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Category: Mortgages Date: 2/17/2012
Buy-to-let is enjoying a bit of renaissance: more mortgages available, higher rental yields and high demand. But have you considered the investment risks?
According to recent figures from the Communities and Local Government's English Housing Report, the number of privately rented properties has risen from 2.4 million in 2005-06 to 3.4 million in 2009-10 – that's 15.6% of all residential property in England!
But while the potential for returns on a buy-to-let property are big, so are the risks…
With any investment the return you will get is uncertain – you could even make a loss.
With a buy-to-let investment, you can earn money in two ways:
On the flipside, you can also lose money if:
So, if the possibility of losing money doesn't sit comfortably with you, then maybe a savings account would be more appropriate (however uninspiring the meagre rates or interest are at present).
If you bought a buy-to-let property at the height of the housing boom (or bubble), you may not have seen any capital growth on your investment yet – in fact, you're probably recording a loss.
According to the Halifax House Price Index the average value of a property in August 2007 was £201,081; in January 2012 it was £158,879 – a near 21% decrease.
However, even with this 21% decrease, if you'd invested in a buy-to-let property in 2002 then, on average, your property may have risen 62% in value. Go back to 1992 and average values have increased 142%.
Halifax House Price Index 1992 - 2012
Date
Average house price
% change from previous
January 2012
£158,879
-21%
August 2007 (the crest of the wave)
£201,081
+105%
January 2002
£98,088
+50%
January 1992
£65,520
n/a
SOURCE: The Halifax House Price Index.
Remember past performance is no guide to the future performance of house prices.
So the nature of buy-to-let, as with most investments, is that you have to be prepared to invest your money for the long term to give your investment the best chance to grow. The Halifax House Price Index seems to corroborate that previously, property has performed very well over the longer term.
But will it continue to do so – that's the rub. We are living through unprecedented times and, although the past performance of property has been stellar, past performance is no guide to future performance – there's just no way to know how a particular investment will turn out.
Before becoming a buy-to-let investor you need to be comfortable with this risk – property is not necessarily a one-way bet.
You receive income from your buy-to-let in the form of a monthly rental payment from your tenants. The rent you can expect to receive from a buy-to-let depends on your property, its location and a variety of other factors. It goes without saying as well that your property also needs to be tenanted!
For a buy-to-let investment, income is particularly important as you will have regular costs to cover. Aside from the costs of buying your property – Stamp Duty, valuation/survey fees, legal fees, mortgage arrangement fees, re-decorating, etc. – you'll have numerous day-to-day maintenance and management costs:
You should also consider putting aside a little each month in a contingency fund. This could cover costs such as redecorating your property in order to attract new tenants and to cover your costs during any untenanted periods.
If you borrowed money to buy shares, you might be considered a bit reckless; but borrowing money to help fund a buy-to-let purchase is becoming more and more commonplace.
A buy-to-let mortgage allows you to invest in a property with a relatively small amount of money and reap all the gains in house prices rises and income. However, because it's now considered quite normal to borrow to fund a buy-to-let purchase, you may not have considered the additional risks that are inherent with borrowing to buy-to-let; risks that may have been overlooked by some investors in the recent house price boom.
If you had a £50,000 deposit and a £100,000 mortgage on a £150,000 buy-to-let property, if that property's value increases by 10% you will have made £15,000 in profit. That's actually 30% profit on your original investment of £50,000.
However if you bought the £150,000 property outright and property prices went up 10% - you'd make £15,000, which is a 10% profit on your original investment of £150,000.
If you decided to split your £150,000 to purchase three buy-to-let properties (each worth £150,000) and property prices go up 10%, you'll make £45,000, or 30% profit on your original investment of £150,000.
If you buy a single buy-to-let property worth £150,000 outright, if that property loses 10% in value, you only lose £15,000.
If you buy three buy-to-let properties (each worth £150,000) with a deposit of £50,000 each, a 10% loss in value would lose you £45,000, or 30% of your original investment, a much heavier loss.
Normally when you invest, the risk you take is limited to the amount you invest – you can't lose any more than you've put in. But as soon as you borrow you increase your risk: it now becomes limited to the amount you invest, plus the amount you've borrowed (and any interest due). That means that you could potentially lose far more than you originally invested.
This risk is exacerbated because the majority of buy-to-let mortgages – are on an interest only basis, to be repaid when the property is sold. So if house prices drop and your property is worth less than the mortgage on it, you would have to fork out the extra cash to repay this portion of the debt by the end of the mortgage term or if you wanted to sell the property.
In essence you could end up in a situation where you have to throw good money after bad.
And there is the dilemma of borrowing to buy – you have the chance of making more, but at the risk of losing more.
It's easy to see why buy-to-let is an attractive investment: you can physically see your bricks and mortar and manage it in a way you just can't do with shares or other investment routes.
But it's also very easy to overlook the very real investment risks associated with buy-to-let, the considerable costs you might incur, not to mention the drain this type of investment might have on your time, and the stress it might have on your life – that's even if you employ an agent (untenanted periods can still be a financial worry for instance).
If you want to have an easy life as an investor, there are less involved ways of investing, such as through an investment fund (within or outside of an equity ISA).
Borrowing to fund investment is a risky business – you're not only risking money you've got, but also money you haven't got, money that would have to be paid back if your buy-to-let loses a marked proportion of its value.
Before entering into any investment you're always best advised to seek professional guidance – from an independent financial adviser and maybe from an accountant as well.
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Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at anytime.