Property can be like a game of snakes and landlords. When you’re new to the business hopefully you will climb a few ladders, but you can be particularly vulnerable to slithering down the occasional snake. Here are my tops tips for avoiding the pitfalls.
1. Tempted By New Build
NLA research tells us that 80% of smaller landlords with between one and four properties have new builds. These shiny new properties can be very tempting particularly when they are promoted by skilled marketing teams. Buyers are often tempted by the prospect of a low maintenance, easy to let asset being sold to them at a discount. But remember that pricing is an art and what the developer calls a discount is probably their target sale price. You will also be paying a developer’s premium and the constant supply of newbuilds means that they can be vulnerable to price falls in a downturn. Ask pre credit crunch investors in Leeds, Cardiff and Swindon who are still nursing losses. Blocks of flats are often sold to investors, creating a surge of rental properties when the development is complete. The sales team may give you very optimistic figures for what you can rent at, but the sheer maths of so many properties being rented at once may well depress prices. As a leaseholder, you will also be beholden to management agent charges and you have broken a golden rule of investing – there will be no opportunity to add value.
2. Unclear Strategy
I worry that many new landlords adopt a somewhat random purchasing strategy. You may be tempted to buy cheaper properties that are far away from your home, but have you thought through the implications of management and the prospects for capital growth? I always recommend that first time landlords start simple and buy close to home. Put together a strategy that considers location, type of property and tenant and how the properties will be managed, by you or an agent. As a general guide, if you have £50,000 in cash you will be able to use about £40,000 of that as a 25% deposit and you’ll need the rest for fees, furniture and getting the property ready. So you will be able to buy a property for about £160,000. If you are a cash buyer consider splitting your cash into smaller chunks and getting mortgages as this is more cost effective. Always seek a strong rental yield, which should be at least 5-6%.
3. The Legal Framework
I met a couple at a landlord forum recently who were having to license their property and they told me they’d received a letter from the local authority telling them they needed to show their deposit protection certificate. They had no idea what this was. If you don’t have one you wouldn’t be able to serve a section 21 notice on tenants if you needed to regain possession of the property. There are many risks incurred by not understanding the legal framework for letting. As a minimum you need to understand how to create and end a tenancy and the difference between section 8 and 21. I recommend you take a landlord foundation course so that you get a good understanding of landlord and tenant responsibilities. Around half of landlords use agents, but you need to understand the law to make good sound decisions about your business.
4. Falling Foul Of Licensing & Article 4
Be careful where and what you buy as you might need a license. All three storey properties with five or more people living in two or more households require a mandatory license. A household is a group of related people. Five unrelated sharers constitute five households. Some boroughs have introduced additional or selective licensing where some or all privately rented properties must be licensed, do check before you buy and refurbish as you may be required to adhere to certain criteria. If the local borough has made an article 4 planning direction you may not be allowed to let to unrelated people and could be restricted to family lets only. I have a friend who gleefully bought a house in East London hoping to let to sharers, only to find that this would infringe planning restrictions.
5. Lending Restrictions
Getting finance continues to be quite tricky. You may assume your credit file will not present you with problems, but there are a number of risks. Firstly you will need to have no adverse credit such as default accounts or County Court Judgments. Having more than 3 searches on your file in a six month period can impair your credit file so only make an application for credit if you’re sure you want to proceed and prioritise mortgages because they will need the highest possible credit score. High balances on credit cards can also affect your credit score, so if you can, pay off your cards before applying for a mortgage. If you don’t already own a property and are purchasing a buy to let as your first property you will be restricted to a small number of lenders and may need to consult a broker. Other possible barriers to getting finance are a lack of income from acceptable sources, normally employment and generally not from rental income. Many lenders require a minimum income of around £25,000. The property you are buying must have been owned by the vendor for a minimum of six months and you can’t remortgage a property until you’ve owned it for six months. That’s particularly tough if you originally bought the property on bridging finance. Some lenders restrict the purposes of capital raising and may require you to have owned the property for 12 months. Generally first time landlords can choose from a wide range of lenders but beware that once you have a few properties many lenders impose caps on the number of properties you can own either mortgaged with the lender you are applying to or a simple cap on all properties owned.
6. Inexperienced With Tenants
As a first time landlord you may have limited experience of dealing with tenants. One of the most cost effective ways to mitigate risk is to carry out tenant referencing. This would usually involve an identity and credit check plus employer and previous landlord references. This can help ensure you get a tenant who will take their responsibilities seriously. Managing your relationship effectively will also help prevent arrears and encourage constructive behaviour. I always have an induction meeting with new tenants, talking through issues relating to the property and generally opening up lines of communication. It’s an opportunity for you to demonstrate to the tenant that you have a customer focussed approach and encourage mutual respect. Tricky situations will inevitably arise and first time landlords are less likely to be able to draw from experience. Some of the harder situations can be around grey areas such as tenants being untidy, noisy, moving extra people in or not reporting maintenance issues. Taking time to listen to tenants, build up trust and find out what is going on can be invaluable. If tenants have moved extra people in or are disturbing neighbours through noise, try to establish the facts by investigating and gathering evidence. Set clear boundaries and explain the consequence of unacceptable behaviour. If you need to end the tenancy, try to do this through mutual agreement. A legalistic, heavy handed approach to ending a tenancy can backfire as the tenant may stop paying rent and stay in the property until they are removed by bailiffs. Successful landlords have excellent people skills and a more diplomatic approach is always preferable.
