Investing in Residential Property
October 14, 2011
Investing in the Private Rented Sector (PRS) remains popular with private investors from all walks of life because it is the one asset class that enables the ‘man on the street’ to leverage their investment using bank financing. You only have to look at the numbers of investors seeking to acquire additional PRS assets.
And despite what some may think, lenders are still willing to lend, principally because residential property is seen as a safe asset class. Total returns from residential property have a history of strong performance and have out-performed other commonly held asset classes. It should also be remembered that in the event that an investor defaults, the lender has first charge over the asset, so lending on residential property is generally considered to by relatively low-risk.
Of course, lending has reduced over the past 3 years as the banks have been forced to strengthen their balance sheets. They’re in the position to be able to pick and choose who they lend to and, perhaps understandably, have become more cautious and stricter with their lending criteria. In this new lending landscape, lenders are cherry picking only to the ‘best’ applicants. So step one, before seriously considering making an investment in property, is to check your credit score and make reparations if there are any issues.
First time landlords
You may or may not have held a mortgage before, but the process for a buy-to-let mortgage is slightly different to a residential mortgage in terms of lenders’ criteria and also the range of available products.
Long gone are the days of 100%+ mortgages. Your deposit will need to be a minimum of 20%-25% for a buy to let mortgage, and products’ interest rates get noticeably better if you can place a 40% deposit or more.
Lenders’ fees are also generally higher than the residential market; many are set as percentages of the loan amount, although in most cases this can be added to the loan itself.
Choosing a product
Because the number of products reduced so greatly through the economic downturn and many lenders left the market, competition has been lacking and lenders have not been so quick to reduce their product rates, unlike the residential market where you can currently pick up fixed rates for under 3%. Recently however, we have seen a handful of buy-to-let lenders returning to the market and more are expected to return over the next 12 months, bringing landlords a wider choice of mortgage products.
You need to consider which type of mortgage product you want to opt for. A fixed rate product allows you to budget because your monthly repayments will be fixed at a set rate for a number of nominated years.
Or you can opt for a tracker, which tracks the Bank of England base rate, or lender’s Standard Variable Rate (SVR) by a specified margin. The payments can go up and down but they normally start with lower pay rates, over fixed products initially, but are subject to fluctuations. Recent market sentiment suggests that rates will stay low for the next 12 months or so, even in the face of additional Quantitative Easing measures, so if you believe that the base rate will not change dramatically, a tracker is the way to go.
Each lender will have their own calculations for how much they will lend, relative to the expected rental income.
A typical example might be: the rent will need to be 125% of the monthly mortgage payment based on a pay rate of 5%.
They will often want an investor to be able to demonstrate a minimum income too, typically of £25,000 to £30,000 from employed/self- employed earnings and formal evidence of the income will need to be provided.
But it’s always important to do your own calculations and ensure that the figures make good business sense. Remember that stamp duty is likely to be involved at the outset and that the monthly mortgage repayment will not be your only outgoing; service charge, ground rent and a contingency for maintenance should all be factored in when weighing up the numbers.
First time Buyers (FTB)
If you are a first time buyer with no current mortgage, some lenders will want to see that your income could cover the mortgage as well as your current rent.
This is because there is a concern among lenders that some first time buyers and self employed people (who previously would have used the self certification route) are attempting to use buy to let mortgages, rather than residential mortgages, to get a foot onto the property ladder.
The lenders will expect the property to be instantly lettable (rather than a renovation project) and the surveyor would be expected to comment on this along with the value and rent achievable figures. This means the property needs a fully functioning kitchen and bathroom and be in good decorative order.
There should be nothing on the report that could lead a lender to question whether someone would want to rent it.
Like every investment acquisition, do rigorous research. Chose your proposed investment property with care and fully investigate the costs and finance options available to you. Ensure that the numbers make sense and you’ll be in a position to buy with confidence.