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BTL: Have you considered the investment risks?

Category: Buy To Let
Author: Tim Leonard
Updated: 09/11/2018

Buy-to-let is still booming, despite recent government initiatives that many thought would dampen activity. Indeed, more mortgages are available, rental yields are stable and demand is through the roof, 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 3.4 million in 2009/10 to 4.7 million in 2016/17.

But while the potential for returns on a buy-to-let property are big, so are the risks…

BTL investing

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:

  • Income (from rent)
  • Capital growth (through the value of the property going up)

On the flipside, you can also lose money if:

  • Your outgoings on the property exceed the rent you make, or the property sits empty
  • Property prices go down

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 rates or interest are at present).

Capital growth on a buy-to-let property

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.

Although the recent 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.

Income from a buy-to-let property

You receive buy-to-let income 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, and it goes without saying 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, redecorating, etc. – you'll have future costs and taxes to consider (such as capital gains tax and inheritance tax) as well as numerous day-to-day maintenance and management costs, such as:

  • Letting agent's fees
  • Mortgage interest (and capital if you opt for a full repayment mortgage)
  • Landlord's insurance
  • Annual safety checks (on the boiler, etc.)
  • Rent insurance (designed to protect you for untenanted periods or against having tenants in arrears)
  • General building maintenance
  • Income Tax

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 cover you during any untenanted periods.

Borrowing with a BTL mortgage

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 price 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 for this purpose; risks that may have been overlooked by some investors in the past house price boom.

For example:

If you had a £50,000 deposit and a £100,000 mortgage on a £150,000 buy-to-let property, and that property's value subsequently increases by 10%, you will have made £15,000 in profit. That's actually a 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.

But on the other side of the coin…

If you buy a single buy-to-let property worth £150,000 outright, and that property then lost 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 many 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 went on 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.

Conclusion – the human element

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 easy to overlook the very real investment risks associated with buy-to-let and 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, 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, or 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 it's always advisable to seek professional guidance – from an independent financial adviser and maybe from an accountant as well.

What next?

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Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.