As investors we understand the concept of Risk and Return, the two are inextricably linked; the more Risk we are prepared to take, the greater will be our Return.
Investors’ by their very nature are the Risk Takers.
Lenders on the other hand are Risk Averse. This doesn’t mean to say they avoid Risk altogether; they prefer however, to minimise their Risk, and have strategies in place to make sure the Investor shoulders most of it.
A far cry you might say from the behaviour exhibited by Lenders’ in recent years, leaving them with bucket loads of worthless sub prime investments. Fear not! for Lenders have learnt from their mistakes , mistakes derived from the poorly understood relationship between Uncertainty and Risk.
So, what’s the difference?
Statisticians can calculate the probability of events occurring. They are able to do it because hundreds of thousands of observations have been made over time, recorded and extrapolated. The Stock Exchange is a great example of this happening on a minute by minute basis. Similar facts are collated by the Investment Property Databank (IPD), Meteorologists & Scientists to name but a few groups; and, where data is collated it brings with it predictive power.
We know for example that to toss a fair dice gives us a 1:6 chance of shaking a 6 and consequently we could decide what those odds are worth in terms of Risk and Return.
Uncertainty, on the other hand is represented by ‘the intangibles’; human reaction, freak weather or fraud for example. Unexpected occurrences, create unexpected reaction and, before long have affected the predictions so carefully planned for.
We have seen the effects of such events on many occasions, for example ‘The run on Northern Rock, The Dot Com Bubble & The bombing of the Twin Towers. Heisenberg describes this as ‘the uncertainty principle’.
Normally, we can insure against the Uncertainty of weather, flood, fire & theft however, when it comes to Economic disturbances like sudden fluctuation in Exchange Rates, Interest Rates, Inflation or the availability of Funding it is often too late to save investments from failing.
The press, our vehicle to those ‘in the know’, put out such an array of mixed messages that our logical understanding of the investment market becomes like the stylised illusions of Escher. What we are led to believe; that stairs go up and water flows down, become skewed by visual and audible signals. Even Politicians, Solicitors and Bankers betray our belief systems by becoming ensconced in scandal, deceit and unprofessional conduct.
For many Investors’ it’s too late to reflect, and promise to do better at assessing Risk next time, there simply won’t be a next time. However, for new investors’ let them learn from the lessons of inevitable Uncertainty. Imagine and prepare for the worse and be pleasantly surprised.
How, then does this philosophy relate to the Investment proposition? The answer; Investors’ educate themselves to be more Risk Averse, take on board Less debt, provide adequate reserves as a contingency and above all be honest. Anything’s possible you just have to want it enough.
So, how is buying a property to rent different from buying a home to live in? The property price is of course the same but the type of funding available to purchase a Buy to let is different. Why? Because it carries more risk for the lender.
As an independent Mortgage Broker I have access to 30 lenders who combined are presently offering hundreds of deals for Buy to Lets Fixed and Tracker rates from 3.19% over base. The Lenders require capital of between 25-50% of the property value. They will also want you to demonstrate that rents of 125% are achievable. Obviously the less risk the lender is exposed to the better rate you will be able to get.
You may have heard stories about investing in Buy to Lets with ‘No Money Down’; strictly speaking this practice is illegal and frowned upon by lenders and the FSA and is one of the reasons so many property owners are now in financial difficulty.
The moral of the tale is if you are going to borrow money to buy property do it sensibly, treat tenants fairly and keep your property in a good state of repair. If you have confidence in the market and your ability as a Buy to Let Landlord then in the long term you will be rewarded handsomely.
To summarise you will need:
At least a 25% deposit.
Rents in excess of 125% of Mortgage repayments.
To demonstrate that you are a Credible Landlord (this may be evidence that you have already succeeded in the industry or that you have a business plan which clearly sets out how you are going to manage the property) or that you will be using an ARLA (Association of Residential Letting Agents) accredited property agent.
Although lenders don’t usually require it, it’s always a good idea to protect any loans you take out in case of the unexpected happening. For example you may become ill or even die unexpectedly and be unable to manage your portfolio, leaving your nearest and dearest responsible for repayments and management. For the sake of an extra few pounds a month much of the risk can be insured against.
The other factor that affects investors is the ongoing and terminal Tax considerations of Buy to Let Investments.
In the short term all rents are treated as income and should be declared on a Inland Revenue Self Assessment tax form within the property pages. The good news is that expenses of the letting business can be offset against the rent, for example:
Repair and maintenance Costs
On disposal of the property any Capital Gain (the difference between the buying and selling price less certain costs) is subject to Capital Gain Tax. There is now a single tax rate of 18% of the Gain. However in each tax year (April –April) individuals are entitled to make a Capital Gain of £10100 (2009/2010) before any gains are subject to Tax, it follows that if an investment is in joint names the entitlement increases to £20200 as two personal allowances are due. There are also special rules in place where you have personally lived in a property before disposal. For more information on Tax issues the Inland Revenue’s website http://www.hmrc.gov.uk is a great source to delve into.
Now you have read my Buy to Let Blogs do the Buy to Let Quiz.