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Investing in buy-to-let: diversifying into commercial property

September 11th, 2009

Many experienced residential property buyers see commercial as a development of their investment business. This is due to the perceived advantages of commercial property investment; longer leases, fully repairing and insuring leases (FRI), no tenant hassles to deal with.  All of these points are generally true, but there are also downsides such as longer rental voids between tenancies and the entry point for investment usually a lot higher than residential property investment.

One key factor for diversifying into commercial is financing, not just raising the funds to purchase an investment, but also having financial reserves to cover void periods – it is not uncommon for a commercial property to be empty for 1 or more years between tenancies.  As an investor you also need to place greater emphasis on the quality of the tenant, e.g. their ability to pay, because if their business goes under you are left with no rental income.

Commercial property investment is hugely complex when compared to residential, it is impossible to cover all of the aspects in blog posts, we would probably need to write a book on the subject, and even then it would only just get you started.

If you are thinking of commercial property investment it is worth understanding some basics on the financing side, at least then you can consider if you want to investigate further. 

Without a proven history in commercial investment a bank is unlikely to lend an investor more than 60% LTV, leaving 40% deposit to find.  Secondly a bank will want a much higher rental cover than for residential, at the time of writing the best we could find was 150%, thus rental income from the lease needs to be 1.5 x the mortgage interest (this compares with 125% for residential property).

A bank will also want to know the quality of the tenant, their ability to pay, a term commonly used for this is the “covenant” of the tenant.  In today’s market the bank will most probably require the property to be tenanted before a mortgage is provided, thus making it almost impossible to buy an un-tenanted property unless you have very large cash reserves or equity in another asset for additional security.

All of this said, if you can find a commercial property with a good tenant and long lease (e.g. 10 years plus) with a rental yield of 8% or more it is a very attractive investment, continuous rental income (increasing at rent reviews) and no tenant hassles to deal with.  Such investments are out there, the bigger problem today is raising the finance.

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Investing in buy-to-let property: leveraging for growth

September 10th, 2009

So now you are an investment property buyer, you have your first one or two properties, and you want to start growing your portfolio. The key stumbling block for most investors is financing, they have insufficient private funds as deposits one future property purchases creating what appears to be an insurmountable barrier, but it does not need to be.  There are several ways in which you can overcome this issue, such as remortgaging, mezzanine finance, and  BMV properties, we will give a brief overview of each of these strategies for growing your portfolio.

Property Remortgaging.  You can remortgage one or more of your existing properties to release equity. Most lenders will have a criteria that you need to have owned your property for at least 6 months, they will also require evidence that they are being managed profitably, e.g. with interest rental cover of at least 125%. Some lenders will impose restrictions on the number of properties, e.g. if you have more than 5 or 10 (varies by lender) they will not lend for additional properties. When this happens you need to obtain commercial finance, for this you will need more of a proven track record and you will find the LTVs offered generally lower, sometimes only 60% LTV.

Mezzanine finance.  This is where you obtain secondary finance for your deposit, most lenders will not allow you to specifically borrow money to use for your deposit, but if you have “existing funds” in your accounts, that historically where obtained as loans, then it is possible to get round this issue.  The mezzanine finance can be taken as a secured loan against an existing asset, e.g. equity in your initial buy-to-let property or any other asset you may have. Note however that you will be paying a higher interest rate for this finance which needs to be considered in the overall portfolio profitability.

BMV properties.  This is where you purchase a property at below market value (see Simple2buy.co.uk), typically properties can be found at 10% to 20% or more below current values (September 2009). Once you find a BMV property that you would like to buy you can then use a purchase technique where the loan is based on valuation and not purchase price, in effect this reduces the deposit needed.  For example if the buy-to-let mortgage requires 25% deposit, and you buy a property at 15% discount, you then only need 10% cash for your deposit. Sounds too good to be true? Every day such deals are being completed in the UK, the only issue is there are more buyers for BMV deals than there are properties available, especially at discounts of 20% or more.

Whatever ever your financial strategy there is one fundamental rule to apply, do not make false statements to lenders, it is against the law.  Some investors may choose to do this, but one day it might catch up with them.  If you are going to use a creative finance strategy (such as with BMV properties) you will need the support of a specialist financial services company to ensure all of the lender’s rules are complied with.

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Investing in buy-to-let – managing the property

September 9th, 2009

Having successfully purchased your buy-to-let property the next step is managing the property for long term profitability … as an investment property buyer you have to be involved, otherwise your profits will fall and worse still you may lose your investment and end up in prison!

There are several areas of focus to consider, there are legal issues, tenant management and property management.  We will focus on each of these separately.

