How to fund a buy-to-let empire: Buying with cash, using a mortgage or crowdfunding
07-01-2015
By Marc Shoffman for www.Thisismoney.co.uk
Becoming a buy-to-let landlord is by no means a cheap investment but if your portfolio is built properly you could soon be sitting on double-digit returns.
However, before you can even start snapping up properties and collecting rent you have to think about how you will fund your empire.
We weigh up the best ways to fund property investment.
Starting small: many landlords begin with just one property - some then use mortgages to buy more
Cash
The average property price in the UK is £273,000.
That is a lot of money to put forward upfront and it would take a long time to save up this sort of money.
For example, if you put away £200 a month to build up a savings pot of £280,000, it would take you 39 years assuming a generous rate of 5 per cent.
Most people won’t save for four decades to get into buy-to-let – they are more likely to have a lump sum to put down from a previous savings or investment pot, or an inheritance.
It’s unlikely to be for the full purchase price though - so they will probably need a mortgage.
Mortgage
Most people will start their buy-to-let portfolio with a mortgage. Many will only own one investment property bit others buy new properties by taking advantage of house prices rising over time to release equity by remortgaging.
A buy-to-let mortgage works differently to a residential product. Your application is assessed on potential rental income rather than your own finances.
You can apply either direct or through a mortgage broker, who may have access to special deals and be able to recommend the best lender for your situation.
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Most buy-to-let mortgages are offered on an interest-only basis, meaning you never pay down the debt.
Using a mortgage for buy-to-let boosts returns on investment.
For example, if you had enough cash to purchase a £273,000 property and charged the average UK rent of £774 rent a month, your annual income would be £9,288 and the yield would be 3.4 per cent.
But using a mortgage would boost your yield, as you are putting less money in upfront and using your borrowing power.
If you took out a 75 per cent loan-to-value buy-to-let mortgage on the same property you would need a deposit of £68,250.
You also have other buying costs such as stamp duty and legal and surveyor fees. Your stamp duty would be £3,650 and assumed around another £300 for other costs, so add another £4,000 on top.
This means you are putting in £72,250.
Taking an example mortgage rate of 2.29 per cent, the monthly repayments would be £520 a month and £6,240 over a year.
To work out the yield with a mortgage, you first need to subtract the mortgage payments from the rental income, leaving you with £3,048 a year.
You then take this amount as a percentage of what you have put into the property, giving you an annual yield of 4.2 per cent.
Don’t forget the other costs
Remember you will have other costs such as maintenance and tax.
You also need money aside to pay any tax generated from being a landlord, such as income tax from rental payments. Remember there are reliefs you can claim against your tax bill.
However, it is important to not load up too much debt as you need to pay the mortgage every month or risk repossession. Remember to factor in periods between tenants where there is no rent coming in.
How a mortgage boosts returns - and the risks
Using a buy-to-let mortgage means you can buy your first property quicker as long as you can raise a deposit.
According to a study by Wriglesworth for platform Landbay, on average, every £1,000 invested in a buy-to-let property in 1996 using a mortgage was worth £14,897 in 2014.
In comparison, a buy-to-let landlord buying entirely with cash saw each £1,000 invested grow to £5,071 by the end of 2014.
The cash compound annual return was 9.4 per cent compared to the 16.2 per cent return for investors who borrowed.
Property investors have also benefited from rising house prices which means over time you could earn enough equity in the property to fund another deposit without needing new cash.
A report by Kent Reliance looking at the buy-to-let sector claims landlords typically put down a 28.2 per cent deposit.
The study predicts that rising rents and house prices means landlords will be able to raise enough profit to pay for another 28.2 per cent deposit on a new property within ten years, just from gains in their property's value as long as house price growth outstrips GDP by 1 percentage point.
Obviously there is the risk of house prices falling which would affect the amount of equity in your property and how much spare cash you could raise.
If property values fall your outstanding mortgage will remain the same and your deposit will take the hit - in this way just as a mortgage can magnify returns it can also magnify losses.
Crowdfunding: the armchair investor route
If the thought of getting a mortgage, finding tenants and managing a property seem scary, there are other ways to invest in buy-to-let.
Several crowdfunding platforms will let you put money into either loans to landlords or into property companies and you then get a share of the rent generated.
The platform will work out a rate of return based on the area and rent being charged. Yields can be anything up to 10 per cent and you can often invest as little as £10.
Instead of saving for a deposit and finding tenants or the right property, you can just put money into a platform that crowdfunds buy-to-let loans and matches them to landlords or one that actually purchases a property and rents and manages it on your behalf.
You don’t have to worry about any maintenance, management or tax issues that come with being a landlord.
This is closer to investing than being a landlord but gives you exposure to the property market, despite in some cases not actually ever owning the building.
It is important to be aware of the risks though as this type of investment isn’t covered by the Financial Services Compensation Scheme and you don’t get any of the tax reliefs associated with