If that £27000 was in a deposit account it would not be earning anywhere near that.

Drops in interest rates means that the mortgage costs less now so the ROCE goes up. Rises in rates may make the ROCE fall to the point that the risk outweighs the reward and the yield calculation based on value means that it is worth selling to reinvest the whole in a better performing/lower risk asset class.

That obviously ignores the negative risk of gearing which means that you can lose more than you put in, but based on the property being bought at well below RICS valuation and that it is one in an area of rental demand it is a risk minimised as much as possible.

The need to keep reviewing these things and making further decisions based on the overall picture is the reason BTL is harder work than most have given it credit for and why it should only be part of an investment strategy not the whole.

Informative post thanks.

I have a friend who is a professional property investor. She had the misfortune to encounter "bad tenants" on a residential letting. In total the cost was £7,000 in unpaid rent and legal fees. To counter this the gross yield on a property has to exceed 10% (currently) to reflect the risk factor.

Property is an illiquid investment so comparison to deposit account rates is only meaningful over a period of ownership of a property.

dunstonh

on the downside I stopped by flats before the boom peaked and bought a whole load of shares mostly in financials and mining stocks! fool!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

I made a fortune on resources funds and jupiter financial options has been doing nicely. Of course, that was part of a balanced portfolio with the gains rebalanced. Going 100% into those is very high risk (if that is what you did).

KKevin_2

Thrugelmir wrote: »

Aren't you concerned that if interest rates rise to say 6% plus that you'd be making a loss? With no capital gain to offset the trading loss either.

No, im not concerend.

The flat was clean, tidy and very basic when i bought it, so i decided to rent it out straight away. I currently have the tenant on a lease of 6 Months at a time.

If the interest rate does increase, i would not renew the lease and give the tenant the required notice, give the place a make over and put it on the rental market at £450 - £475 which would be easily obtainable and if the level of rent increased across the board i could be able to get £500 per month.

At the moment the money i am making is being used to pay off the loan.

HelpWhereIcan

Thrugelmir wrote: »

Informative post thanks.

I have a friend who is a professional property investor. She had the misfortune to encounter "bad tenants" on a residential letting. In total the cost was £7,000 in unpaid rent and legal fees. To counter this the gross yield on a property has to exceed 10% (currently) to reflect the risk factor.

Exactly. You have to weigh up the risk you are taking and the return you are getting for taking that risk.

Not everyone will settle at the same figure but each person must compare the actual figures for a property to other asset classes that may represent a lower risk, higher return or less hassle (or indeed all three). It also depends on what you have elsewhere as some asset classes can act as a hedge to others to help protect you overall.

While they may appear to be one offs, incidents like your friend's £7000 costs need to be used to determine whether the property is the right investment eg is it in the wrong area to be a reliable renter; is the managing agent giving good value; is the rent set too high/low etc etc

Thrugelmir wrote: »

Property is an illiquid investment so comparison to deposit account rates is only meaningful over a period of ownership of a property.

Quite right, my reference to a deposit account should be looked at as to a medium to long term return comparison as property cannot be efficiently bought and sold overnight.

eco-friendly_2

dunstonh wrote: »

Mortaged buy to lets have always been classed as a high risk transaction..

Isn't that strange, that lenders will hand out 100-125% loans for ordinary mortgages, would stupidly consider that an investor who's prepared to put down an average of 20% deposit, and being penalized with higher interest rates a higher risk?






What the hell do I know! apart from the fact that most of them are bust, and I'm booming!

eco-friendly_2

Save your keyboard ! not all BTLers have bought new-build properties:p

Thrugelmir

HelpWhereIcan wrote: »

Exactly. You have to weigh up the risk you are taking and the return you are getting for taking that risk.

Not everyone will settle at the same figure but each person must compare the actual figures for a property to other asset classes that may represent a lower risk, higher return or less hassle (or indeed all three). It also depends on what you have elsewhere as some asset classes can act as a hedge to others to help protect you overall.

While they may appear to be one offs, incidents like your friend's £7000 costs need to be used to determine whether the property is the right investment eg is it in the wrong area to be a reliable renter; is the managing agent giving good value; is the rent set too high/low etc etc



Quite right, my reference to a deposit account should be looked at as to a medium to long term return comparison as property cannot be efficiently bought and sold overnight.

The tenants in this case had already been in situ for some 17 months before this was any indication of a problem. Normal practices such as references from employers etc had been obtained. Although risk can be mitigated as far as possible it can never be eradictated in the lettings market.

Kenny4315

My BTL's are doing fine. Mortgage rate is currently 2.65% and going down, full rented out, making nice return, and property is valued way in excess of what I paid for it.

Had one of the tenants for 3 years, and the 2 new tenants are friends of there's and likely to be long termers. Job sorted.

HelpWhereIcan

eco-friendly wrote: »

Isn't that strange, that lenders will hand out 100-125% loans for ordinary mortgages, would stupidly consider that an investor who's prepared to put down an average of 20% deposit, and being penalized with higher interest rates a higher risk?

While I think dunstonh was referring to the risk BTL represents to the investor as an investment class rather than the risk to the lender ....

Yours is a common misconception (oft perpetuated by some BTL lenders in 05/07 quoting their low arrears levels as proof that they were not taking above average lending risks ... and we know how that has panned out)

Buy to Let mortgages have tended to carry a lower level of arrears than residential mortgages only until recently. Arrears figures on buy to let only outstripped those on residential mortgages from about Sept/Oct last year.

However, even though the risk of arrears is the major risk that the lender takes on any mortgage, the risk of arrears can be caused by more factors on Buy to Let.

For example the CML blames falling rents for the recent rise in BTL arrears.

On a residential mortgage the risk is mainly related to the borrower's health and employment status affecting ability to meet mortgage repayments.

On a buy to let you have the risk that market rents fall (as they have been in some areas); tenants have issues with income and paying rent; it taking 6 months to evict a poor tenant causing a loss of £000s that needs to be covered by the btler's own resources; the landlord may run into difficulties themselves and choose to redirect rent away from mortgage payments to meeting their own expenses as they are happy to lose a btl but not their own residence; buy to let does not come under any mortgage rescue scheme; the btler is running a business whose viability can be affected by legislation (HMOs, taxation, tenancy laws, health & safety) etc etc

On top of that the fact that, when repossessed, a buy to let property may not be as easy to sell on.

It often cannot be sold as vacant as any tenancy has to be honoured often meaning that the only interested parties are other buy to let investors at least until the tenants are moved on.

For all these reasons and more, lenders have tended to price buy to let at a higher rate than residential and there is no reason to think they will change that.

I understand your point and why you make it, but unfortunately the facts do not support your assertion.