7 min Read
03 Dec 2015

Written by Liam

Over 30 years experience in financial services, residential lettings and property sales. Director of a leading national estate agency chain, until leaving in 2008 to pursue other commercial interests. Vast experience in new business development, business change, management development and business strategy.

More about Liam

How much can I make from a buy-to-let investment?

How much can you make from a buy-to-let property?

How much can you make from buy to let property?

How much can you make from buy to let property?

Buy-to-let investment has mushroomed over recent years with the high demand for rental property and changes to pension rules fuelling the rise in popularity. Many see property investment as a route to riches with ever increasing house prices and rents providing a steady income and capital appreciation from their investment.

If you are considering purchasing a buy-to-let property then you need to understand the costs involved and the likely return on your investment, together with the risks involved. In this article I aim to answer these questions and hopefully give a clear idea of how much you can make from a buy-to-let investment?

Case Study

I have decided to use a case study to illustrate the returns that can be achieved from a buy-to-let investment, the details of which are as follows:

Purchase price - £150,000

Deposit - £30,000

Mortgage - £120,000 2yr fixed rate @ 3.95%, monthly payment £395

Rental Income

The income that you can expect from your buy-to-let investment will vary depending on the type of property you buy and the area in which you buy. In August 2015 UK rental yields were an average of 5.1% (LSL Property Services plc Buy-to-Let Index), the regional yields varied from a low of 3.7% in the South West to a high of 7.0% in the North West.

For the purposes of my case study I am going to use an annual rental yield of 6.0% which means the rental income from my case study property will be £9,000 per annum.

Rental from buy-to-let investments is liable to income tax but I will deal with taxation in a later section.

Costs

Mortgage costs and monthly payments

Mortgage fees - £1,800

Survey fee - £500

Stamp Duty - £500 (increases to £1,250 after April 2016)

Legal fees - £700

Mortgage repayments - £395 p.m.

Other costs

Loss of interest received on £30,000 deposit @ 3% per annum - £720 p.a.  (net of 20% income tax)

Letting agent fees (approx. 12% of rental costs) - £75 p.m.

Landlord & rental insurance - £80 p.m.

Estimated repairs - £500 p.a.

Estimated void period rental loss - £500 p.a.

Total costs 

Total monthly mortgage/other costs - £693 p.m.

Additional mortgage setup costs - £3,500

Annual rental yield

Annual rental yield (C) is calculated by taking the annual rental income less annual costs (A) and dividing it by the purchase price of the property plus related costs (B).

A - Net rental income = £9,000 - £8316 = £684 p.a.

B - Total cost of purchasing property = £150,000 + £3,500 = £153,500

C - Annual rental yield = 0.4% gross

Capital Growth

Over the past 10 years (2005 - 2015) the average house price in the UK has increased by around 24%. If I assume that house price increases will move in line with the last 10 years then our case study property will increase in value from £150,000 in 2015 to £184,000. This is equivalent to an annual capital growth of 2.4%.

Taxation

Proceeds from all buy-to-let investments are subject to taxation. Rental income (less some allowances) is subject to Income Tax at the individuals marginal rate of tax. Whilst any capital growth is subject to Capital Gains Tax which is levied at either 18% or 28% on total realised gains on all investments over £10,000 in any tax year.

How can I make from a buy-to-let investment - summary

In the case study above the total return in the first year would be:

  • 0.4% in rental yield
  • 2.4% in capital growth 

This equates to 2.8% gross total return on the investment before taxation. Bear in mind that you won't enjoy the capital growth until you actually sell the property.

As you can see from the case study if you experience high repair costs or long void periods your investment could be costing you money on a monthly basis. There are also upfront mortgage cost of £3,550 which in our cases study would wipe out the first 5 years of any rental yield.

The conclusion is that if you are investing in buy-to-let financed via a mortgage then monthly net rental income is likely to negligible at best. You would the be relying on capital growth to achieve a return on your investment. However a buy-to-let investment without the need for a mortgage can provide both a monthly income and capital growth over time.

Note:

  • The above calculations assume that a 30% deposit is available and the balance of the purchase price is secured with a mortgage
  • All costs are estimates and a may be lower or higher
  • House price growth figures are for the whole of the UK and may be lower or higher in specific locations

Update - How new Budget changes will affect buy-to-let returns

  • Currently stamp duty on purchases is 0% for properties below £125,000 then 2% for purchases between £125,000 and £250,000 and 5% for purchases between £250,000 and £925,000
  • The above rates will still remain in place but for buy-to-let and second home purchases an extra 3% stamp duty will be added to these rates
  • The above changes will come into effect from 1st April 2016
  • This would increase the stamp duty payable on the property in our example from £500 to £1,250 if purchased after 1st April 2016
  • If the property is sold then the amount of stamp duty paid can be offset against any potential Capital Gains Tax liability

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Comments

  1. Glyn December 3, 2015 at 3:35 pm

    Given you are including the cost of borrowing in your calculations I think it is disingenuous to exclude the benefits of leveraging by borrowing.

    In your example the investor starts with £30,000 deposit in 2005 and buys a property for £150,000. Then in 2015 he would sell for £184,000 and pay off the £120,000 mortgage, leaving him with £64,000. So this is a return of over 113% on his £30,000 in 10 years pre-tax and pre-costs, not 24%. Unless there is something I’m missing here?

    1. Damien December 4, 2015 at 1:05 pm

      Glyn,

      Thanks very much for your comment and you are correct that the return on the original investment in my example would be 113%. Bear in mind that that return figure is a function of leveraging and not solely a function of the underlying asset. As such a figure of 113% could well be used in a positive spin for leveraging rather than for investing in buy-to-let property as an asset.

      One of the main attractions with buy-to-let investment is the ease in which you can leverage your investment and can offset the borrowing costs by renting the property. However, using leverage in any investment is not just a one way street and any fall in the value of the asset can have a catastrophic effect on the value of your original investment. For example average house prices in the UK fell 18% between Q3 2007 and Q1 2009 which would have wiped out nearly all the original deposit in my example. Average house prices did not return to their 2007 value until Q2 2014. If you were unlucky enough to invest in buy-to-let during this period you would not be able to realise your investment without incurring a loss for a period of 7 years.

      Another thing to bear in mind is that the initial costs of purchasing a buy-to-let investment are quite high, particularly if you have leveraged your investment by way of a mortgage. In my example the upfront costs are £3,500 and with a rental income of £684 p.a. it would take over 5 years to recoup these costs.

      The aim of this article was throw some figures into the buy-to-let discussion so that potential investor have more information at their disposal to help them in their investment decisions.

      Thanks once again your contribution to this discussion, please keep in touch.

  2. Ian October 19, 2015 at 12:01 am

    Given you are taking into account the mortgage costs, the annual rental yield figure should be on a ‘cash’ basis rather than on the total value. In year 1, you receive £684 net rent on an expenditure of £33550 giving a fraction over 2% return. With the capital growth this would make 4.4% return

    1. Damien October 19, 2015 at 5:31 pm

      Ian,
      Thanks very much for your comments and I do agree that there is an alternative way of looking at annual rental yield. However, to be consistent Liam decided to use the same methodology as used in the ‘LSL Property Services Buy-to-let Index’ referred to in the paragraph headed ‘Rental Income’.