Struggling to wrap my head around Buy to Let

Gaaraz

Hi,

I’ve been recently considering where to invest, and it seems that buy to let is still a great (and very popular) option right now, especially when talking very long term.

My main issue is that for some reason, I’m struggling to get my head around the maths. To massively simplify things, if I bought a house for £100k outright with cash (one can dream eh!) I’d get maybe £6,000 back in rent p/a, so 6% - not bad!

But then you have maintenance (£1k?), agent fees (another £1k? I know this is optional but I'd feel a lot more at ease with an agent) and insurance etc etc and that’s without the worry of getting bad tenants, or tenants who may not be in such a good position financially and miss or are late with payments.

Then you factor in a mortgage on say 75% of the value, you’re looking at maybe a 1% or 2% annual return if you’re lucky.

So it seems that BTL is heavily reliant on the house prices, inflation etc?

I’m also confused because my friend has said with a 25% deposit he's paying ~£230 per month on his mortgage, and getting ~£600 per month in rent, and after fees and everything else he’s getting a 13% return – I feel like I’m really missing something here? He also suggested that it’s better to borrow as much as you can, I’m assuming this is because you will then pay a lower amount of tax? I’ve only doing a few quick calculations but I’m struggling to see the value in doing that...

I’d be incredibly grateful if anyone could please shed some light onto this – thank you!

Js_Other_Half

As far as I understand it most buy to let mortgages are repayment only. This means you are relying on the house price on being worth more when it is eventually sold. The interest only repayments are much less than repayment.

Get Martin's guide to Mortgages?

mr-bob_2

The example of your friend you gave - around £200 mortgage payments and then £600 in rent..

The mortgage payment is interest only. So after fees etc he may come out with 200-300 per month - which can then be used to pay off the mortgage, or for whatever else. By the time the mortgage ends - it either needs to be paid off - or sold. In that time - if it went up in value - then you've made a lot of money by borrowing a good portion of it from his initial I assume 25% investment.

The flip-side of that is if it goes down in value and he ends up in negative equity.

When buying a house out-right - it doesn't look that great an investment - if he had 200k to spend and bought 10 propertys spending 20k on each for example then you'd make 200-300 per month on each (well.. less as the properties would be like 80k each) - if they all increased in value 20% in 20 years time then you'd make a hell of a lot of money.

But of course, if they all drop in value - you'd probably be bankcrupt or at least loose all the money you invested.

So it works best by borrowing as much as you can. But it is of course more risky then.

tim123456789

Gaaraz wrote: »

I’d be incredibly grateful if anyone could please shed some light onto this – thank you!

Some people think that we are going to return to double digit HPI any time soon.

with 50% of the poputation soon to have a 30 grand student loan around their necks, don't bet the house on it

tim

Cornucopia

The point is that buying for cash is a different sort of investment than buying with a mortgage.

With a mortgage, the investment is leveraged, which means that you are receiving more benefit than the original investment. Obviously, you don't get owt for nowt, and with the leveraged approach comes greater risk.

If you have the money, and if your aim is very long-term, then buying for cash is an option. As you say, you might be looking at c. 5% yield, all of which would be taxable - so you might see 3.5-4% after tax (which is within reach of a wide range of other investments).

With a mortgage, you have the additional advantage that you can offset mortgage interest against rental income, which adds a further benefit.

So... in parts of London, you might get £1000pm rental on a property worth £200k, with a 70% mortgage that's £410pm, interest only. The investment of £60k is therefore producing c. £7000 pa before fees, which is an 11% yield, 6-9% after tax.

JQ.

tim123456789 wrote: »

Some people think that we are going to return to double digit HPI any time soon.

with 50% of the poputation soon to have a 30 grand student loan around their necks, don't bet the house on it

tim

So what you're saying is there will be further increases in rental demand due to graduates not being able to buy houses, thereby forcing rental levels higher and improving the return from the BTL properties.

princeofpounds

So it seems that BTL is heavily reliant on the house prices, inflation etc?

Yes absolutely. In fact the BTL business model is usually a large bet on two things.

1) House price inflation
2) Real interest rates (interest rates adjusted for inflation)

The renting is almost incidental in some ways. It largely allows the bet to be taken by funding the interest cost to 'rent' the money used to buy the property.

