If interest rates rise and investors en-masse are forced to sell their properties, prices could fall dramatically and potentially lead to a similar situation to the 2007-2008 credit crunch, when many mortgages were forced into negative equity.
Unfortunately, we can’t predict the future, but what is certain is that while demand grows for affordable housing across the UK, buy-to-let will continue booming.
Although it is likely that interest rates will rise in the next 12 months, investors can protect themselves from financial difficulty, if they make sound and well calculated investments in buy-to-let.
The problem is that many investors purchase buy-to-let property without carrying out thorough research on the local market and considering all the financials. If investors fail to make a considered purchase, they are at a much higher risk of losing their property when financial pressures hit them.
So what are the common mistakes that investors make when they invest in buy-to-let?
Location, location, location
It’s a big mistake to buy a property in an area you know little about. Investors need to research the local area and understand market conditions. Rent yields vary from town to town and it’s important to buy in area with strong rental demand.
Think about the potential of the town for buy-to-let. For example, is the town in a commuter belt and are there good transport links? Are there good schools for young families? Where do the students want to live?
In most cases investors tend to invest in property close to where they live. This is a great advantage as they are likely to know this market better than anywhere else and can spot the kind of property and location that will do well. They also have a much better chance of keeping tabs on the property.
Many investors do not factor in the costs of owning a buy-to-let property with contingency funds. If you do not have a contingency fund in place to cover unforeseen circumstances, then they could fall into financial difficulty and potential lose their property.
As a general guideline, 30-35% of one year’s gross annual rental income should be put aside to cover rent arrears, void periods, maintenance, repairs and refurbishment, white and brown goods replacement and the ongoing rental costs, such as gas safety certificates and letting agent fees. This contingency may not be used and should not be seen as an additional annual cost, just part of the investment business plan from the outset for investment protection.
It’s vital to do the maths before investing, or you could be seriously out of pocket. You need to buy an asset, not a liability; and it needs to put money in your pocket every month. Before you think about looking around properties, sit down with a pen and paper and write down the cost of houses you are looking at and the rent you are likely to get.
Buy-to-let lenders typically want rent to cover 125% of the mortgage repayments and many are now demanding 25% deposits, or even larger, for rates considerably above residential mortgage deals. The best rate buy-to-let mortgages also come with large arrangement fees. Ensure you know how much the mortgage repayments will be and, if it is a tracker, allow for the rates to fluctuate in your calculations.
Once you have the mortgage rate and potential rent sorted, then you must do the numbers carefully and work out how your investment will perform. Ensure you factor in maintenance costs and work out how you will cope if you have void periods between occupancy. These are all things to consider. Make sure you know how much the mortgage repayments will be and, if it is a tracker, allow for rates to rise.
Don’t be emotional
It can be easy to follow your emotions when purchasing a property. The golden rule is don’t buy a house because you love it and would like to live there yourself. You need to love the deal and not the property. Any property you invest in must deliver on the financials.
Have a great team to rely on
Property is a team sport. Investors need the support of a good mortgage broker, lawyer, accountant and builder.
Find unbiased professionals and source recommendations from other investors. Don’t rely on portfolio building companies for unbiased advice. Often, they are trying to sell you something. Leverage your time and don’t try to do everything yourself.
This article was written by Peter Armistead, director of Armistead Property.