Single Let Rental Property
Single Let is still the most popular investment type, but it is becoming increasingly difficult to achieve surplus cash-flows on a single let property with the typical 70% loan-to-value mortgage favoured by most investors. This is due to increased costs over recent years, combined with higher house prices and a raft of recent government legislation. In other words: monthly profits are very low after all costs and taxes are paid.
This is especially the case in the South of England. Due to the above factors, it has now become evident that many landlords are increasingly relying on capital appreciation to make sufficient financial returns over the longer term.
The main challenge with single lets is poor cash-flows after all expenses, and it tends to push landlords to rely on an interest-only mortgage. This strategy works well within an environment of strong capital appreciation, but future growth in house prices is not guaranteed in an ever-changing legislative and economic climate.
In order to find a capital appreciation strategy, it may be worth looking at locations with low house-price-to-earnings ratios. Often located outside London and the South, these areas tend to offer the highest potential.
A small house, typically a terraced house, tends to offer a higher yield for single lets. These properties do not incur regular monthly management charges or annual ground rent charges like apartments and, in comparison to leasehold apartments, they are more likely to appreciate in value due to constrained supply.
Small houses in Northern cities give the best rental returns and have lower maintenance and management costs against flats or larger sized houses. Single let properties will not offer the return of an HMO, but they are a lot easier to manage.
When searching for capital appreciation, look for house-price-to-earnings ratios that provide a consistent benchmark against which to assess the relative level and trend in home ownership affordability.
Benchmarking house-price-to-earnings ratios gives a better idea of relative affordability based on the local economics and dynamics of a given area, instead of simply making direct price comparisons between cheaper or expensive areas, which are not always directly comparable.
In London, the average person needs over 13 times their annual salary to buy an average property, but outside London, in the South West and in some parts of the North West, this figure drops to four to six times the average salary to purchase a house. Many cities in the North of England and Scotland are so much more affordable and have significantly more scope for future house price growth, with the house-price-to-earnings ratio in these cities more likely to rise slowly in the coming years.
London has an average house price of £483,000 and buyers need 13.1 times the average London salary of £37,000 to buy a property.
In the North, in Liverpool, Manchester, Nottingham and Sheffield, this figure drops to below six times the average annual salary — lower than the national average of around eight times.
These cities are often vibrant and growing and more likely to see further growth in the absence of any external shocks to demand and confidence.
Opportunity: Although capital appreciation is not guaranteed and we cannot accurately forecast growth, there is more likelihood of capital appreciation in many cities in the North. These cities still have low house-price-to-earnings ratios, even in comparison to the national average of around eight times salary. Affordability remains attractive as long as mortgage rates remain low and we retain positive consumer confidence and market sentiment.
Threats: Ever-increasing government legislation is driving up costs.
Top Tip: Try to buy a property in need of refurbishment to create equity. You will also benefit from having a high-quality modernised property, which will attract better-quality tenants and reduce voids.
Commercial & Retail Property
Commercial property has many benefits as it tends to get more secure, long-term income, but this comes at a price.
Popular commercial property investments are often small shops with poor-quality, short-term leases, many of which have numerous exit clauses. This option is cheaper to buy for investors, often giving a good return and typically selling for between 7% and 12% yield, depending on the area.
A commercial property with a long-term tenant is ideal, but these offer yields as low as 3-5%, and may not give a strong enough return.
The less risky option is a mixed-use property, which is a building with a residence upstairs and a commercial business on the ground. If the ground floor becomes void, the owner still has a constant stream of income.
For cash-rich buyers who are more concerned about regular cash-flows and less concerned with a lower yield, then a commercial property with a longer-term blue-chip tenant is ideal.
Threats: With an oversupply of offices in some areas and the crisis in retail property, it can be a challenge to accurately value any retail assets.
Opportunity: To secure a regular income stream with less ‘hassle factor’ and daily management than a typical buy-to-let.
