Sabsaint andrews bureau the cambridge property specialists Management Sales Investment in residential properties for letting in and around Cambridge
Contents: 1: Introduction 2: Selection process - Position - Size - Type - Presentation 3: The rate of return 4: Finance 5: Tax considerations 6: Conclusions This booklet has been produced for guidance only for individuals who are considering the possibility of purchasing a residential property for letting. The responsibility for the financial decision to buy a property can only rest with the investor and it should be noted that, as with any investment, returns and capital values could go down as well as up. It is therefore emphasised that PROFESSIONAL ADVICE SHOULD BE SOUGHT before entering into any commitments. The booklet is produced by Saint Andrews Bureau Ltd specifically for the Cambridge market. Although a lot of the points made apply to other areas, care is needed when considering the financial returns stated.
1: Introduction In the past, property investment has proved that it can be a worthwhile investment but, like with all investments, great care is needed before the final decision is made. So it remains true for residential properties bought for the purpose of letting. If an individual is interested in investing in residential properties for letting, it is imperative that an understanding of the market is gained and professional advice is sought at all stages of the process. It is also important that a longer-term view be taken of the market with a commitment of at least 5 years. With understanding and care, a sound investment is capable of being made which should produce a reasonable level of income and capital growth. The market in residential properties to let in the UK is enormous. This is despite the fact that the majority of people opt for home ownership as opposed to renting. It is estimated that more than 150 billion is invested in residential properties for letting and that this market, which has grown since the change in the law in 1988, now accounts for more than 16% of the housing stock. With changes brought about by social and economic factors, more and more people turn to the rental market at some point in their lives. This may be due to temporary relocation for employment or studying, or a lack of desire or ability to make a commitment to an owned residence, or a stage between selling one house and buying the next. Whatever the reason, at this moment in time the overall demand for good quality rented accommodation is greater than the supply. As with all statistics, they can be presented in a light which flatters the reality of the situation. Residential investment in properties for letting is no different. Parties interested in this sector should therefore proceed with caution. This booklet is therefore produced as a guide to those areas which should be considered at each stage before taking a final decision on investment. 3
2: The selection process Think position It has been said that there are three important factors to consider when purchasing a property position, position and position. The rule applies equally to the purchase of residential properties for letting, as position will affect the letting potential and the potential for capital growth. Letting potential In Cambridgeshire, due to the economic and educational position of the city, the overall market is good. However, it can be split into three segments: (a) The inner circle: within walking distance of the city, the letting market is very good. (b) The middle circle: within six miles of the centre, the market is good; and (c) The outer circle: outside the six-mile radius of the city, where the market is reasonable but need not be as consistent as the other areas. As such, void periods can be longer and price becomes a much more sensitive issue. The capital value of the properties within each sector is in most cases also reflective of the position: the closer to the city, the higher the value. Capital growth The potential capital growth, which can be achieved on a residential property could be affected by the rent achievable in the letting market, but of much greater significance will be the home ownership market, which is almost eight times as large. If a property is in an area that is desirable for home ownership demand in this market will push up the value of the property regardless of the potential for letting. The rent, which can be achieved from such a property in percentage terms i.e. the gross running yield may not be as great as for other locations. When looking at properties for rent, the link between home ownership, letting potential and potential capital growth must therefore not be over looked. Think: size of property The next decision to take is on the size of property required. This will, to a degree, be dictated by the amount that you wish to invest. However, in looking at size, consideration has also to be given to whether you wish to look at the student market or the professional market. The student market As a university city this market in Cambridge, usually within the walking distance category (or very close) to the city, is very large and is mainly catered for by university-owned buildings and by specially built private blocks or converted houses. However, it is often the case that: (a) Void periods (or 50% of market rents) arise during the vacation period of July and August; (b) Multiple occupancy is nearly always the case, with four, five, six or more sharing a house. This can be as one household (i.e. under one tenancy agreement) for up to three or four individuals or multiple occupation with more than one tenancy agreement. A houses defined as multiple occupancy brings with it significantly more regulations in terms of equipping the house and safety requirements; and (c) Greater management time may be needed and dilapidations may be greater than for the professional market. Allowing for the extra work that may be involved with the student market, the potential return can still be good per household. Often this equates to an average of 60 to 65 per room on an inclusive basis (of services) for a house, which is properly presented. However, demand has to be satisfied prior to the start of any academic year otherwise there is a great risk of having the house empty for a considerable period of time. The professional market The professional