Baffling London BTL economics

westernpromise

A mate of mine has just sold a 3-bedroom flat in west London for £950k to a BTL buyer. The buyer was desperate to complete before April 1st, as this saved him nearly £29,000 in stamp duty. The agents have told my mate that there is no way he’d get £950k for that flat today - more like £875k.

All of us - my mate, the agent, and me - are completely bewildered by what on earth this buyer was thinking.

London prices have, so far as I can see, flatlined for a year or so, and actually declined in the higher price brackets. This guy can’t have been unaware of that and hence can't be buying it for surefire capital growth - he needs it to go up by 4% just to recoup the stamp duty.

But he can’t have been buying it for yield either. You can let places like that, around there, for about £29k a year. I know this, because I do exactly that myself.

So the flat owes him £986k, and his gross yield’s going to be at best 2.9%. There can’t be any leverage to multiply that yield because there is no way, net of the looming tax changes, that he can borrow at better than 2.9% net. So that’s the best it can be and probably it's worse.

How is there any money in overpaying by £75k to save £29k and then let the place out at 2.9% gross? What am I missing? Is he stupid or am I?

Conrad

He's thinking long term. Global population was 2 bn 50 odd years ago, today 7 bn. 25 years from now that flat will be worth several multiples more

michaels

Presumably the buyer would not agree with your pre/post deadline valuation differences or they would not proceed at that price.

In terms of the yield, 2.9% gross would not appear to make sense given the alternative investments available unless perhaps you were very bearish of not only equity but also probably banks as property has got to be a long term investment due to the transaction costs and given that much better yields are available elsewhere in the country it would appear again that the buyer is taking a long position on property prices.

Only time will tell if it is a winning bet.

michaels

Conrad wrote: »

He's thinking long term. Global population was 2 bn 50 odd years ago, today 7 bn. 25 years from now that flat will be worth several multiples more

I thought demographics currently suggest that population will max out below 11bn - although I guess big changes in longevity could impact.

chucknorris

westernpromise wrote: »

A mate of mine has just sold a 3-bedroom flat in west London for £950k to a BTL buyer. The buyer was desperate to complete before April 1st, as this saved him nearly £29,000 in stamp duty. The agents have told my mate that there is no way he’d get £950k for that flat today - more like £875k.

All of us - my mate, the agent, and me - are completely bewildered by what on earth this buyer was thinking.

London prices have, so far as I can see, flatlined for a year or so, and actually declined in the higher price brackets. This guy can’t have been unaware of that and hence can't be buying it for surefire capital growth - he needs it to go up by 4% just to recoup the stamp duty.

But he can’t have been buying it for yield either. You can let places like that, around there, for about £29k a year. I know this, because I do exactly that myself.

So the flat owes him £986k, and his gross yield’s going to be at best 2.9%. There can’t be any leverage to multiply that yield because there is no way, net of the looming tax changes, that he can borrow at better than 2.9% net. So that’s the best it can be and probably it's worse.

How is there any money in overpaying by £75k to save £29k and then let the place out at 2.9% gross? What am I missing? Is he stupid or am I?

Neither of you are stupid, like you, I did suspect that the rush to buy prior to the April deadline might inflate prices, and as it happens this did occur. But it wasn't guaranteed that it would happen, and that the inflation would exceed the extra stamp duty, although that said, if it was me, I would have also waited.

Conrad

michaels wrote: »

I thought demographics currently suggest that population will max out below 11bn - although I guess big changes in longevity could impact.

11 bn is 4 bn more than today, so still a significant increase in demand for resources such as property, and you can be sure a good chunk of the population increase will want to live in London


I'm noticing in my own buy to let target area sellers are just chancing any old mega high asking price, and invariably getting it.


I'm looking to buy another at the moment and the yields are low but I just know it's going to be easy capital growth over the coming years given my target area on the M25 is still way cheaper than much of London. I notice plenty of buyers looking further out as they are priced out of one area after another.


I'll still make 3 times the interest only mortgage payment, plus substantial capital growth, it's a no brainer.

westernpromise

What baffles me is that this is absolutely certain to be cash-flow negative over the next few years.

Let’s say he’s got a lifetime BTL tracker at BoE plus 2.75% (a deal that requires a 30% deposit). He thus has a £663k mortgage that costs £22k a year. He could have been getting say 3.5% via a 5-year bond on his own £325k (the remainder of the buy price, the SDLT, and a few grand of purchase costs). So that would be £11k of gross income, say £7k net with no risk to the capital. That’s what his BTL investment has to beat.

So he lets the place out at £29k a year, pays 40% tax on that income and gets 20% back. That’s a £6k tax hit which leaves £23k. Out of this he pays £22k in mortgage interest. That’s before he’s spent anything on letting fees (probably £3k), service charges (another £3k a year), a very modest £1k say on repairs. So he’s £5k a year negative outright, £12k negative versus the 5-year bond, and he’s overpaid another £50k. Over the next 5 years he’s thus going to need a capital gain of about £150k before CGT just to break even. That’s a steady 3.5%. To make significant gains he needs 5% or more compound but the question then arises as to what return is enough relative to the risk he’s taking and the liquidity issues of having to find £12k a year to fund his bet.

I’d want quite a bit more than 5% to take on this deal at this point in the cycle, myself.

Cakeguts

Was he a UK BTL buyer or from somewhere else?

Generali

westernpromise wrote: »

What baffles me is that this is absolutely certain to be cash-flow negative over the next few years.

Let’s say he’s got a lifetime BTL tracker at BoE plus 2.75% (a deal that requires a 30% deposit). He thus has a £663k mortgage that costs £22k a year. He could have been getting say 3.5% via a 5-year bond on his own £325k (the remainder of the buy price, the SDLT, and a few grand of purchase costs). So that would be £11k of gross income, say £7k net with no risk to the capital. That’s what his BTL investment has to beat.

So he lets the place out at £29k a year, pays 40% tax on that income and gets 20% back. That’s a £6k tax hit which leaves £23k. Out of this he pays £22k in mortgage interest. That’s before he’s spent anything on letting fees (probably £3k), service charges (another £3k a year), a very modest £1k say on repairs. So he’s £5k a year negative outright, £12k negative versus the 5-year bond, and he’s overpaid another £50k. Over the next 5 years he’s thus going to need a capital gain of about £150k before CGT just to break even. That’s a steady 3.5%. To make significant gains he needs 5% or more compound but the question then arises as to what return is enough relative to the risk he’s taking and the liquidity issues of having to find £12k a year to fund his bet.

I’d want quite a bit more than 5% to take on this deal at this point in the cycle, myself.

You're forgetting the power of leverage.

Assuming he invested £325,000 plus the £38,750 in SDLT and let's say £1,250 in fees he's put up £365,000. If he's lost £50,000 straight away by overpaying and the £40,000 that he's paid in transaction costs, he's lost 25% near as dammit of his investment straight off the bat.

He's taking a bet on prices rising. If they continue to rise at 10% a year then he's laughing of course.

Herzlos

What if he's not taken out a mortgage?

michaels

Generali wrote: »

You're forgetting the power of leverage.

Assuming he invested £325,000 plus the £38,750 in SDLT and let's say £1,250 in fees he's put up £365,000. If he's lost £50,000 straight away by overpaying and the £40,000 that he's paid in transaction costs, he's lost 25% near as dammit of his investment straight off the bat.

He's taking a bet on prices rising. If they continue to rise at 10% a year then he's laughing of course.

Yep - and even the vol has got to be worth something....