Legal issues

As a landlord you will have legal obligations, these are more than your responsibilities to the tenant under the terms of your tenancy agreement, and failure to comply can result in a criminal offence being committed.  The most important issues are those relating to safety, as a landlord you will need to ensure periodic gas safety checks and electrical safety checks carried out by approved gas and electrical contractors. Then there is tenant deposit protection, as a landlord you have to arrange for an approved third party company to hold the tenant deposit.  More recently energy performance certificates are required for any property before it is let. 

All in all there are quite a few legal obligations on the landlord, ignore them at your peril!  All of these issues can be organised by a letting agent, alternatively you can save costs by arranging directly with approved companies, a quick search on the internet will reveal a plethora of choices.

Tenant management

Most tenants will respect your property, but much will depend on your relationship with them.  An absent landlord who never checks up on their property is at greater risk of a tenancy going wrong.  We suggest periodic visits to the property, check on its condition and that everything is satisfactory for the tenant – let the tenant know you are there to deal with any problems, either property or tenant related.  It is also advisable to maintain business-like communication with your tenant, be polite, avoid misunderstandings as these can soon deteriorate and create problems later in the tenancy. 

Before letting to a tenant you should also carry out adequate reference checks, these should include tenant credit checks to ensure the tenant does not have any major financial issues, otherwise you could end up with unpaid rents later in the tenancy. We recommend www.Credit-Check-Services.co.uk for carrying out these checks.

When using an agent or managing the tenant directly, always ensure a full inventory check is carried out.  The inventory check must be signed and agreed by the tenant at the start of the tenancy, otherwise you will find it difficult to claim for any damages (should they occur) when the tenant moves out. The inventory list should not only document the items within the property but also the condition of everything from windows and walls to carpets. 

Property management

Ensuring the property is maintained is fundamental, ignoring a missing roof tile, a small leak, etc, could result in higher costs in the longer term, properties need to be maintained.  When carrying out any decoration or refurbishment go for durable quality appropriate to your rental market.  Think to yourself, how will this look after 3 years of letting, will it need replacing, are there more cost-effective options.  You need to expect some wear-and-tear, the property will need redecorating from time to time, so the lay out and materials used need to be chosen for minimal maintenance costs whilst ensuring tenant appeal for your target market.

Overall managing the property is a mix of good business sense and compliance with the legal obligations of a landlord, if you ignore these you will at best lose money, at worst end up in prison.

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Investing in buy-to-let property – financing

September 8th, 2009

So you have found the type of property and location you are interested in, next you need to review the finances.  There are effectively two separate components to consider here, one is the financing for the mortgage, the other is the cash flows and ultimately profit form letting.

For the mortgage you will need (in most cases) a buy-to-let mortgage and a quick google search will produce a seemingly unending list of mortgage brokers offering their services here.  But you need to know the numbers will work, so here are the key metrics mortgage lenders will require:

LTV, the Loan-to-Valuation (or purchase price whichever is the lower).  In the current market most products are either at 70% or 75% LTV, which means you need to fund a large deposit.  You can raise the deposit from releasing equity elsewhere, but you cannot have a “second loan” for your deposit on a residential buy-to-let (it is different for commercial property, we will discuss this later).

The second metric used by lenders is the “rental cover”, typically this will need to be at least 125% of the mortgage interest payments.  This is best explained by an example:

  • Assume a £100,000 mortgage on your £135,000 property purchase price.
  • Mortgage interest rate on the lender’s SVR of 5%
  • With 125% cover the lender requires you to have 1.25 x 5%, e.g. 6.25% rental income on the mortgage of £100,000, thus you need to have rent of £6,250 per annum (£521 pcm)
  • Thus for the £135,000 property you are buying you will need £35,000 deposit and a market rental income potential of £521 pcm.

One factor we do not mention here is that for any mortgage you will also need to show some proof of income and you will also need a good credit rating.

Next, the key part, the financials need to generate monthly cash flow and a rental profit. All too often newbie landlords focus on the gross rent and mortgage interest and assume that providing it generates a positive difference that it will be fine, wrong!  There are key costs and loss of income to be considered in your financial calculation, these are as follows.

Rental voids, it is very unlikely you will rent your property for 12 months a year, every year.  You need to budget for times when it is empty (rental voids), we suggest 1 month per year, or 8.33% of the rent.  Next you need to budget for letting agents, even if you manage the property yourself you will need an agent to find a tenant (you could do it yourself but the agent will normally find a tenant much more quickly thus reducing rental voids).  Letting agents will typically charge 10% (or more) + VAT, so that is another 11.75% of your rent.  Finally there are maintenance and insurance costs (including service charges for flats which can be higher), it would be prudent to budget another 10% of your annual rent for this.  In summary:

  • Rental voids 8.33% of rent
  • Letting agent 11.75%
  • Maintenance 10%
  • Total costs around 30% of the annual rent.