When you have a larger portfolio, your rental profits can help ease you through cashflow difficulties. Having a smaller portfolio makes you more vulnerable and means having alternative sources of income can be vital. You can mitigate against cashflow problems by ensuring you have a good balance between capital growth and rental yield. If your properties are increasing in value, you have the option of releasing further equity. If your rental yield is higher, you will have higher rental profits. I recommend you run all your property transactions through a separate bank account. NLA research shows that on average landlords spend 12% of their income on repairs, 7% on letting agent fees and they budget 17% for voids or other unexpected events. Your rental income should exceed the cost of your mortgages and it’s a good idea to allow a surplus to build up in your property account. I have a regular standing order that pays rental profits into an ISA each month so this helps to build up deposits for future purchases or capital to pay down debt. This also means that I have some exposure to equities as well as property, spreading risk.
Three in ten landlords have had a void in the last 12 months, according to NLA research and two thirds of them said that it was unexpected. For first time landlords a void can mean that they will have to pay the mortgage on their property from other sources of income which they may need to support themselves and their family. Avoiding voids or keeping them to a minimum is vital. This begins with how you manage the tenant’s exit. A few months before the end of the tenant’s contract, ask them what their plans are. If they plan to leave, aim to start advertising the property at least six weeks before they move out. If you use an agent, ensure they have a set of keys and the tenant’s contact details to negotiate access and make viewings as amenable as possible. If you are not getting enough viewings, be prepared to lower the price or be flexible on whether the property is furnished or unfurnished. Carrying out works inbetween tenancies can prolong voids, so try to do these mid contract. The existing tenant may appreciate the improvements and stay longer.
9. Exposure To Interest Rate Rises
As Bank base rate has been pegged at 0.5% for over six years, new landlords may be unfamiliar with the impact of rising interest rates. Managing the risk in relation to this is important. Every landlord should have a 5 year business plan even if it is just 2 sides of A4 and a spreadsheet mapping out how they hope to maintain or develop their business. Your plan should include interest rate predictions. I expect Bank Base rate to rise to around 3.5% by 2020. NLA research tells us that the average mortgage rate that landlords are paying at the moment is 3.3%. The margin between base rate and mortgage payrates has been narrowing over the past two years with best buy 65% LTV rates just over 2%. So I would expect buy to let mortgage rates in 2020 to be around 4.5 to 5%. It’s a good idea to stress test your portfolio at interest rates of 5%. Landlords told NLA research that on average rates would need to reach 7.3% before they had serious problems. I suspect that’s a little optimistic as rental yield averages around 6% and many landlords would suffer from very costly mortgages if rates rose that high.
10. Political Change
The private rented sector has become a political hot potato, leaving landlords vulnerable to poorly conceived headline grabbing policy and potential changes in the law. If you work with the public sector – for example three year local authority leases – or take tenants on benefits, then your business will be more vulnerable to the whims of public policy which can change virtually overnight. I know a London based landlord who would buy and redevelopment properties specifically for tenants on benefits. The introduction of welfare caps reduced his rents and meant he had to completely rethink his business model. The current political direction of travel is increased regulation. On the horizon might be three year tenancies, indexed rent rises, and a national register of landlords. Immigration checks and Universal Credit are due to be rolled out across the UK in the next two years and new legislation limits the use of section 21 notices. Changes afoot in Scotland and Wales could also be a precursor to legislation in England. It is important that you keep abreast of these changes and consider how these could impact your business.
Being a landlord can be quite a lonely and isolated business, so I recommend you join a landlord association to meet others and network. Complete a landlord development course and get accredited, it shows you are serious about what you do. You will need to complete continuous professional development and that’s a good incentive to go to meetings, stay up to date, have fun and share experiences with colleagues. You should also read journals like UK Landlord, Property Investor News and check out property websites to keep on top of key issues within the landlord community.
12. Skills Weaknesses
Investing in property in not the equivalent of investing in shares. You are providing homes for people and should never forget the level of responsibility this entails. I believe a successful landlord needs three key skills: to be good at finance and funding property deals, an interest in bricks and mortar and property maintenance skills and an inner community worker who enjoys and is good at dealing with people. You will also benefit from some surveying and conveyancing knowledge to help you make informed decisions when dealing with lawyers, builders and architects. The risk is that you are oblivious to where your weaknesses are. Successful landlords reflect on their strengths and weaknesses, are committed to continuous development and build a team of people around them to augment skill areas where they themselves are less proficient.