Running a rental property business is one of the best ways to make money in the UK, however times have changed and you have to get it right if you want to make any money these days. This is the most comprehensive guide to starting a rental property business that you will find anywhere.
Three facts of life – Everyone needs food, clothes and somewhere to live.
Let’s take the last statement “Everyone needs somewhere to live” Not everyone can purchase their own property. There may be underlying issues, such as not being able to raise a deposit or being credit worthy to raise a mortgage, or maybe too old to raise a mortgage. These are just a few reasons.
Some people simply do not want to own their own property and would much prefer to stay in rented accommodation as they do not want the aggravation of keeping a property maintained.
Maybe it does not suit their plans at present, they may be trying to save for that essential deposit. Whatever the reasons there will always be a rental market and a place for the private landlord.
So where do you begin if you want to become one of the many private landlords that have sprung up in the UK? Do you have available cash to purchase outright, or do you have a small deposit and require additional funding with a mortgage?
Buy to Let Mortgages
So, you haven’t got enough cash to purchase outright, but you have some cash available for a deposit. How do you calculate how much you can borrow with the deposit that you have available? This all depends on the selected lender.
Ok, this is the boring bit, but hang in there as this is fundamental in understanding how much you can borrow.
For calculation purposes let’s assume that you are required (by a specific lender) to deposit 20% of the purchase price. Also let’s assume that the purchase price is £100,000, therefore you require a mortgage of £80,000.
All lenders have slightly different stress tests to determine how much you can borrow but the principle is roughly the same, the amount you can borrow is usually determined by the amount of rental income that you expect to receive. The formula for calculating how much you can borrow is:-
The amount you wish to borrow, multiplied by 125% (or 140% – if you are a 40% Tax Payer) multiplied by a notional interest rate, for example 5.5%.
The amount of rental income will be confirmed by a Surveyor instructed by the lender. The reason why the figure of 125% (or 140% – if you are a 40% Tax Payer) in the equation is used is in case the property is unlet for a period of time, or lying fallow to use and old farming expression.
The notional interest rate is an interest rate, determined by lenders, purely for the stress test for this calculation. It is not the actual interest rate of the mortgage product which you select for the mortgage.
The rate is usually between 5% or 6% but this can change in the future. So let’s go back to our £100,000 purchase with a mortgage requirement of £80,000 and a Notional Interest Rate of 5.5%.
£80,000 x 125% x 5.5% = £5,500. Now divide the £5,500 by 12, to provide a monthly rental income required, = £458.34p. This figure is the minimum amount of monthly rental income, required by the lender, to qualify you to borrow £80,000.
A local estate agent or letting agent can provide you with details of rental yields within the area you wish to purchase. If the rental income that you expect is £500 per month then you are well inside of the stress test and it’s ok to move forwards. But if the rental income you expect to receive is only £400 then you would be expected to deposit a higher amount to help bring the calculated required income down.
So much would you be required to deposit if the rental income was lower than £458.34p? Let’s work it backwards for our £400 per month rent. Annualised this £4,800. £4,800 divide by 5.5% = £87,272.72p, divide this figure by 125% = £69,818.18p.
Therefore your rental income of £400 requires you to deposit £69,818.18p (As a check, take £69,818.18p x 125% = £87,272.72 x 5.5% = £4,800 divide by 12 = £400 per month Rental Income)
This calculation has been completed for the purpose of lending criteria and is calculated by using an INTEREST ONLY mortgage not a CAPITAL and INTEREST (REPAYMENT) mortgage.
Now go and have a little lie down!
As with any business venture where you are likely to make money there are bound to be costs involved. Firstly, if a mortgage is required, there is the cost of a “Standard Valuation for Mortgage Purposes”.
This is a requirement by the lender to make sure that the rental property is suitable to lend against. It has to be habitable and have a working Bathroom and Kitchen.
A lender is not going to lend money against a property against an old barn that used to house chickens or pigs. (A bridging loan may be required here to bring the property up to standard for a Mortgage Lender to consider lending) .
This type of Valuation is purely for the benefit of the lender, but you pay for the cost. At present there are many lenders who are offering free “Standard Valuations”, but not all of them.
It’s always good to obtain the services of an Independent Mortgage Broker to source your mortgage. On a property for say £250,000, lenders can charge anything up to £500.
If you require general information on the condition of the property then a “Home Buyers Report” should be conducted by a Surveyor, usually the selected Lender can arrange this but you can arrange an Independent Home Buyers Report.
This will be at an additional cost to a Standard Valuation. This will give you a general, overall description of the property and point out any superficial failings of the property.
Home Buyers Reports can be arranged by you with an independent Surveyor or you can arrange this with the Surveyor instructed by the lender. Again, with our £250,000 property a Home Buyers Report could cost on average about £600.
Now we have the Grandfather of valuations, the “Full Structural Survey” this report is the most costly by far. This report will be the most thorough and should provide you with the real detail of any failings in the property, or any potential problems arising in the future.
