With interest rates at historically low levels and a shortage of affordable property to live in its no surprise people are attracted to property as an investment. Is this prudent? Do investors understand the risks? Are they making the most of the opportunity?
When investing in property there are many conditions to consider. The first question I always ask a potential client is why make the investment? There is no right or wrong answer, how they respond allows me to understand their risk appetite and match their borrowing to that.
Future pension vs monthly income
Many people want to build a pension pot for when they retire so they can sell the house and live off the proceeds. I know their preference is for capital appreciation rather than monthly revenue. For them the best option would be a mortgage with a repayment option so at the end of their desired time frame the mortgage debt is paid off and they own 100% of that house.
Other people want to maximise a monthly income from any investment. Their best option is likely to be an interest only mortgage to keep payments as low as possible. While interest only is often frowned upon in the buy to live mortgage world, on Buy to Let (BTL) properties its becoming more popular and I examine this below.
A changing environment
At the moment, the “in” thing is to be a property investor however many people are not maximising their investment opportunities being unaware of the changing regulatory and financial environment.
In recent years, the buy to let mortgage market has changed dramatically with additional stamp duty levied on the 2nd and additional properties. Also, lenders have changed the way they assess the property owner’s ability to buy and service the mortgage debt:
- Previously a 25% deposit based on the property value would have been sufficient as long as coverage (the amount received in rent vs. the amount paid in interest) was at least 100%. Now lenders apply stress tests based upon rental income and use different interest rate scenarios. These vary massively from lender to lender: some lenders for example will want 125% rental coverage based upon an interest rate of 5.5%.
- The takeaway for us is that a lender wants to see the rental income coming in higher than any mortgage payment and to ensure the borrower can meet the payments even when interest rates rise.
This shake up has affected run down properties more as the rental assessments used by the lender is based upon the current (not future) rental condition. They could easily apply a £0 rental income figure if the property is in bad disrepair which means no mortgage to finance the refurbishment needed to make it rentable.
How to respond
So how are people dealing with this scenario?
For a start its sorted out the ‘wheat from the chaff” (savvy vs not savvy investors). For those able to afford to buy the property outright with ‘cash’ and fund the works then the property can be remortgaged and most of (in some cases all) the original investment can be taken back out.
- I buy a property for £100k and spend £20k on refurbishing the property which takes the estimated value to £150k. I can then remortgage up to 75% of the value of the property (subject to lenders stress test) which equates to £112.5k. Only £7.5k of our original investment is left in the property which is now earning a rental income.
If you are unable to buy the property outright though there are plenty of other mortgage products on the market such as light refurbishment mortgages and bridging loans. These allow you to roll up of interest and pay everything at the end of the bridging term. You can then remortgage your investment as explained above, as the property would now be in a lettable condition.
And finally: importance of gearing
For those with a buy to let property that is debt free, or if you have a recent inheritance, the world is your oyster and I will explain how to improve your potential return through gearing.
Gearing is a way of spreading risk and not putting your eggs all in one basket. Here’s how it can work for you:
- if you have one property of £200k and borrow £150k to put as a £50k deposit on 3 additional properties you can finance all 4 with buy to let mortgages.
- The first property funds 3 more so you would be receiving 4 rental incomes each of approximately £950pcm.
- Though you have 4 mortgages each should cost less that £300pcm for interest only.
- Your monthly income would be £3.8k vs mortgage costs of £1.2k so an annual profit of £31.2k
Now for the jewel in the crown, capital appreciation (how much your property has gone up).
If you own one property that rises in value by up 25% over 10 years that would be £50k but multiply that by 4 you have £200k enough to get another property? Or 4? Interested?
If you like what you’ve read why not give us a call. We can walk you through the process, discuss your plans and examine finance options.