market is also large in Cambridgeshire. Professionals are individuals who are working and can be families, individuals or professional sharers. Because of the combinations possible, the sequence for demand by size of property is normally in the following order: One bedroom first, then; Two bedrooms Studios Three bedrooms Four or more bedrooms Generally, the demand for one and two bedroom properties within the city limits (or slightly beyond) is very good. If the property is in a good position and is well presented, letting can usually be achieved on a consistent basis throughout the year. Demand for three bedroom properties are slightly less, and they sometimes remain un-let for limited periods. For larger and village properties, care is especially needed. A house for four or more, which is close to the city and which can be used for sharers and/or students, will usually let but sometimes the market dries up depending on the time of year or other circumstances. A house for four or more outside the city limits, particularly if it is restricted to families only, will have a more restricted market. Similarly, demand for smaller houses in the villages can vary from month to month, leaving the possibility of longer void periods between lets. 4
Think: Type of property The choices available for properties to rent can be broken down between: (a) New or old newer properties may have lower maintenance costs than old properties, but older properties may have greater charm, particularly if they are Victorian or have quaintness about them, and may have larger dimensions in terms of rooms sizes and gardens. (b) House or flat houses usually come with some form of garden; flats may have communal gardens. Flats will be leasehold and the cost of ground rents and/or service charges have to be built into the equation. From a demand point of view, the choice is evenly balanced. The decision really comes down to a personal choice. However, obviously with leasehold properties, the fact that the lease will have an expiration date has to be amortised over the period of the lease. For this reason it is important to establish the ownership of the freehold and its effect on the leaseholders, in terms of both control and management. Think: Presentation Furnished or unfurnished A decision will have to be made as to whether the property is to be furnished or unfurnished. Unfurnished will normally require carpets, curtains and kitchen appliances (cooker, refrigerator and washing machine or at least plumbing for a washing machine). In terms of rental, the difference between furnished and unfurnished is minimal. Obviously, if the property is to be furnished then all items of furniture or furnishings must comply with the safety regulations under the Fire and Furnishings (Fire) (Safety) Regulations 1988. Generally, the demand for one and two bedroom properties within six miles of the city is 60%/40% in favour of furnished accommodation. For three bedroom properties, particularly away from the city, the demand is 50%/50%, and for larger properties (unless they are for professional or student sharers in the city) the demand is 70%/30% in favour of unfurnished. If a property is to be furnished, ensure that the contents are in a good condition, of modern design in neutral colours and adequate for the purpose of living in the property from the day of entry. Decorative order When tenants are selecting a property, they may view five or six properties, take around 15 minutes of viewing at each site and then make a final decision. As an owner, you should be trying to capture prospective tenants attention by presenting the property in the best possible condition. A well-presented property in terms of decor will attract potential tenants, particularly if the rent being asked is above the average for the area. A dirty property, or one which is in a shabby state, or one with an unfriendly feel, will be passed over if the tenant has the option. From experience, it is also found that if a property is in good order, the tenants will tend to look after the property to a greater degree. Fixtures and fittings In today s market, the two parts of the property that attract particular attention are the kitchen and the bathroom. The kitchen should ideally be modern, with a cooker, washing machine and refrigerator. The bathroom should have an effective shower. 5
3: The rate of return Armed with your views as to the overall picture of the property you wish to purchase, and supported by the views of potential for letting from a reputable residential letting agent, carry out a selection process by looking at the Rightmove website and the Cambridge News property paper and scouring estate agents advertisements. Or visit their offices and place yourself on their registers of potential investors. Professional property management companies, such as Saint Andrews Bureau Limited, can carry out the search for a potential investor. However, if you have the time, there is no better substitute than drawing up a shortlist of potential properties yourself. Such a shortlist can then be discussed with, and visited by, Saint Andrews Bureau Limited with a view to crystallising your thoughts and assessing the potential return on the property. The actual rate of return depends upon a number of factors, but the following is given as an example of what should be taken into consideration. It should be used as a To arrive at the rate of return, the following factors need to be taken into account: (a) The cost of the property, including professional fees, stamp duty and other costs of purchase. (b) The gross rent which can be achieved from the property, allowing for possible void periods. Always take a conservative view of the rent potential and build in at least two weeks void period. (c) The running costs of maintaining and managing the property during the let period. (d) The extent to which the property is financed from your own resources or from borrowings from a bank or building society. To highlight each of these factors the following income and expenditure statement is shown for a property purchased on the assumptions stated: Assumptions: (1) Purchase of a one bedroom property for 210,000 inclusive of costs, with a gross letting potential of 900 per month, giving a gross yield of 5%. (2) 75% of the purchase consideration, i.e. 157,500 is funded by way of a loan, with interest