Return on investment

lordyjordy

Hi all

I'm looking at buying a family members property but want to rent it out for the first year as I don't spend much time in the uk at the moment....

I've done a few sums to work out my return on investment but they seem high have i made a mistake

they go as follows

purchase price........................................................................... £157k
amount invested
(including fees, deposit, refurb costs, stamp duty)................. £32555
Annual income from rent.........................................................£9600
Interest paid on mortgage (annual)..........................................£4806
(mortgage required £133k @ 3.59%)

profit = annual rent - interest on loans = £4794

ROI = profit / total invested x 100

so ROI is 14% surely my sums are wrong it seems too good

I know this doesn't take into account for buildings insurance and maintenance costs though

cheers

bowlhead99

You have a few things wrong.

1) As you noted, you haven't accounted for landlord's building insurance or maintenance. Maintenance might not be much if you are doing an initial refurb and it is all in good nick, but you need to allow something. So let's increase the expenses from 4800 to 6000.

2) The gross yield of 9600 on a 157k property is about 6% which is not particularly high so might be realistic, depends on the type of property and your local market. But to be prudent you should assume you don't achieve 100% occupancy and you have a void month or two before, after, or during the year you're trying to rent it, even if someone initially says they'll sign up for a year. So let's reduce income by a twelfth, from 9600 to 8800.

3) You said you are not in the country much. No worries, your rental agency / property management company will help source you a tenant, keep things ticking over by collecting the rent, deal with tenant issues and emergencies and project manage any maintenance in your absence, for maybe a bit less than 10% of the rent. So let's reduce rent income now from 8800 to 8000.

4) So now you are looking at income of 8000 and expenses of 6000. This is 2000 profit to pay tax on. Assuming you're only a 20% taxpayer and not a 40% taxpayer, that's 400 quid out of your 2000 profit, leaving you with 1600 clear net profit after tax.

4) You say it costs 157k but you'll have a 133k mortgage. So you only have a 15% deposit of 22k. With a small deposit on a brand new purchase having never lived in the property you will be unlikely to get consent to let the property out, from your lender. Even if they went for it, you would be looking at adding %s onto your interest rate and reducing your profit by £1k+. More likely you would need to apply for a proper buy-to let mortgage. Not sure what rate you would be looking at but no way you'll get one these days with less than 25% equity in the property (max loan to value of 75%). As someone who doesn't spend much time in the UK, are you UK-resident enough to be a normal credit risk for a mortgage anyway?

How's it looking so far? Well, the profit of £1600 from (3) above doesn't even work because per (4) you can't get the finance cheap enough and/or your deposit figure needs to be increased by another 15k or so to get you up to 25% deposit from 22k before. But still, lets be generous and presume you can get the cheap finance and immediate consent to let with a low LTV (which you can't).

What will property prices do in your area over the next year or so? Nobody knows for sure, let's say they fall by a modest amount, say 5%. So the property declines in value from 157 to 149 or so. But you spent a few thousand on refurb only a year earlier so perhaps you only lose 5k to 152 instead. Give you the benefit of the doubt (not that you should really do that if stress testing your calculations, but I'm going easy on you). And you made 1600 profit on the rental activities, after paying your taxes, so you have some money to reduce the mortgage from 133k to 131.5k.

So how have we done. Property value 152k on paper, mortgage 131.5k, total equity 20.5k. If for some reason your plans change and you want to sell up and cash in your profits, you need say 1.5k for estate agent fees and 1k for solicitors, so of your equity 20.5k you will keep 18k.

This is presuming the tenants do not absolutely trash your place leaving excrement everywhere and causing 5k of damage above the level of deposit and budgeted maintenance that was set aside, and shorting you on the rent by 1k they forgot to pay before disappearing. It would be a bit harsh if I presumed that would happen and knocked your equity down to 12k from the 18k, so let's just say it won't happen and you do have a full 18k of value in your investment.

Initial investment: £32,555. Remaining value, £18,000. Loss £14,555.
Loss as a percentage of initial investment, 14555/32555 = 45%. ROI: negative 45%.

so ROI is 14% surely my sums are wrong it seems too good

It seems too good until you run through some other numbers to see what else the ROI could be. Then you know it's too good. Otherwise wouldn't we all be doing it?