Now to make all of this work together, our example above suggests that you need to budget for at least 130% rental cover on your mortgage interest costs, and remember, today mortgage interests costs are quite low, so you are better off using expected future mortgage interest rate costs, no one knows for certain but a rate of 6% + seems more realistic. Thus you need to achieve a minimum market rent of £7,800 p.a. (£650 pcm) for a £100,000 mortgage on your £135,000 property investment.

Our next post in this series will cover managing the property and tenants.

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Investing in buy-to-let … selecting the property

September 8th, 2009

This is where many investment property buyers go wrong, choose the wrong property and it will become a headache, but if you choose the right property you will have a profitable property for the future. The key factors to consider for selecting the property are the location and the type of property.

Location of the property –

This is all to do with market supply and demand, you need a property in a location where there is a current and (expected) future demand from tenants.  A property in a small rural village is unlikely to have much demand, likewise an over-developed city or town centre with excess supply of flats is not going to be good either.

Ideal locations are near to public transport or good road access for getting to work.  Local facilities also need to be considered such as schools, shops, and leisure.  Ask yourself the question, “could I live here?”

You may also be interested in student multi-lets, locations near universities and colleges.  Make sure that the location is in an area where the university campus is going to remain for many years to come – some universities have campuses in multiple locations, if they consolidate locations you could find yourself with no students to rent to.

Consider the local economy, is there a single major employer for the area such that if they were to close down there will be high unemployment?  This is difficult to gauge but it is really important to factor in, get it wrong and you may struggle to let out your property.

Type of property –

Many landlords have been taken in by builders in recent years offering flats with rent guarantees for 2/3 years, then finding out later there is an over-supply of flats and market rents fall.  You need to assess the local market and ensure your type of property is in more demand for renting.  Note that over the last few years many flats have been built, often creating an over-supply, thus you may find small 2/3 bed houses in greater demand.

If you choose a flat, which can be a great investment in locations such as London, then you need to consider the costs for ground rent and service charges.  Sometimes these costs can be disproportionately high when compared with the equivalent sized house, thus eating in to your rental profits. On the positive side flats require less hand-on maintenance by the landlord as all main buildings work is covered by the freeholder’s management company.

This is a very brief overview on selecting a buy-to-let property, but equally it highlights very important factors, choose  wisely and you will have a profitable buy-to-let property for the future. Our next article in this series will cover some of the key financials for proeprty buyers.

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Investing in buy-to-let property – part 1

September 7th, 2009

There have been many casualties with buy-to-let investors making poor decisions when investing in property, sometimes the result has been bankruptcy.  Our short series of articles about investing in buy-to-let property is intended to offer some helpful information to those considering this type of investment.

After this 1st introduction we will be covering the following topics for interested property buyers seeking to become landlords of the future:

2 – Selecting a property

This will cover how you should consider choosing a property, covering aspects from location through to the type of property to consider purchasing.

3- Financing

An overview of buy-to-let financing, some of the key metrics banks look for, and how to better prepare yourself.

4 – Managing the property and the tenants

This is fundamental, you cannot just buy a property and watch the cash come in, it only makes a profit if you manage the property correctly, we give some helpful insights on this.

5 – Leveraging for investment growth

After successfully managing your first property you would like some more? Here we will suggest methods on how to increase your portfolio successfully.

6 – Diversifying into commercial property

For some they see commercial property as much less hassle, “easy money”, the reality is that it is higher risk, but equally if you have a good strategy it can prove very profitable.

7 – A summary of pitfalls to be aware of

Finally we will be summarising the pitfalls, is not that we want to be negative, but every investor needs to have the risks in the back of their mind at all times when making investment decisions, in that way hopefully the most profitable decisions can be made.

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Is buy-to-let a good investment?

September 7th, 2009

Over the last 10 years there has been a huge increase in the number of private buy-to-let landlords who have seen property investment as a key part of their “wealth management strategy”.  For those who invested in the late 1990s it has proven to be an excellent investment, but what about those who invested in the last 3 years, most are sitting on a loss.

Clearly there will always be peaks and troughs in property values, some will get their timing right, others will not.  And despite what many will think, it is not always clear when is a good time to buy, or sell, even some experienced investors get their timing wrong.

If you are a property investor who only invests for the short to medium term then you have the greatest exposure to losses, and likewise gains, both of which can be spectacular.  Some of these property buyers are now starting to view 2009 / 2010 as the time to start investing again, getting ready for the next lift in property prices, but are they right?

Our research has found that most analysts are talking of more modest growth over the next 5 to 10 years, we have yet to find any credible economist forecasting a UK property price boom in the next 5 to 10 years, but economies can change, and with it the forecasts of economists!

The key message for buy-to-let investors is this, if you want to reduce risk and realise long-term profits then invest for the long term.  Select your property wisely, in a location where tenants will be easier to find, and you will minimise rental voids, maximising the future profitability of your property.