Top Tip: Remember that vacant commercial property is worth significantly less. With an oversupply of offices in some locations, along with changes in the retail industry, it may be less risky to buy a mixed-use commercial property. Be careful of the possibility that some large, trusted, well-known agents may still be valuing retail property too optimistically.
Houses in Multiple Occupation have become very popular over the years and there is an increasing oversupply in some parts of the UK. Getting a high-quality property with an en-suite and larger room size in the right location is increasingly important.
You can target the single professional market or get a single group of students together. Many Northern towns like Liverpool and Manchester have large student populations, and a common practice by most landlords and agents is to ask students to get their parents to sign a financial rental guarantee, so the rental income is very secure and underwritten by parents.
Unfortunately, the HMO market is also currently under threat from the valuation office and council tax banding, with some councils insisting on charging council tax per en-suite room. This policy is a big threat to the HMO market and could be a potential game-changer should it be rolled out across the country.
Threat: The HMO market is currently under threat from oversupply in some areas, as well as potential changes in the valuation office and council tax banding system. However, this may or may not be rolled out by all councils.
Opportunity: Higher profits and the only sector where you can afford to pay a repayment mortgage, yet still have excess cash-flow after all costs.
Top Tip: Despite the increasing oversupply, good-quality en-suite rooms in the right location, with an average room size of at least 11 square metres and above, will always rent well. Use the ‘Room Only’ tenancy agreement from the NRLA for better legal protection.
‘Rent to Rent’ and Short-Term Lets = Airbnb and Booking.com
Although it may actually be against mortgage and lease terms for a leasehold or freehold property to be rented out on a short-term basis, this is a new and fast-growing market. It is becoming increasingly popular and is dominated by the two major website portals, Airbnb and Booking.com, which are in competition with the hotel industry.
There are two options here:
You can either rent your property on a short-term basis directly on the major accommodation portals such as Airbnb and Booking.com
You can effectively sublet your property to a ‘rent to rent’ operator.
‘Rent to rent’ and short-term lets represent a fast-growing market. As with the HMO market, there is plenty of supply and new operators are entering the business in most major cities. This is despite many apartment leases outlawing this type of rental model.
For landlords looking for a guaranteed rental return, there is the growing ‘rent to rent’ market, where owners sublet their property to a professional short-term operator, who effectively operates the owner’s property in the style of a small B&B or hotel. These ‘rent to rent’ operators tend to offer a guaranteed rental return. However, this is usually via a limited company with little or no assets, should any dispute arise later.
These guarantees are rarely supported by any significant financial backing, should they exit their rental agreements early. Despite the challenges of ‘rent to rent’, this usually offers a property owner a guaranteed rent over a longer period, and the operator is usually responsible for most, if not all, of the maintenance, depending on the agreement. For those reasons, it can be an attractive option to property owners.
On the flip side, the property owner may decide to operate their property themselves on a short-term basis, but you need high occupancy rates to make a decent return after all the additional costs associated with this business. Typically, you receive about 0.60-0.65p for every £1 you receive in gross rent after all costs, and before tax.
This is a management-intensive strategy, as you really need a very high occupancy rate to get a good return after all the costs and extra hassle which goes with running a model which is effectively very similar to running a small hotel. Also, risks are higher with more damages likely and you are at the mercy of a bad review, which can dramatically impact demand.
The management, cleaning and maintenance costs are very high for a typical short-term let property and the biggest issue is cleaning costs eating into profits. Most agents charge between 15-20% plus VAT for management, but this excludes damage costs. Increasingly higher fees are being charged by the two leading website portals that dominate this marketplace, with Booking.com charging up to 20% and Airbnb increasing their costs, too.
Whilst a regular residential rental is not subject to VAT, holiday let rentals fall under the VAT rules. Depending on your Airbnb income, that may mean you need to register for VAT.
Threats: Oversupply and the expansion of the short-term rental regulation introduced in London, which imposes a 90-day maximum rental limit per annum on property listings. It may also be against your insurance, mortgage and/or lease terms to rent your property on a short-term basis. You may also need to carry out a fire risk assessment.
