Planning a Buy-To-Let Strategy – Part 1
The first task that a potential BTL investor should do is decide on his or her personal BTL strategy. Put another way, you need to plan just how you are going to make a BTL investment.
Writing a strategy is time consuming, but do trust us on this – clearly setting down how you will make a BTL investment will more than repay your time, and may save you many thousands of pounds at a later date.
Your BTL strategy or plan doesn’t have to be a 100 page blockbuster (in fact it certainly shouldn’t be that large!), but it should contain what you aim to do in each of the four key building blocks of making a BTL investment, which are:
Analysing these four steps and what you aim to do in each of them is crucial. You must think long and hard about each one, and write down what you intend to do. While plans will change as events unfold, you must have an initial plan to begin with, which will give you guidance (and confidence that you have a plan) as you carry out these key steps for real.
If for any reason you subsequently decide to change your pre-agreed plan just stop for a minute, look at the logic that originally led to your initial strategy, and see whether your potential new change is beneficial not just for the specific step it refers to, but to your overall plan.
Now that may seem a little confusing, so let’s provide a very simple example:
BTL plan for Joe Bloggs, as of March 2010
Target market: One- and two-bedroom flats bought for between £300,000 and £500,000 in either Hammersmith or Clapham Junction areas in London, located no further than 15 minutes’ walks from either Hammersmith tube or Clapham Junction train station respectively. The target tenants are young professionals working in the West End or the City, either renting on their own, with partners, or with friends.
Target logic: Strong evidence from local estate agents and free newspapers that consistent demand from professionals for one- and two-bedroom properties in these areas, even over the last two years. According to my survey of 10 agents, the rental price for a one bedder in both areas currently varies from £550 to £800 per month, and for a two bedder from £750 to £2,000.
Finance: My maximum cash available for a BTL investment is £150,000. Assuming £25,000 kept for property buying costs & contingency reserves, my maximum cash available for property deposit is £125,000 - resulting in deposit of 25% at a £500,000 purchase price. Mortgage type: Fixed rate over 35 year period, in order to give certainty of payments. Financed on an interest only basis. According to Sharpsuits Mortgage Website, four different companies offer mortgages fitting this profile, at fixed rates of 5% over 35 years and with arrangement fees no higher than £2,000.
Tenant management: Tenants to be found and managed by the Pro-Tenant company in Hammersmith or Northcote Agency in Clapham Junction. Each charge a 10% fee of monthly rentals, to include all services. Logic: A rental agency will free up my time and give my price of mind over the day-to-day management of the property.
Exit strategy: Property to be kept until at least 2014, my anticipated return of the London market to 2007 peak property prices. Only when there is significant evidence that property market has recovered significantly will I put the property up for sale. After subtracting all selling costs, I will not sell this property unless I can clear a minimum £100,000 gross profit on the initial purchase price.
The numbers: Worst case scenario. Buy for £500,000 (including all buying costs; property costs £480,000 excluding buying costs) in 2010, financed by £120,000 deposit and 35-year interest-only mortgage for £360,000 at 5% fixed, with arrangement fee of £2,000. Assume property market does not recover as anticipated by 2014 and so cannot sell until 2016. Assume nine months rental each year, with revenue exactly covering all ongoing costs (management fees and mortgage interest) and three months period each year without tenant, resulting in me having to pay £4,500 in interest payments each year for those three months (£27,000 in total over six years). Sell for £600,000 in 2016, net of selling costs. Gross Profit = £70,500 (£100,000 gain on property minus £27,000 interest payments for periods of non-tenancy minus £2,500 arrangement and exit fees for mortgage). After assumed opportunity cost of 3% p.a. on my initial £120,000 deposit (derived from average saving account interest rate) , compounded to £23,000 over six years, and another £1,500 opportunity cost on the interest payments I had to cover on non-tenanted time, my profit comes down to £46,000.
Expected scenario: Buy for £500,000 (including all buying costs; property costs £480,000 excluding buying costs) in 2010, financed by £120,000 deposit and 35-year interest-only mortgage for £360,000 at 5% fixed, with arrangement fee of £2,000. Property market recovers as anticipated by 2014. Assume 12 months rental each year, with revenue exactly covering all ongoing costs (management fees and mortgage interest). Sell for £650,000 in 2014, net of selling costs. Gross Profit = £147,500 (£150,000 gain on property minus £2,500 arrangement and exit fee for mortgage). After assumed opportunity cost of 3% p.a. on my initial £120,000 deposit (derived from average saving account interest rate) , compounded to £23,000 over six years, my profit comes down to £124,500.
This is just an example (and it tends towards the brief side) and ignore the specific figures, which are all fictional but this strategy includes a clear idea of what Joe Bloggs intends to do in all the key areas of the BTL process, ending with calculations on expected profit. You may argue that Joe’s scenarios are too conservative or aggressive, but the point here is only to show what a BTL strategy might look like.
Your plan could look very different format wise (e.g. using spreadsheets for the numbers), but it should include all the key elements covered above.
Once you understand this outline, you should move on to Planning a Buy-To-Let Strategy – Part 2
