Why Investing in Buy-to-Let Could be the Perfect Pension Plan
Buy-to-Let is the investment strategy most investors begin with when they're growing a property portfolio, planning their pension or starting a property business. Although this is one of the better-known strategies, there are still a few key elements you need to consider to make this strategy work.
So grab a coffee, pull up a seat and get your property journey started here...
If you were to pick up any property investor book from amazon, or speak to any estate or letting agent, buy-to-let is the strategy they would ‘recommend’ or talk about.
This is the traditional way of investing in rental property, and some of the other strategies mentioned later on in this guide are varied around this method.
This strategy doesn’t require creative thinking to get started, and once you have learned how to find, negotiate and manage your properties successfully (all of which we will share with you how to do in your training), you can then systemise the process.
Where the Money Is
With vanilla buy to lets, your income can be made in one of two main ways, which is why many investors use property as a pension plan and why it can work well for this.
The first is with the rental income.
As a rule of thumb to help compare properties, you should consider the rental yield for each property you look at.
There are many definitions on rental yield, but I look at it as: the yearly rental income ÷ (by the purchase price + refurbishment costs) x 100.
If you’re looking at a property to buy that could rent out at £500 per month. This would give a yearly rental income of £6,000. Then let’s say it could be purchased for £70,000 but would need around £5,000 to refurbish it in a condition that’s ready to rent.
Your calculation for Rental Yield would look like this:
£6,000 ÷ (£70,000 + £5,000) x 100
= 8% Rental Yield
From experience when you are buying vanilla buy to let’s for cashflow, you will need a rental yield of 8%+ so you have enough income to cover all costs and still make a profit too.
Your second way of making money is with equity.
Equity can be described as the Difference between the value of the property minus (-) how much finance you have on it”.
For example if you had a £100k property with a £60k mortgage you would have £40k worth of equity in the property.
Equity is created in one of three ways:
- Buying at a discount
- Adding value with refurbishments
- Property prices increasing in value (capital growth)
To make the best return on your investment with buy to let’s, you want a combination of both rental income and equity.
From experience, it’s best to focus on properties that give you a minimum rental income of £200pcm cashflow after all costs.
For your equity you want to be negotiating the purchase at between 15-25%+ discount to the market value, which will automatically lock in a buffer against house price changes and a decent amount of equity.
Then depending on your budget and strategy you can add more value by doing small scale refurbishments if you wished.
The third way mentioned of creating equity, with Capital growth, is really out of your hands as it depends on the market, but by doing your due diligence and buying in the right area, you can make sure your investment achieves suitable capital growth overtime.
Cash Rich and Time Poor
This strategy traditionally suits investors who have money to invest in deposits and a good credit rating to raise finance. Or have enough money to purchase a property outright.
Using the power of leverage and buying with buy to let mortgages can work really well here as it allows you to spread your investment over multiple properties instead of just buying one property outright for cash.
Mortgage finance often changes, but in 2013 typically buy to let mortgages are available at 75% LTV (Loan To Valuation), which would require a 25% deposit.
- Money to invest for an outright purchase of the property or deposit
- A clean credit rating and a good regular income if you wanted to get a buy to let mortgage
- Property contacts - Sourcer’s & letting agents to help find you the best properties and manage them to free up your time
- 2-4 months
Initially finding a suitable property may take a few weeks, whilst you refine your process and learn what to look out for.
Once you have found the right property and negotiated the best purchase price, most property sales via an estate agent take 8-12 weeks.
If you have found the property by dealing directly with the vendor (the property seller) then this can be quicker and take 4-8 weeks depending on how you are financing the purchase.
If you are using mortgage finance this will be at the higher end of the timeframe as it will take a couple of weeks for the lender to process your application.
Note: the following assumptions apply:
- Purchase costs in this example include sourcing fees to find the right property as well as the traditional purchase costs like legal fees and surveys
- The mortgage is interest only, at 5%
- Other letting costs are worst case scenario. A budget of 3 month’s rent per annum to include (maintenance, management fees, voids, arrears, insurance and other costs)
Market Value of Property: £125,000
Negotiated Purchase Price: £100,000
Mortgage @ 75% LTV: £75,000
Deposit Required @ 25%: £25,000
Purchase costs: £5,000
Property Value: £125,000
Return On Investment (Instant Equity)
Total Invested: £30,000 (deposit + purchase costs)
ROI: £20,000 (equity – total invested)
ROI £20K ÷ £30 = 66%n (ROI ÷ total invested)
Return On Investment (Rental Income – Per Annum)
Total Purchase Costs: £105k =£100k + £5k (purchase + costs)
Rental Yield: 8%
Gross Rental Income (per annum): £8,400
Mortgage payments (per annum): £3,750
Other Letting costs (per annum): £2,100
Net Rental Income (per annum): £2,550
Total Invested: £30,000
NET ROI %: £2,550 ÷ £30k=8.5% (Net rental income ÷ total invested)
On the above example with a £30,000 investment you would be getting a primary return (NET Return on Investment) from rental income alone in the first year of 8.5%.
In addition to your secondary return on equity which would give a Return on Investment (R.O.I.) of 66% without any house price growth, or adding value with refurbishments.
This is achieved simply by buying at a discount.
This is very achievable if you stick to the seven fundamentals of buying the right properties.
A Case Study - How NOT To Do It
The very first property I purchased was in 2005 and it was a 3 bedroom terrace in Warrington. As I had no previous experience in buying property I didn’t know what ‘investors’ did and looked for.
I just knew I could get a mortgage of ‘x’ and I needed ‘y’ in rent to pay the mortgage.
The first property we looked at, we bought.
My First mistake...