Our own opinion at the house4sale blog is think long term with buy-to-let investments, also do not place all of your financial resources into buy-to-let, diversify your investments to mitigate risk.

For those who want to start investing in property, and also the novice landlords, we will be publishing a series of posts about how to be successful with buy-to-let properties, an essential guide for anyone who wants to build a property portfolio.

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Mortgages direct from lender

July 28th, 2009

The credit crunch has taken its toll on the number of mortgage products (in particular for buy-to-let) and naturally on the number of mortgage brokers. We have found out first hand the advantages of approaching a bank directly … read on.

In 2007/2008 there were 1000+ mortgage products, buy-to-let landlords and home buyers could obtain mortgages with ease using a self-certification income. Today the number of mortgage products has dropped significantly, and some banks are now offering products direct, not via a mortgage broker. The upshot is that many mortgage brokers will not be able to get you the best deal, you now need to do some more research yourself.

Whilst we believe mortgage brokers are a key resource for property buyers you should not rely on them exclusively, here is our case study:

  • Buy-to-let property mortgaged with the same bank for 10 years. An equity release was required to build up a fund to buy other properties.
  • A reputable mortgage broker was appointed to find a product. The offer was a tracker at BBR + 3% for 2 years, then revert to the lender’s SVR. There were admin fees and a 3% arrangement fee to pay. After 4 weeks the mortgage failed to complete due to a small technicality about the property freehold – banks often look for excuses not to lend.
  • Next approach was to the existing mortgage lender (should have done this first). They offered the same SVR interest rate for a remortgage equity release, and best of all only £255 in admin and legal fees. Note that this bank was no longer offering products through mortgage brokers, the advantage we had was the existing bank relationship and a known low-risk profile.

 Clearly this example does not apply to everyone, however it does support the view that approaching an existing bank with whom you have a proven history of mortgage borrowing could save you time and a lot of money in fees!

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Handelsbanken and Leumi Mortgages

July 26th, 2009

More foreign banks are joining the influx of banks to provide mortgages on UK residential property.  Yesterday we reported the Bank of China had entered the UK market, now we have learnt that Handelsbanken of Sweden and Leumi Bank of Israel are also now providing mortgages in the UK.

This is fantastic news for anyone seeking to buy UK property, especially for buy-to-let investors who are currently getting very poor deals from the British banks.  Here are some examples of what we understand is available from the non-UK banks:

Buy-to-let 3% over base rate tracker mortgages with 25% deposit

Lower arrangement fees, typically from £995

Buy-to-let mortgages based on 100% rental cover (most UK banks require 125% cover)

Leumi bank we understand is offering a tracker mortgage at just 1.625% above 3-month LIBOR, that is a current rate of around 2.56%.  This compares with the best UK bank rate of 2.95% from HSBC.

The fact that foreign banks are entering the UK market suggests that they now see it as very profitable to lend here, and maybe they see that property prices are at or nearing the bottom of the market – so for them, their loans are secure.

As to getting access to these loans you need to find an approved broker.  So far we have found the following can access the Bank of China mortgages:

  • Savills – 0870 900 7762
  • Legal & General Mortgage Club – 01226 230504
  • LargeMortgageLoansUK – 020 7519 4900

Maybe the tide has finally turned and we will soon see the big name banks on the UK high street offering mortgages at more reasonable rates.

Buy-to-Let investor looking for BMV Properties at discounts to todays valuation? << click here

Do you want to check tenant backround for financial risk? << click here

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Buy-to-let investors return

July 21st, 2009

With the low interest rates many people are seeing their savings make poor returns in deposit accounts causing investors to look elsewhere for higher returns on  their money.  Some of these investors are now turning to property as an alternative source of income.

One of the places where the increase in activity can be seen is auction rooms.  12 months ago properties could be purchased at significant discounts at auctions, but today those discounts are reduced as more investors seek to purchase buy-to-let properties.  But, when you take into account the price falls of the last 12 months then those bidding are actually picking up better deals today as the overall market price has fallen.

In many cases buy-to-let properties can now be purchased with 6% + yields in the south east, higher yields of 8% + can be achieved in the north east of UK.  Overall, even after allowing for rental voids and management costs these provide attractive returns when compared with money left in a deposit account. 

But property investors also need to be cautious with respect to capital growth.  Many analysts are predicting the the recovery in property prices will be slow over many years, some even say it will be 2015 before prices recover to their peak of 2007.  For the investor this suggests purchases should be based on rental yields, not on hopes of short term capital growth.

One last comment, if you are seeking to invest in buy-to-let, make sure you carefully check tenants to ensure they will be able to pay the rent, you can purchase tenant checks from Credit Check Services for as little as £8.95.

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