You might think you don't need to worry about costs to sell etc., or selling for a loss or negative equity and you will just live in it. But if you are only going to put the 'buy' costs in and not the full 'round trip' costs, then the ROI you generate is garbage and can't be compared with any other reasonable investment opportunity.

100saving

bowlhead99 your post is very interesting as i am looking at investing in property in the near future for a possible letting opportunity. thanks!

Is their anything else that should be looked at? I was looking at buying something for around £130-140k ish and renting long term say 10 to 20 years.

bowlhead99

At the end of the day any business comes down to income vs expenses.

The projections on the income side need to be net of the costs of getting that income - marketing, tenant relations / day to day management, and void periods caused by the tenants running out of money and abandoning you, or refusing to pay for one reason or another and waiting between tenants including where you are doing repairs to damage caused by previous tenants.

The projections on the expense side need to include your painting and decorating and carpeting and insurances and every type of maintenance item, you may prefer to have service contracts on the boiler for example or to instead pay for call-outs from the gas man every time it goes wrong. Youll need to know what regulations to comply with, gas safety certificates and fire doors and whatever.

People paying ££ per month to rent from you who have problems with the property are going to want those things fixed quickly and at their convenience rather than slowly at your convenience or not at all. If you were living there yourself, you might put up with a boiler problem or a mouse infestation or simply take great care to avoid stepping on the wonky floorboard, but you can't expect a tenant to respect your property, and you can't assume he won't hurt himself doing something silly around the property that he tries to sue you for not doing some preventative maintenance.

If the place is furnished you may be able to let it for more but you need to budget for replacements and bear in mind that the furniture will get trashed faster than you would trash your own furniture that you couldn't give back to someone at the end of a tenancy period. If it's unfurnished I guess it's just things like ovens and washing machines and dishwashers you need to budget for. And there are things like utilities and council tax to pay for the weeks or months in which you don't have tenants.

So there are a bunch of 'looking after the property' costs to keep it rentable and then the biggest cost is usually finance because you'd be mad not to have some of the purchase price financed with mortgage because of the tax shield it creates. But you need to see if you can stand a doubling (or tripling) of interest rates which are currently at an all time low, and still make profits on your projection of average rent income - the local market might not be able to stand you putting the rent up by £500 a month just because your personal interest rate changed one month.

Buy to let mortgages are hard to come by without a large deposit and proof that you can get rental income of at least 120-130% of the monthly interest bill, and importantly for you, many lenders won't touch you with a buy-to-let mortgage if you don't also own your own home first. Not clear from your signature but I guess not. Some would lend against a sound business model if you meet their minimum income criteria which you may not. And the ones with the appetite for higher risk lending won't have the lowest interest rates or best terms and conditions.

Is their anything else that should be looked at?
(sic)

Well at 22 you probably don't have much or any experience of even being a tenant, looking after a property that you live in or even maintaining your own financial affairs as an adult, all of which would at least give you some relevant insight into running a property investment business. Another relevant skill or experience would be being able to deal with angry customers and negotiating with pushy letting agents or property managers. Not to say you can't pick this up as you go, but budget for making mistakes and not handling everything in the most optimal way, and reduce your forecasts accordingly.

Finally, if per your signature you only actually have less than 12k in a bank account representing your entire life savings, how are you looking at buying an investment property in the near future??

Presumably you need the 12k as an emergency fund to handle unemployment or other unforseen circumstances and beyond that, you're in the prime of your life and will likely have other opportunities over the next decade or two to spend or invest the money in education, family, travel, life changing experiences or other shrewd investments which will be blocked if you lock away all your capital for 10-20 years as you suggest.

If your income was £109k not £19k then the types of investments available to you would open up because you would have a greater capacity to take risks. Even then, most people on 6 figure salaries don't buy single investment properties before getting themselves their own home to live in and a broader portfolio of savings and investments. Even for them, the £11,649 you say you have in savings as of today would simply make a decent provision for repairs and maintenance and refurbishment on a property as a cash float, and not be available to help buy the property.

Maybe you are going to suddenly inherit all the capital to buy a place and have a cash float for its upkeep. We can't presume to know your circumstances. But even if you did, piling your entire worldly wealth into one property is a bit too much 'eggs in one basket' for most people. To reduce risk, two places at 70-80k each would be lower risk than one place at 140k. Still most people wouldn't do it if they only had an income of 19k and a full time job.