He also suggested that it’s better to borrow as much as you can, I’m assuming this is because you will then pay a lower amount of tax?

The interest component can be offset against tax, like any business, so there are tax benefits to borrowing more. I'll note that this is somewhat unfair in some sense because as a private individual you do not get to do this.

There is also a benefit because it increases leverage. This principle is really at the core of BTL and is normally the only reason people get rich because of it.

Imagine you buy a house with a 20% deposit for 100k. You wait 3 years and the price goes up to 110k. Rent and interest/transaction costs roughly cancel. You sell, pay off your 80k mortgage. You are left with 30k.

You have made 50% on your money in just 3 years. You are a business genius!

Unfortunately, it works the other way too. If the prices went down just 10%, you would have lost 50% of your money.

It's been a one-way bet for 22 years, aside from the dip in the crisis. So it has 'always' been better to borrow as much as possible, but that doesn't mean it actually is a good idea. Lots of people were burnt in the early 90s recession but an property boom of unprecedented proportions tends to smooth people's memories somewhat...

with a 25% deposit he's paying ~£230 per month on his mortgage, and getting ~£600 per month in rent, and after fees and everything else he’s getting a 13% return

Is he talking about

- 13% on the current value of the property (which is not impossible but probably not true for 99% of BTL).
- 13% on his original purchase price (which is possible, but not a particularly meaningful metric from a finance perspective)
- 13% on his equity (which is possible because of the leverage, but this is only possible because it's much more risky than owning a house with no mortgage).

Anyway, ordinary people think BTL is a great way to get rich, but it's main 'advantage' is that it's one of the few investments available to Joe Public where he can access huge amounts of debt finance to fuel leverage.

Now, since the crisis the HPI part of the business model seems to have run out of steam (unless you own prime London property), but it's still possible that because of the interest rate policies being used to bail borrowers out, BTL can still win on the real interest rate leg of things. At least for now.

Gaaraz

Wow, thank you all so so much for the replies! Incredibly insightful and I'm very glad I asked now even though I did ask some arguably silly questions

I didn't even think about potentially having an interest only mortgage, sounds like a great option, but I guess it's a case of either:
Interest only - better for the short term, much lower payments, but much higher risk in the long run
Repayment - higher monthly payments, but at the end of it you are at least guaranteed to 100% own the house

I think personally I'd probably go the repayment route still, and then that would also help in terms of keeping income tax down somewhat? I'm not adverse to paying tax of course, but if I can keep my overheads down as much as possible that'd be great.

Despite it being very reliant on inflation/house prices I am still very tempted - house prices have become stagnant but it seems that rent continues to increase, and I feel like the sooner I jump onto this bandwagon the better

Going to speak with my parents about potentially going halves on a BTL property so we can get the ball moving ASAP. If not, I'll continue to wait and save as much as I can.

princeofpounds wrote: »

It's been a one-way bet for 22 years, aside from the dip in the crisis. So it has 'always' been better to borrow as much as possible, but that doesn't mean it actually is a good idea. Lots of people were burnt in the early 90s recession but an property boom of unprecedented proportions tends to smooth people's memories somewhat...

This is a great way of looking at it, thank you, a lot of people have got rich from BTL but I guess we could also see an increasing number of people being burnt by it too. I'll be 100% sure not to over stretch myself and not take on any monthly payments that I couldn't cover by my salary if I had to. I'm not sure about the 13% thing either sorry, I think as someone alluded to earlier he probably has an interest only mortgage though, which would explain the disparity between the monthly payments and rental yield.

suze200

Gaaraz wrote: »

I think personally I'd probably go the repayment route still, and then that would also help in terms of keeping income tax down somewhat? I'm not adverse to paying tax of course, but if I can keep my overheads down as much as possible that'd be great.

You can only get tax relief on the mortgage interest.

Gaaraz

Ah, pardon my ignorance but how exactly does that work then? I just thought the income tax I pay would be on rent less mortgage repayment.

princeofpounds

No, it's on the interest portion, which is a business expense, whereas the repayment is not an expense, it's a purchase of an asset.

That doesn't mean a repayment mortgage is a bad idea for BTL - after all the objective over time will be to build up equity and repayments is one way to do it that doesn't rely on HPI. But it's not tax-deductible.