We feel in love with the property and could even see ourselves living there...
It was a home, a nice family had looked after it and it was well presented on the viewings, candles in the fireplace, clean & tidy, (I'm sure I could even smell bread in the oven!) the whole nine yards.
The vendors had really gone to town to make the property stand out and sell it
After the viewing, we looked at what rent we might be able to get (by checking some internet site) and then thought let's go for it. No more due diligence, no more viewings... I didn’t even speak to any local letting agents.
What did I think it was worth... Being honest, I had no idea.
I thought it was on the market for £120k... Let me say that again
“ I thought “ it was on the market for £120k.... (but I was wrong)
I wanted to get it at a better price, but didn’t want to be cheeky... so I guessed what I thought would be a good deal... £114k sounded good so I called and placed the offer.
The agent sounded pretty pleased when we gave the offer and 5 minutes later (actually it was more like 1 minute later – I remembered how quick it had all seemed) they called back to say it was accepted!
Brilliant I thought... But less than 24hrs had passed and buyer’s remorse started to kick in. It all seemed too easy and I was getting doubts thinking we should have looked into it in more detail.
I couldn’t sleep, I just kept thinking something wasn’t right. I got up and started to do some more checks online to do some more due diligence.
After checking sold prices I realised we’d just offered £114k and all the other house sales showing up were less than £100k!
I then checked the other properties on the market and noticed the one we had seen was being advertised at £115k.... not £120k that I first thought.
I felt sick...
How did I get it so wrong?
After some phone calls the next day I found out that the vendor had just dropped the price the day we viewed as they were desperate to sell as they had found another property.
This new information combined with knowing what the sold prices were actually achieving made me feel worse.
But we didn’t want to pull out. It didn’t seem fair, it was a nice home and a nice seller, I didn’t want to let them down...
You may be reading this and thinking how naive I was, or soft, and I agree. I was 23 and made plenty of mistakes back then I promise you. This was one of them.
(note: learning to negotiate is key and a skill that you will need to learn early on if you want to get good at buying the right properties at the best prices... A lesson that I learned the expensive way!)
That lack of initial research, not knowing the vendor's situation, and falling in love with the property meant we overpaid significantly...
Not knowing what to do literally cost us thousands.
The Top 3 things I Should Have Done Differently
- Check recent sold prices to see what the ‘market value’ should be
- Ask more questions – understand why the vendor is selling, their timeframe, their motivation
- Place a lower initial offer – it's fine if it gets rejected, you can always increase with a 2nd offer. You're not trying to make friends here.
My advice would be to decide on your offer and then take a further 10% of it. If you think £100k is the right offer. Then offer £90k...
Both Sellers and Buyers can get remorse if a deal seems to easy.. If both parties give a little in the negotiations that’s fine. It’s all part of the process.
A Case Study - When Things Go Right
After I had learned a few valuable lessons (Read: made mistakes J) on my first property purchase, I decided to get a job at an estate agency. This gave me some great experience and helped me learn from these mistakes.
I left the estate agents in September 2007 and I purchased one of my next properties in December 2007.
This was a 3 bedroom mid terrace in Oldham.
It was on the market for £90k. The vendors were selling due to financial difficulties and they needed to sell quickly.
They had responded to one of my adverts about buying property quickly and I went to meet them at the property.
It was in ok condition, but would certainly benefit with a small refurbishment.
The property was slightly overvalued I felt, and I was more prepared this time, so when I went to see them I took a couple of printouts of other properties on the market that were similar and some recent sold prices
(you can get this great information for free from sites like Rightmove and Zoopla, they now even have reports that they will generate for you on the site, and these can be helpful to take with you to show vendors)
We sat down and discussed their reasons for selling, their situation, what they needed and what outcome they would be happy with.
It felt strange... Whenever I had been with vendors before in their living room, it was as an estate agent, and I always felt like I was the one doing the selling... but this time the roles were reversed.
I found that just by asking a few simple questions, being approachable and listening, people really start to open up.
They told me the whole situation, and we spent more time talking about them than the actual property.
They agreed with the information I gave them on local house prices and possible values and said the estate agents had told them to put the price that high as they were confident they could sell it.
Unfortunately, estate agents often do this, as it’s so competitive to get the instruction (the property on the market) as they know another agent from across town is likely to come later on and give wild promises on values.
It’s easy and too tempting as an agent to get a vendor (a property seller) excited by telling them you can achieve a great price
This is why you see so many properties on the market that are overvalued and aren’t priced correctly.
The proof on this occasion was the property had been on the market for 4 months, only two viewings and no offers
By going in with my research already prepared... by understanding the vendor's situation... and by being approachable I managed to agree on a price that we were both happy with.
The purchase cost me around £75k including all purchase costs, legal fees and a small refurbishment.
I had negotiated a discount to give me my instant equity AND added value with a refurbishment.
Unfortunately, the rental income was less than 8% on this one... but at the time I didn’t have any targets for this. I was still learning, and on the face of it the rent was enough to cover my mortgage, cost and a bit more, so I was happy.
Fast forward a few years and it has been a good purchase because I have had a long-term tenant their ever since...
No though, since then I have refined my criteria, and although over time the rent has increased and I now do actually get my 8% target rental yield on this property (thanks to inflation pushing up rents), I would probably look at this deal differently if I was to approach it again
Cashflow is definitely king... and it’s important you get a high rental yield from the start
Throughout this training I will tell you where I have gone wrong, so you can learn from my mistakes.. and I hope you find this valuable
I’ve paid the high entrance fee... bought the bad deals, made the mistakes and its cost me literally thousands... and I’m putting it all down here, so you can avoid these same costly mistakes in your journey.