at 3.0% p.a. Financial position in year one Gross rent 10,800 Assumes 12 months full let Less: Allowance for void periods (415) Assumed at two weeks per annum Rent 10,385 Expenditure Management fee (1,555) All costs with VAT Building insurance (189) Based on 105,000@ 1.80 per thou. Contents insuranc (44) Based on 8,000 @ 5.50 per thou. Safety checks (258) Gas obligatory annually and electric recommended Repairs (1,080) Provision @ 10% of rent Net income before interest 7,259 Interest 4,725 3.0% on 157,500 Net profit after interest 2,534 Year 1 on investment = 4.8% Please note: (a) For leasehold properties, allowance has to be made for ground rents and service charges. This may be 500 p.a. or more but will normally include building insurance, garden services and common area cleaning. (b) The repairs stated are given as an estimate. In reality they may be greater or smaller. (c) For void periods, the owner will be responsible for Council Tax (albeit possibly at a reduced rate) and other utility costs. (d) Allowance from a cash flow point of view must also be made for capital repayments on the loan. This depends on the specific arrangements made with the lender. Loans can be obtained for capital and interest or interest only. (e) Tax may be due on the net income after interest, depending on an individual s own position. Depending upon the situation, it is possible that the rent income may not totally cover the running costs in the first few years, but capital growth over the medium to longer term would be the upside potential. Further information on the impact of an investment over five and ten years, taking into account inflation and estimated capital growth, can be provided on request. 6
4: Finance With the development of the residential letting market, upon the initiative of the Association of Residential Letting Agents (ARLA), a number of lending institutions are now offering loans on Buy to Let schemes for residential properties. These schemes vary with each lender but in general are made on the following bases on properties to be let on Assured Shorthold Tenancy agreements: 1. Loans are generally made available up to around 75% of the valuation of the property offered as security. 2. Interest can be around 3% above Bank Base Rate or at fixed rates depending on market conditions. 3. Repayment of capital over 5 to 25 years or more, with options on interest-only loans. 4. Confirmation may be needed of ability to service the loan from other income, although some will look at rental flow only. Generally, a ratio will be looked for of a minimum gross rent of between 130% and 150% of the monthly mortgage payment. 5. Restrictions may also be imposed by not lending on flats, converted houses, and multiple tenancies or on properties to be let to DSS tenants or diplomats. It is therefore important to specify the type of property at an early stage of arranging any loan. A list of the current lenders involved in the Buy to Let scheme is set out in Appendix B, together with contact numbers. Saint Andrews Bureau Limited can discuss your requirements with these lenders, or individuals can contact the lender direct to discuss their requirements. Usually, once a loan is put forward in principle, the lender will require confirmation from a residential letting agent of the expected rent and the anticipated length of time it would take to let. In discussing requirements with lenders, interested parties should determine the extent of the fees proposed by the lenders before any commitment is entered into. A list of lenders fees is always available. 5: Tax considerations For an individual, the net income from letting residential properties is taxed under Schedule A of the Taxes Act at an individual s marginal rate. In principle, all expenses attributable to a rented property (including any VAT on the costs) and 100% of any interest borne on finance used to purchase the property is allowed against gross rental income. In addition, for furnished accommodation, the landlord has the option of claiming 10% of the rent as a provision for wear and tear. The overall net position is then taxed in the hands of the individual and must form part of the disclosure in the annual tax return. Personal allowances unused against other income can be allocated against Schedule A income. For overseas landlords, net rental income will be assessed to UK income tax. Unless approval is obtained from the Inland Revenue (by submitting Form NRL 1), managing agents will be required to deduct tax at source at the standard rate before remitting to the overseas landlord. With consent, this tax will not be deducted, but overseas landlords will still be required to account for the income and pay the relevant tax on an annual basis. Independent professional advice should be sought if you are in doubt about the tax implications on rental income. 6: Conclusions Investment in residential properties for letting should not be for the short term and, as a minimum, you should be prepared to lock away your capital for at least five years. In purchasing a property, consideration can be given to using bank finance thus improving the potential from capital growth as the loan remains fixed in value terms over its life. However, you should borrow only what you are comfortable with and be guided by the extent of cover available for capital and interest from the net rental income. Seek professional advice before making any financial commitments, and do not be rushed into buying any particular property until you have checked all aspects of letting and the returns which you expect to achieve. With care, you should then be able to gain from an involvement in the residential property purchased specifically for the letting market. 7
saint andrews Sab bureau the cambridge property specialists 18 Mill Road, Cambridge CB1 2AD Tel: 01223 352170 Fax: 01223 301172 Email: cambridge@sab.co.uk 18 Castle Street, Hertford SG14 1HH Tel: 01992 501752 Fax: 01992 504974 Email: hertford@sab.co.uk The Market Place, Market Hill, Royston, Herts SG8 9JS Tel: 01763 242222 Fax: 01763 241010 Email: roystonsales@sab.co.uk 37a High Street, Longstanton CB24 3BP Tel: 01954 781963 Fax: 01954 789050 Email: longstantonsales@sab.co.uk www.sab.co.uk
Sabsaint andrews bureau the cambridge property specialists Management Sales Investment in residential properties for letting in and around Cambridge