The Buy-To-Let Process
Let’s be very clear about one thing - if you’re new to the BTL business, then the most important rule to remember is to NOT plunge in and make an investment just because – for example – property prices are relatively cheap in cyclical terms. Making a substantial investment in anything is a large commitment, and you need to be absolutely sure what you are doing and what the risks are before you go ahead and spend your hard-earned cash and/or take out substantial BTL mortgages.
So what do prospective BTL investors need to do? Before answering that, you need to understand fully what the key determinants of your return on a BTL investment are.
In the order of how you encounter them, they are:
Buying your property
Your future profit is defined largely by what price you pay for your investment property – even in a rising market. Think carefully about this. BTL amateurs often focus too much on what they may get for their property in the future, thanks to an anticipated rising market. But that’s the wrong focus, because the general level of property prices is outside your control. What is entirely within your control is how much you pay for a property in the first place.
To illustrate the point, consider a property that (for example) you believe has a fair market price of £250,000. Let’s assume that the rental payments you receive cover the cost of an interest-only mortgage and all other ongoing expenses, and that that the fair market price of your property increases by 20% over a two year period.
Scenario 1. Buy for £250,000. Sell two years later for £300,000, net of all selling costs. Profit £50,000. That appears straightforward, and it is! (For these examples we'll ignore calculations of real return, once inflation is taken into account, and to the opportunity cost of the deposit you have to pay for the property in the first place.)
But how about a scenario where property prices rise by just 10%....
Scenario 2. Buy for £250,000. Sell two years later for £275,000. Profit £25,000. Not as much of a return as the first scenario, but still not too bad you might think.
But – and this is the key learning point – your profit in both these scenarios depends exclusively on the general market trend for property prices. Of course if the percentage increase in the fair market value of your property is higher than the 20% of Scenario 1 then you’ll make more of a profit, and if it’s less than 10% you’ll make less money. But the point is that your return depends almost entirely on the overall market rise in property prices, in which you individually have no influence.
What is in your influence, however, is the first step in the BTL process – the purchase of your property.
If you have properly defined the area and type of property you want, and have a clear maximum buying price you will pay for a property of the type you are seeking (and have the determination to stick to that strategy) then with persistence and the willingness to spend some time in the hunt, you can pick up property for less than the far market value.
That’s even more likely in a buyer’s market that we have at the moment, when there are more sellers than buyers, and where you can make lots of offers below asking prices (as long as you are crystal clear on what type of property you want, and stick to that strategy). Let’s illustrate the point in some more scenarios:
Scenario 3. Buy for £225,000. If you believe the true market worth of that property is actually £250,000, you’ve instantly made a “paper profit” of £25,000 (although in reality it would be less because of selling costs). But most crucially, you’ve preserved £25, 000 of your precious cash (or, more likely, have to borrow less via a BTL mortgage). And if you sell the property two years later for £300,000, you‘ve made a £75,000 profit, rather than the £50,000 in Scenario 1. That’s 50% higher profit!
If you’re on the ball, so to speak, you’ll already be working out a Scenario 4, where you buy for £225,000 and sell for £275,000. Now you’ll make a £50,000 profit, rather than the £25,000 made in Scenario 2. That’s 100% higher.
So the price you pay for your BTL property is the most important part of the BTL process. It’s 100% within your control as you never have to buy a property that you believe is too expensive, and in today’s buyers market you are free to make as many low offers to as many suitable properties as you want. Getting the best possible purchase price dramatically improves your return on investment - whatever the state of the property market - when you come to sell your property.
Let’s state this again: in most cases you make the vast majority of your BTL return on investment when you acquire the property in the first place.
Financing your property
Unless you are awash with cash, you’ll have to put down a hefty deposit and then borrow the rest through a BTL mortgage or other source of finance. The focus of many amateur BTL investors is on minimising these finance costs, often by taking gambles on the direction of future interest rates, and taking out variable or fixed mortgages as a result.
Well, obviously it helps to minimise finance costs! But as explained in Planning a Buy-To-Let Strategy – Part 3, certainty of mortgage payment is also an attractive factor, and our belief is that you can better use your precious time (and get a better return for that time) by planning your strategy carefully and finding the right property at the right price, than by spending time sifting through 100s of mortgages in order to chisel out an extra couple of hundred pounds a year interest savings though the best mortgage deal in the market.
Finding a tenant and keeping your property occupied
The “bread and butter” of BTL investments, in that if you don’t have a tenant then you’ll be facing crippling mortgage payments with no means of paying them. Problems here can best be avoided by reading our sections on Planning a BTL Strategy.
Selling your property
This is what many amateur BTL investors focus on – and wrongly in our opinion. Why? Because as we state above, you usually make more of your profit when you buy your property then when you sell it. If you don’t – because the market has sprinted ahead and you sell for far more than you expect – well that’s just great! Even then, you’d still have improved your return by being a “canny” buyer in the first place and buying a suitable property at the very best price possible
To summarise, you make a return on your BTL investment through four main areas:
The rest of the Buyto.com site covers the first - and most important step above – Planning a BTL Strategy.
