Things to Consider Before Purchasing Your First Buy-to-let
A buy-to-let property is bought specifically to be rented out to tenants allowing property investors to benefit from the monthly rental income or the capital growth of the property (or, both).
Buy-to-let properties can be a very attractive investment, but, like all investments, there can be risks. Before purchasing your first BTL property, you need to do your due diligence. Here are three key things to consider.
Understand the local market
You need to fully understand the area in which you’re thinking of purchasing a BTL property.
This means establishing the average sold price and monthly rental income in the area as well as determining whether there is a demand for your type of accommodation. Even if you’re purchasing a BTL to rent, you may decide to sell the property.
Who is your ideal tenant and would they want to live in your property in that area? Are there local amenities that your tenant will benefit from? (E.g. transport links for commuting professionals or schools for children).
Are there local developments in the pipeline that could affect the demand of your property?
It’s always good to pick an area you’re familiar with as the more you know about the area, the better.
Establish the earning potential
Your BTL property will not be a good investment if the numbers don’t stack up. If your property is left empty or you’re not making a profit from the rental income, you could end up in an unhealthy financial situation. In order to work out your earning potential, consider the following:
Any costs involved with making the property habitable for tenants will affect your bottom line, and you’ll initially feel the pinch of these more if the property requires renovation work before tenants can move in and provide an income.
When it comes to determining the costs of work, it’s a good idea to take a quantity surveyor to a property viewing to get a rough estimate of how much the work will cost. If you then decide to purchase the property, you should get a contract drawn up between you and the builders to establish exactly what will be done and at what cost.
When budgeting for work, always include a buffer in the event of unforeseen issues. Maintenance can also be quite expensive so this should be considered when choosing the right type of property.
You’ll also need to consider the costs of insurance and the fees of a letting agent, however, you may be able to offset these when paying tax.
Capital growth or rental yield
As a buy-to-let investor, you will either be relying on capital growth (an increase in the properties’ value over time) or the rental yield (the income generated from the property expressed as a percentage of the property value).
You’ll need to work out which of these has a greater benefit to you based on the price of the property, the costs involved and the rental income.
A good benchmark for rental yield is around 5% per year, however, some properties can reap yields over 7%, with HMOs achieving between 12% and 15%.
The rent you receive from your property will be taxed at your relevant tax band, which could subsequently be pushed into the next tax band as your income increases.
However, you can deduct some costs from your tax bill such as letting agent fees, buildings and contents insurance, council tax and utility bills (if you pay them on behalf of the tenant) and essential maintenance.
Additionally, from April 2020, relief on mortgage interest will be capped at the basic rate of 20% for all landlords, regardless of whether you are a higher rate (40%) or additional rate (45%) taxpayer.
Capital gains tax
As a buy-to-let investor, capital gains tax will still apply to you. This is paid when you sell the property and is calculated based on the properties’ increase in value. Expect to pay 18% or 28% depending on your tax bracket.
However, for the 2019/2020 tax year, the first £12,000 profit is CGT-free and for couples with joint assets, this doubles to £24,000. You can also offset the cost of stamp duty, legal fees and estate agent fees against your CGT bill.
If your BTL property is a second property and purchased for more than £40,000, you’ll be liable to pay a 3% stamp duty surcharge.
The 3% stamp duty is also charged on the entire property price, not just the value over a certain tax band.
For instance, if you are buying a second property with a purchase price of £300,000, the extra 3% stamp duty would equate to £9,000. That’s on top of the basic rate of stamp duty you’ll need to pay at £5,000, making the total payable £14,000.
You will need to purchase the property with a BTL mortgage as you won’t be living in the property.
Lenders will typically require your anticipated rental income to meet at least 125% of the monthly interest payments on the loan. So, if the mortgage interest amounts to £1,000 a month, you’d need to demonstrate rental income of £1,250.
The interest charged will depend on the total amount borrowed, the expected rental income and the type of mortgage you take out. Most lenders will require a deposit of at least 25%.
This is where the right type of finance is crucial for the success of your investment. Don’t just go straight to your bank, instead speak to a specialist broker that deals with BTL mortgages and other types of property finance. They will be able to advise you on the best solution to get the best return.
Understand your legal requirements
As a landlord, you must be aware of your legal obligations.
At a basic level, you must be able to ensure the property meets health and safety standards and is fit for purpose for your tenants. This includes gas, fire, and water safety as well as making sure the property is maintained and in good condition.
Failing to meet legal requirements can result in unlimited penalties and even prosecution. This is where having a good letting agent will help as they can advise on everything you need to do.
Whether this is your first Buy-to-Let or you are a portfolio landlord, financing in your sole name or under a limited company, Ramsay & White can help. We have access to the number 1 Buy-to-let lenders in the market.