Not saying it can't work for you or for others. But I have a salary many times higher than yours and more savings/investments than you, and I haven't gone into investing in an individual investment property yet.

If I was going to, I would be doing a lot more research than asking on a forum, and as a general rule I would want to ensure I was going into ANY business opportunity from a position of financial strength rather than weakness.

Remember your 'business rivals' who own the other rental properties in your street or area and participate in setting the 'going rate' for rental income, will have on average significantly greater cash resources and experience than you. It is easier for them to make profits because they can ride out vacant periods, spend money making their properties look smarter, afford to advertise better, be choosier about tenants, negotiate harder with letting agents, they know trusted workmen for maintenance items etc etc.

Also in 10 years when you're looking to exit, if the professional landlord down the street wants to sell the house next to yours for £20k less than what you hoped the going rate was for the street, because they need a quick sale, have already made better annual rent profits than you and will be able to offset their capital shortfall losses against capital gains on their disposals elsewhere and save some tax, then they might just do that. If you have millions by that point perhaps you can buy them out and get a sweet deal. Or alternatively you may just have to suck up the lower selling price, and have a few years' worth of profits wiped out when selling your own place that summer at a lower price than you were expecting.

There are no doubt other things to consider but perhaps some food for thought.

lordyjordy

@bowlhead99

WOW what an answer...... thanks for the effort

some food for thought in there....

the only thing I would say is that I've got a lot more than 12k saving and at the end of the day I need/want to get on the property ladder at some point... may as well do it now and let someone pay the mortgage for me

btw im a heating engineer so no hefty plumbing bills

cheers for the advice though brought me back to earth

anyway great answer

100saving

Thanks for the answer, but I think I deserve a little bit more credit than you are giving me.

A - I have been looking at BTL for a number of years and understand whats involved in running a household thanks. I am doing lots of research at the moment and these forums are just one small element of the process.

B - I have 12k savings on my own but am not looking to buy the property on my own so this is not an issue. Also i am coming up to a pay review as my training at work is coming to an end.

C - As far as the exit plan goes on any BTL I may own this is not a big part of the plan. If i am making a good return why would i sell it? I would just hand it on to my children.

But i understand what you are saying but i think you are looking at all the negative things with BTL. When ever someone on these forums says they want to do a BTL they get treated like the devil, but if i said i wanted to buy a property to live its all good news and help.

MoneySaverLog

Starting out I'd look at flipping a few properties, rather than getting into the BTL game. Even then I'd use a service like http://www.pentontaylor.com as an example.

Nowhere near getting into property as a investment though.

bowlhead99

100saving wrote: »

Thanks for the answer, but I think I deserve a little bit more credit than you are giving me.

But i understand what you are saying but i think you are looking at all the negative things with BTL. When ever someone on these forums says they want to do a BTL they get treated like the devil, but if i said i wanted to buy a property to live its all good news and help.

This is true, BTLs are not the popular thing they were when everyone was flipping properties, building up a highly leveraged portfolio and making free money out of nowhere in a booming market. Some of that is because in the credit crunch when property prices fell and the ability to refinance fell away, owning a BTL property was exposed as the risky investment it had really always been, and many people got burned. The ones who had truly appreciated and prepared for the risk, fared much better.

Generally when someone asks about BTL it is because they already know the positive potential it can have (provide income and geared capital gains). I am not going to write a long post to explain what profits can be made, because they wouldn't ask if they didn't think it can make profits. Why would I focus on the positives, when anyone producting marketing material for property investment already does that and anyone asking about the potential outcome from a BTL investment is aware that one outcome is a big pile of profit?

They would be better served by me explaining why it may not make profits and in fact comes with a stack of risk that they are ill-prepared for.

BTLs, compared to savings and fund investments, are a minority pursuit. More people on here have not done them than done them, some because they don't have the cash or the opportunity but many because they don't have the time or the risk capacity. The typical person might like the idea of it, but is grateful for that idea to be shot down because it saves them a potential personal loss greater than the amount of money they were willing to invest.

Some people who post here have several which proves that the model can work. All you need to do is avoid what can go wrong, so a summary of some things that can go wrong is going to be way more useful than knowing what can go right.