The Surveyor will get his rubber gloves on for this type of Survey. Cost for £250,000 property could cost up to £2,000. Just like a Home Buyers Report a Full Structural Survey can be arranged by you with an independent Surveyor, or you can arrange this with the Surveyor instructed by the lender.
The cost for these types of reports are determined by the value of the rental property. A valuation on a one bedroom flat in Doomsbridge will cost a lot less than the valuation on six bedroom Victorian house at the seaside. Always obtain three quotes for anything other than a Standard Valuation.
Stamp Duty, or to give it its proper name – Stamp Duty Land Tax (SDLT). How much you pay is determined by the purchase price and type of the property. We will stick with our residential property.
The rate of SDLT for purchasing a second home, for any purpose, not just for renting, as of April 1st 2016 is follows.
Up to £125,000 – SDLT = 3%
£125001 – £250,000 = 5%
£251,000 – £925,000 = 8%
£925,001- £1,500,000 = 13%
Anything over £1,500,000 is a whopping 15%
Therefore our £250,000 second property will cost you £10,000 in Stamp Duty. Ouch!
(Technical bit – The calculation above for our £250,000 appears that it may cost £12,500 in SDLT, however, the rate up to £125,000 is only 3% and then from £125,001 to £250,000 the effective rate is 5% which makes the overall payment 4%, got it? no, then use the SDLT calculator.
Other than our initial three facts of life at the start of this BLOG, there is a fourth fact of life. If you earn a pound then potentially the government will want you to hand over some of it, yep you guessed it, Tax.
Because of recent changes in tax relief on interest payments, the Chancellor of the Exchequer at the time determined that the maximum amount of Tax Relief will be the basic rate of tax, currently 20%.
Because everyone’s Tax position is very different then it is strongly recommended that you speak to a qualified Tax Specialist to ascertain your proposed tax position.
Be assured, any income generated from your rental property, even to a family member, is liable for tax, don’t ignore it, get your situation regarding tax organised from the very start.
A consideration for purchasing a portfolio of properties is whether to do this on a personal level or to form a Limited Company. The tax advantages could be more beneficial by setting up a Limited Company. Again, expert advice is required from a Tax Specialist.
There are many items you can and can’t claim for tax relief when running a rental property business. A good place to look is the Government website.
Types of rental property
Whichever option, there are some considerations on what type of property to purchase. So, which do you think would be best, a flat or house. There is no real or proper answer.
Both have their advantages and disadvantages. In general flats can cost less to purchase. This depends on the area where you intend to purchase.
Generally, houses tend to be more favourable than flats for several reasons. Most houses are Freehold (Although it is not impossible to come across a leasehold house) for this reason there is no Management Fees or Ground Rent to pay on a Freehold property.
Management Fees will include the Buildings Insurance for the entire block of flats under the Leasehold arrangement.
Stay away from Freehold Flats, like Leasehold Houses, it is not impossible to come across a Freehold Flat. This type of property is almost impossible to raise a mortgage on.
If you were to buy a Flat cash and wanted to sell, then any purchaser requiring a mortgage would find it extremely difficult to acquire funding for this type of property. Stay clear!
Houses are good. Two or three Bedrooms are ok. If you are buying a two bedroom property, make sure that the two bedrooms are roughly the same size. This increases your chances to rent.
You may have a couple who are not in a relationship that want to rent, in which case one of them will have the master or main (Biggest) bedroom and the other will have no other choice but to take the box room. With bedrooms roughly the same size then you shouldn’t have this problem.
Flats can be good acquisitions because they generally cost less to purchase, which can make it easier to get one foot on the housing ladder. This should help in building your property empire because the outlay is often lower.
If you do purchase a Flat then make sure that the Lease is more than 80 years old. Future borrowers trying to raise a mortgage will have difficulty to do this if the lease is below 80 years, this is because there has to be a sell on advantage of a long Lease if the property is sold in the future.
And do you really want a flat on the tenth Floor of Peckham Peaks? If you do, then the majority of lenders don’t.
The garden. Unless you have a member of the Alan Titmarsh Fan club renting your property, that intends to rent your property for the next 20 years, then beware of purchasing a house with a large garden. Unless you intend to develop the garden or add an extension.
Renters don’t usually tend to the garden too much. So that leaves you responsible for making the property and garden respectable for the viewings. Give this some serious thought if it is a big garden.
So, a house it is then, but make sure that it is near a school if you are looking to rent to a family. Make sure there are shops nearby.
The cottage in the Forest that was once owned by Little Red Riding Hood’s Granny may look appealing but, really!! You don’t want to be hiring the services of the Big Bad Old Wolf to be picking you up a pint of milk on the way home now do you?
So, to conclude. Do your research. Speak with Local Estate Agents with rental departments. Employ the services of a qualified Mortgage Adviser and Tax Specialist.
If you enjoyed this article on starting a rental property business. Read another of our articles in the property series here.
High & Wise
Note: all figures accurate at time of writing