WHICH TYPE OF PROPERTY IS BEST FOR BUY-TO-LET INVESTMENT?

Both new and experienced buy-to-let landlords will find themselves, at times, torn between which property to buy. While there are numerous factors for landlords to consider before making their final decision, a buy-to-let property is an investment, first and foremost. Therefore, the long-term return on investment on their property purchase should be a primary consideration of private landlords.

When you start looking into buying an investment property, there are a lot of things to consider, from the location to the mortgage provider - but what about the property type?

RENTAL YIELD

Rental yield is an important factor when considering what type of property to invest in. It determines how much you’ll earn from a rental property compared to the property’s cost. If you’re looking to make money from your investment in the short to mid-term, rental yield may well be your focus.

It’s quite simple to calculate your rental yield. There are different methods of calculating rental yield. We keep it simple and use the most commonly used method of calculating expressing rental yield.

To discover your rental yield, you:

1. Calculate your annual rental income from the property (or projected income if you haven’t purchased yet), less all running costs associated with the property. Costs you deduct should include mortgage payments, landlord insurance, ongoing repairs and maintenance, and any additional costs you may incur via your letting agent, such as additional property inspections.

2. Divide the result of the first calculation by the total amount invested in the purchase of the property. Total amount invested means you should include all fees and taxes that you paid, not just the actual price of the property itself.

Based on a property price of £200,000, let’s take a look at a calculation of rental yield:

Annual rent = £18,000 Annual costs = £10,000 Net annual income = £8,000

Total investment = £210,000

£8,000 / £210,000 = 0.039. 0.038 x 100% = Rental Yield of 3.8%

Top Landlord Tips for Calculating Rental Yield

1. Take Void Periods into Account

Although the calculation for working out your rental yield uses the annual rental figure, this assumes that your property is going to be occupied for all 12 months of the year. Depending on the type of lets you offer or the type of tenants that live in your property, you could well find yourself with at least one month of the year when you don’t have a tenant in there.

When calculating your rental yield, continue to use your annual rental figure, but “stress test” these figures by calculating what your yield would be if you had your property empty for one, two, or three months throughout the year.

Not only will this highlight whether your buy-to-let investment is sustainable allowing for void periods, it will also focus your mind towards cost control.

2. Look at Market Rents Before Buying

It is unbelievably common for landlords to buy a property in an area they don’t know too well, assuming that they will be able to charge a specific rent amount and have high demand to live in it. Many private landlords become unstuck or don’t make the money they want to early in their buy-to-let investment career for this reason. A property can seem like fantastic value based on price, but it will quickly become a problem if you can’t find anyone to live there.

As part of the process of buying, ensure you thoroughly research whether you’re getting a good deal in terms of the purchase as well as the rent levels you’re going to be able to collect.

3. Include ALL Costs from Your Deductions

There are landlords who think they achieve a fantastic rental yield, but actually because they haven’t included certain costs they make nowhere near what they believe they do.

By calculating your rental yield as accurately as possible, you will not only be able to understand exactly what you can make from your buy-to-let, it may help you avoid buying a completely unsuitable property.

Here’s a handy list you can refer to of running costs you ought to include:

• Tenant acquisition fees.

• Landlord insurance costs.

• Rent protection insurance costs.

• Redecorating and property maintenance costs during tenancies.

• On-going letting agent fees.

• Running costs during void periods, which will typically include at least council tax and utilities.

• Costs of any furniture and white goods you supply in the property (you may want to include these in your investment figure instead).

Also, here’s a list of what you ought to include in your property investment figure:

• The actual cost of the property.

• Any mortgage arrangement fees.

• Solicitor’s fees.

• Surveyor’s fees.

• Costs of any initial repairs made to the property prior to tenants moving in.

• Any additional legal fees you incur.

HMOs and Multi-Unit Properties

Recent research from Mortgages for Business found that Houses in Multiple Occupation (HMOs) - which is defined as any rental property shared by three or more tenants who are not members of the same family - brought in the highest rental yield in 2017 at 8.9 per cent. Next to HMOs were multi-units - such as blocks of flats - which produced yields of 8.1 per cent.

However, getting an HMO licence can be a long and arduous process, and for many, it’s not feasible to purchase a multi-unit property, even with a mortgage.

So if you’re looking for a property that falls outside of those parameters, what can you use to find your best possible rental yield? Well, research from from various sources has found that the number of bedrooms, and whether the property is a flat or a house, can impact rental yield:

Of all properties, two bedroom houses currently offer the best rental yield, and if you’re in the market for a flat, two bedrooms is also the way to go. However, for one-bed properties, flats outperform houses, though houses again offer better rental yield when you get to three or more bedrooms.

Of course, the location you buy your property in can impact rental yield, both in terms of where in the country you invest, and what local services are available in the specific area your property is in.

CAPITAL GAINS

For long-term investors, capital gains will be an important factor when deciding what type of property to purchase for buy-to-let.

Data from Zoopla shows which type of property - detached, semi-detached and terraced houses, or flats/apartments - have increased most in value over the past five and the past 20 years.

It’s important to look at capital gains over both the shorter and longer term, as fluctuations in the market can distort the data.

Either way, terraced houses appear to bring in the highest capital gains, whether you plan to sell up in half a decade or in two. Detached houses, on the other hand, could give you reasonable capital gains in the short to mid-term, but may fall behind other property types over longer periods of time.

While this data can’t tell us exactly what the market will do in the future, it’s a good indicator of how things could progress.

Avoid Estate Agent or Property Developer Sales Speak

If an estate agent or a property developer at a new build site meets you and hears that you’re looking at buy-to-let, they’ll be beside themselves trying to talk up the incredible rental yields that you’ll be able to achieve should you buy one of their properties.

By all means, take their brochures and any information they can provide, but be sure to do your own research and calculations, as most of the time these grand proclamations will be based on the property value and rent income alone, with none of the additional costs considered. They could be promising you rental yields of 10% while the truth is the real yield will be close to 3% or 4%.

Which Property is for Me?

Ultimately, it is up to you and what you want to achieve as a private landlord. The best approach is to look both at your rental yield and your potential capital gain. It is often the case that landlords find they can gain excellent rental yields from low cost properties, but are unlikely to see a significant capital gain in the long-term. Likewise, the opposite is also true, and areas with high capital gain potential are often those where rental yields may be lower.

Take the time to calculate both the potential capital gain and your potential rental yield from each property you consider investing in. This will leave you in a great position to invest and be a successful landlord.