Opportunity: Higher profits, but only if you can secure the right configuration and size of property in a prime city centre location.
Top Tip: For better returns, a prime city centre location is critical. A two- or three-bed property with a sofa bed in the living room can sleep up to eight people. Remember the VAT issue and keep in mind that it may be against your mortgage and lease terms to rent your property on a short-term basis.
Property Development and ‘Flipping’ Property
Flipping property is much talked about, but very few succeed at this on a consistent basis. It is a very challenging business model for those without extensive cash resources and property development experience gained from many years trading in property.
Buying and refurbishing a property has many challenges, but it is not impossible. It is a risky business unless you have the necessary business, valuation, and operational skills, the right contacts and specialist experience.
The most common mistake made by amateur property developers is overpaying for a property. The challenge is having the experience to correctly value a property upon purchase and not over-pay.
Combined with incorrectly estimating the refurbishment costs (because many fail to carry out an accurate feasibility appraisal), this can lead to very low profit margins after all costs and taxes are taken into account. It is often caused by poor due diligence and less experienced developers relying on a builder quote for their appraisal costs, rather than a detailed appraisal by a professional such as a qualified Quantity Surveyor.
Threats: Between the purchase of the property and completion of the project many months later, your main risk is a change in sentiment and market confidence, which can quickly reduce demand for the property you are selling. It is important to be aware of the power of economic cycles on the property development business.
Opportunity: A great model to run and build a long-term business if you have the right skills, valuation and business acumen.
Top Tip: Always engage the services of a Quantity Surveyor before contacting any builders. Start your due diligence instantly upon verbally agreeing to any deal and understand all the dynamics and costs well before you exchange on any property.
If you have the risk appetite and resources to succeed in this specialist area, then buying land with the aim of securing planning permission value uplift is a great business model. While it is riskier, it is a rewarding business for cash-rich investors with the right experience and business acumen to gain a planning uplift in a complex planning system.
The business is dominated by larger house-builders and more experienced, higher-net operators who have the necessary resources and experience to navigate the planning system. Land with planning already secured is unlikely to create any new value and is often purchased by builders or developers who can afford to operate on smaller profit margins. Ideally, you need to be a cash buyer to make it in this business, as it is often difficult to raise finance on land without planning permission.
Threats: According to an article published in The Times on 07/12/2019: ‘’A land value tax that captured the wealth created by planning permission would raise £9 billion a year’’. This suggests a change in tax policy from the government, which may gain support by using this ‘planning gain’ sector to help close wealth inequality, an increasingly important topic for the government to tackle.
Opportunity: High returns for high-net, cash-rich, skilled business people who have a higher risk appetite and specialist experience, backed by substantial resources.
Top Tip: The best way to create real value and find land is to literally walk the streets, find your target plot, and then contact the owners of any property not currently for sale directly via the Land Registry or portals such as LandInsight, Promap or Nimbus.
Options Agreements and Purchase Lease Options
This is a very niche strategy, largely used by developers who agree to buy land on the basis of purchasing a property after planning has been secured. An Option is the right to buy, but not the obligation to do so. In other words, you don’t have to complete the deal and can pull out under pre-agreed terms, but the vendor is still contractually obliged to sell to you.
You can effectively ‘own’ and control a property at a fixed price, within a certain time period. Taking this further, a Purchase Lease Option is the same as a Purchase Option, with the additional benefit of being able to use and control the assets in return for a monthly lease (rental) payment. You can control the property as the effective ‘owner’ during the agreed period and then rent it or apply for any planning permissions. This means you can invest in property, if unable to obtain a mortgage, and have low available deposit funds. Often used for vendors who would consider renting their property over a long term with a view to selling the property at some point in the future, outlined in the option agreement. In my experience, it is difficult to find vendors who are willing to agree to a Purchase Lease Option, and even harder to get the option with low entry consideration.