The last 10 years has been marked by the buy-to-let housing investment boom. With property prices doubling in just 5 years, we saw a stampede of investors seeking to jump onto the buy-to-let boom. Many were a new breed of landlords, middle-income Britain wanting to cash in on the possibilities of wealth that property price inflation offered. One of the key factors was the change in behaviour by financial institutions. Prior to this period, for a buy-to-let investment, the investor was required to provide between 15% – 25% of the purchase price of the property, before a bank would advance the balance of the funds.
In addition rental income had to be at least 1.5 times greater than the mortgage payment. These two factors both changed; for a buy-to-let property lenders were now only asking for 10%-15% investment
(on off-plan purchases, special products meant that sometimes only a few hundred £ were needed)
In addition, personal financial situations were not looked into as rigorously as before. Not only was property for personal ownership more financially viable but for many, having investment property was now almost the norm. Was this you?
The rise in the buy-to-let investor saw a change in sentiment. Investing in bricks and mortar seemed like a “solid” investment for the future, rather than putting money into share markets and facing the constant ups and downs. It was seen as a better way for saving for retirement then putting money into a pension fund. With interest rates at a historic low it seemed like an ideal investment opportunity.
Now the situation is somewhat different, and in many ways we are returning to the previous “prudent” position. Semi-professional landlords need to take stock of their position in the current climate. It is time to focus not on the reward part of the equation but on RISK. Have your risks been identified and mitigated?
Risk 1: Do the figures really stack up? Does the rental income cover costs?
When looking at a BTL opportunity, landlords need to consider not only whether the rent will cover the mortgage, but will it also cover incidentals. These include void periods and the additional costs during the time (payment of mortgage, council tax, utility standing charges), service charges, repairs and renewals, cleaning charges between tenancy’s, agents fees and how much of an interest rate increase the income covers. Also another cost to consider is the cost of the money that you have put in, i.e. how much savings interest your deposit money would have earned if you had put it into the bank. If you have used money from credit cards and other loans then the cost of this borrowing should be factored into your calculations. With these questions addressed it becomes much more apparent whether we are talking about a valuable investment or a drain on your finances.
Many investors re-mortgage one property to release the deposit money that had initially been invested, and then use this for further investments. From a relatively small capital investments one can build a size-able portfolio, all based upon bank borrowing. This will now be very difficult, any equity may well be “locked in”.
Risk 2: Tenants
The key to successful BTL is to ensure that the property is never empty and tenants that pay the rent. Location and marketing the property is crucial to avoid empty or void periods. As you assess your own portfolio, if there are properties that are consistently hard to let, or where tenants do not pay on time, etc then consider selling them. To procrastinate will mean further cash leakage. Even selling at loss may be a good idea, since you will be releasing what could otherwise be an ongoing liability.
Many commentators are suggesting that BTL investors should sit tight, since in a period of falling house sales the rental market rises. While broadly in agreement with this view one thing does strike me. Salaries are not rising significantly but the basic cost of living, like council tax, food, fuel, utilities are, which may actually mean a downward pressure on rents. So although demand will be there, the amount of rent affordable to a tenant may not be as much as landlord had thought. In addition, particularity in London and the South East rentals have been bolstered from demand from abroad, including demand from the City in terms of investment property and demand from central and eastern Europe for workers. If the economy falters, that demand may diminish.
Risk 3: Future funding
This is the area that is most difficult to understand at present and of gravest concern to investors. When fixed rates or tracker rates on the current mortgage expire will you be forced into the lenders higher standard variable or will you be able to find a new deal in the market? With house valuations heading south, and loan to value ratios becoming tighter (i.e. lender will lend only 75% to 80% of the value), it is likely that you’ll have to put your own money into the investment to get a good mortgage deal. To ensure that you have funds available for this, it worth trimming the portfolio by selling non-performing assets.
Risk 4: Liquidity
What happens if several of your properties are vacant at the same time, and need repairs before new tenants are found. Do you have the cash reserves to cover it? If you don’t and you get into arrears on the mortgage, suddenly your credit status is impaired and you can’t borrow. The property gets repossessed, and sold for £50,000 less than its value six months ago. You still don’t have any cash so the situation is repeated. Rather than assets you now have major liabilities. Remember that as the properties are held personally, not through a limited company, you are liable. This can lead to dire results, but as the debts will at this point be unsecured you do have a range of options to reduce your exposure. If all this sounds close to home, do get in touch.
In order to avoid this you need to ensure sufficient liquidity for worse case scenarios, which goes back to portfolio management.
Every cloud has a silver lining, and there are likely to be some real bargains, especially for the cash buyer in the coming months and years. In the same way that funding looks like its returning to the norm, ie as it was a decade ago, so the bargains that have elusive in recent years are also likely to return. So get planning now so you are in are in a position to take advantage of opportunities when they arise.
So key actions that you need to take to ensure that your reward is maximised and risk minimised:
- Review the portfolio understanding the overall indebtedness
- Construct a P&L for each property to understand the components of the portfolio
- Identify the properties that are draining income and sell.
- Identify properties where re-mortgage maybe difficult and consider selling these.
- More opportunities will arise in the near future and the released cash may be better used for that.
- Reign in activities, run a tight ship, and ensure you have access to sufficient cash to cope with the unexpected.
Remember you may be asset rich, but if you are highly leveraged and cash poor, then your ability to respond effectively to the new financial situation may be compromised.
Donald Findley has been providing solution for business for 20 years. Cashflow Dr and its sister company Debt Dr can help you cut your losses, organise a smooth and cost-effective exit and get you started again, or we can rebuild the business. We protect your assets, and help you sleep at night. Tel 08456 449 220