If you’re buying property in the UK, consider your investment returns
UK property, especially buy-to-let properties which can generate solid rental income, remain in high demand in the current low interest rate environment.
But, if you have decided to buy an apartment in the UK, have you worked out your investment returns? Have you estimated the net revenues you can expect to receive, as well as considered the ongoing costs?
You may well have done but, just to be sure, let’s go back to the basics and look at some of the key investment considerations:
What’s the Return on your Investment? (“RoI”)
Basically, the return on an investment is the reward to you, the investor, for taking the risks involved in investing in a property. You will be expecting to secure a “return” or “yield” on your money. Just like you would when you put your cash into the bank or building society to earn interest.
When you buy an apartment for its rental income this return is usually called the “Return on Investment”(“RoI”) or “yield”. Whichever term is used, it refers to the rate of return generated by an investment into residential real estate. Hereon we’ll use RoI for consistency.
The basic calculation of RoI is quite simple: Annual rental received divided by total acquisition costs, with the resulting answer expressed as a percentage
- using the average cost of housing in the UK of GBP £239,196, say £240,000
- annual rental GBP £12,000
- divided by: costs of acquisition GBP £240,000
- RoI is therefore 5%
This is the initial gross RoI but, in any analysis, it is important to work out the net RoI. The gross RoI is before deduction of any acquisition and annual costs, discussed further below.
The difference between gross RoI and net RoI can be significant and therefore have a material impact on the value ascribed to a property. Accordingly, it’s always necessary to compare like with like when working out RoIs.
RoIs may change over time as rents rise but capital values stay the same (RoI rises) or capital values increase but rentals don’t (RoIs drop). So, it really depends on which point in time you measure the RoI.
How to enhance your RoI by using “leverage”
When purchasing real estate, most people will borrow money from a bank or a specialised mortgage lender to facilitate such purchase. This may be for the acquisition of a first or second residential property.
If as, per the above example, the RoI based on the average UK house price is 5% this return on an investment can be magnified (enhanced) by bringing borrowings or debt into the equation. This use of debt is sometimes called “leverage”.
As before, if a property is bought with 100% of your own money for GBP £240,000. It is rented for GBP £12,000 per annum, so the RoI is 5%
However, if you secure funding (a mortgage) for the same property but:
- bought at GBP £240,000 with a 70% loan (GBP £168,000) at 4% per annum interest
- invest 30% (GBP £72,000) of your own money
- rent it for GBP £12,000 per annum
- then the ROI is much higher because you are measuring your return against the amount of your investment (equity). In this case, GBP £12,000/72,000 gives an RoI of 16.7%
- sometimes this is called “Return on Equity” (“RoE”) because the return is calculated on the equity you invest
Of course, you still have to pay off the monthly mortgage (at an interest rate of 4% in this case) but this should leave you with a profit between rent received and mortgage repayments. In essence you are funding the property for “free” if rent is equal to or > loan repayments.
Plus, of course, you are gaining on the uplift in capital value of your investment. So, when the time comes to sell, your RoI (RoE)can be measured on the increase over your original investment of GBP £72,000.
We mentioned gross returns above. There are, obviously cost associated with the acquisition of any property and these include:
Legal fees/conveyancing fees
Stamp duty: as temporary relief to the property during the pandemic, the threshold for stamp duty to be payable has been increased from GBP £125,000 to £500,000 in England and Northern Ireland. The result of this means that some 90% of property transactions will no longer attract such duty.
For those transactions still subject to the duty, the average amount of tax payable will fall by around GBP £4,500. Some buyers in London and the South East may save almost GBP £15,000 depending, of course, upon the value of the property they purchase.
Temporarily revised rates:
- up to GBP £500,000: 0%
- on the tier from GBP £500,001 to £925,000: 5%
- from GBP £925,001 to £1.5m: 10%
- above GBP £1.5m:
However, people buying additional homes will need to pay an additional surcharge of 3% over and above the stamp duty levied on the first GBP £500,000 of property value. However, this will still result in savings, as the 3% surcharge previously applied to the first GBP £125,000, with higher rates above that.
There may be a number of certificates or approvals to be obtained at buyer’s cost, depending on the jurisdiction, and these may include (but not be limited to):
- electrical safety;
- fire safety;
- confirmation the property is not on a flood plain
Your legal advisor will have a check-list of such requirements.
If you are planning to rent the property, especially as an absentee (ie overseas) owner, you will need a managing agent to find and monitor your tenants. Agents will charge a fee for finding the tenant and also for providing ongoing management and compliance services.
These fees vary between agents and may be around 5-10% of the monthly rent for management with 1 month’s rent for finding a tenant.
Other costs which an owner may have to incur:
- internal repairs and maintenance for which owner is liable under the lease agreement;
- management fees to the entity managing the apartment block: these will include common area cleaning, security (if applicable), contribution to building insurance premiums and other operating costs;
- ground rent if the property is on a long lease (although in practice, some ground rents are only nominal amounts).
Investing in property in the UK remains attractive for the long-term, This may be because such type of investment has provided a true constant across the history of investing and wealth building.