You need to know the average cost of properties in your chosen area and the rents that you are likely to receive. Aim to cover at least 125% of your mortgage repayments and go higher if you can.
Source: Office for National Statistics – UK House Price Index: March 2021
Source: HM Land Registry – UK House Price Index summary: March 2021
Return on investment (ROI) is a concept that you really need to grasp, and it is pretty simple to do this.
If you invested £1,000 over a year and you made £100 at the end of the year, your ROI would be 10%.
So, if you put down a £30,000 deposit on a buy to let property and you were able to realise £500 a month in net operating profit this would mean £6,000 per year.
Your ROI on this deal would be 6000/30000 or a 20% return.
This ROI of 20% does not include any appreciation on your property, or any other factor such as tax breaks and other incentives. It is simply a “cash on cash” ROI.
It is better to keep it simple like this, so that you can compare it with investing your money in other ventures.
Analysing Profit and Cashflow
Use the 1% rule. This rule states that you should be able to earn rental income from a property that is at least 1% of the price that you paid for it on an annual basis.
So, if your buy to let property will set you back £200,000, then you must be confident that you can earn at least £2,000 a year in rental income from it.
I recommend the minimum monthly profit on any buy to let property should be £200 a month. You will want to use your own rule here. Maybe 2% is more comfortable for you, or possibly more.
Whatever rule you make, if the buy to let property doesn’t pass this test then just walk away. This is a very quick way to analyse a buy to let property investment.
First and foremost, the numbers need to stack up. Put simply, your cash flow on a buy to let property is what you have left after all of the expenses have been paid. So, if your rental income is £1,000 a month and your outgoings are £800 a month then you have a positive cash flow of £200 a month.
Some people are tempted to factor in the capital appreciation of their properties into this equation. It is obviously a great thing when the value of your property goes up, but you cannot rely on this.
It is best not to use it in any analysis that you do. Just treat it as a very welcome bonus if property prices continue to rise.
A good way to estimate cash flow is to assume that the expenses on a buy to let property, excluding the mortgage payments, will account for 50% of your rental income.
This is best illustrated by an example.
Let’s assume that you are interested in a buy to let property that you know can bring you in £2,000 a month in rental income.
The reason that you want to factor in 50% non-mortgage costs, is because over the long term you have to take into account maintenance and other costs, and cover for void periods where you will not have rent coming in.
So, if your mortgage payment is £500 a month, you can fairly accurately predict a £500 monthly contribution to your net operating profit (cash flow).
You may be thinking that 50% is a lot for non-mortgage expenses, but experienced investors tend to use this for their calculations. Some months the expenses will be a lot lower and others will be higher.
Use Deal Analysis Spreadsheets or Software
Once you start to investigate different areas of the country and connect with more estate agents it is likely that you will have a lot of offers to review.
I recommend that you create a simple deal analysis spreadsheet that you can just plug the numbers into so that you can see immediately whether a property is worth investigating further.
You will need to be aware of all of the costs associated with buy to let investment in order to make your spreadsheet as accurate as possible.
Buy to let tax such as buy to let stamp duty is important to know about as is the cost of buy to let insurance. Make sure that you factor in all likely buy to let costs.
Buy To Let Goals and Action Plan
Having clear long-term financial goals for your buy to let investments is something that you really need.
The government and others have certainly made buy to let property investment more of a challenge now.
A few years ago, it was a lot easier to purchase a rental property, rent it out for a while and finally sell it for a large profit.
Those opportunities were severely halted by the financial crisis and other legislation recently brought in by the Government.
But if you are prepared to stick around in the buy to let property investment market for a few years then there is still a lot of money to be made.
Have a clear reason for getting involved in property investment. You need a big “WHY” and you then need to set your goals to be sure of success.
After you have set your buy to let property investment goals then create a plan to achieve them.
There are a number of ways to invest in buy to let, including the standard vanilla strategy (renting to one household), Houses in Multiple Occupation (HMO) or even property funds.
If you are looking for a higher profit potential from your buy to let property, converting it into an HMO could be worth considering.
However, be aware of the responsibilities associated with each path. Looking after HMO tenants and regulations can really sap your time.