Buy-to-let investing has always been popular among real estate investors. Those who want to become landlords, and don’t mind getting their hands dirty, can make a lot of money with it. But, just what is it, and how does it work?
What Is Buy-To-Let Investing?
Buy-to-let investing is a uniquely British phrase that describes the process of buying real estate with the sole purpose of renting it out to others. In America, this is known as buying “rental properties” or becoming a landlord.
Rental properties generally come in one of two types:
- Residential and;
Residential properties are properties like single-family homes. These properties may be rented out to the general public for an agreed-upon rent.
Commercial properties include warehouses, factories, office buildings, and sometimes multi-family homes, condos, and apartment complexes.
Commercial properties are the favorite among real estate investors because they offer a high profit potential and consolidated maintenance. If a real estate investor purchases a rental unit, a condo, or a multi-family home, he becomes the owner of the property. However, many buy-to-let property owners choose to incorporate, or lease out the management details to a third-party property management company.
In these cases, ownership of the property is transferred to a corporate entity. In most cases, buy-to-let properties must be purchased with mortgages and, in countries where rent control is imposed, property owners must obtain special mortgages to make the investment viable.
These mortgages, called “buy-to-let mortgages,” require special qualification from a lender. For first-time lenders, banks may require lenders to have at least £25,000 in annual income in addition to the expected rental property.
But, unlike traditional residential property, banks will take into account the expected rental income to determine the loan amount. In general, banks regard investment properties as a higher risk than owner-occupied mortgages.
Advantages Of Buy-To-Let Investing
One of the biggest advantages of buy-to-let properties is that the income can become “passive” over time, and with enough hired help. Landlords who turn over day-to-day operations to a third-party management company often put themselves into a position of simply cashing checks.
This type of role becomes largely managerial, and it’s a more relaxed type of businesses that others.
Another advantage is that buy-to-let investors earn money two ways. First, rental income provides a consistent and fair rate of return on investment. Second, price appreciation on the property can enhance rental income. So, even when rental units remain empty, long-term appreciation may be able to make up for short-term rental income losses.
Rental properties also scale well. A buy-to-let investor can start with one property, establish it as profitable, and then buy another one. As properties become too difficult to manage individually, the property owner can hire a third-party property management company.
The property management company takes over the day-to-day operations of the business for a nominal fee. This lets the buy-to-let investor focus on buying more properties and increasing his real estate investments.
Finally, buy-to-let investors have a degree of control over their rate of return that other investors do not. Once investors have good tenants in the rental units, investment income becomes very predictable.
While rental income is generally considered to be salary in the UK, and assessed taxes at a rate or 20 or 40 percent, landlords can deduct certain costs from their taxable portion of their rental income. These costs include interest on their buy-to-let mortgage and some types of maintenance costs on the property. Finally, no national insurance contributions are levied.
In the U.S. investors, enjoy similar tax benefits, including deductions for all normal business expenses associated with upkeep and repair of the property, interest tax deduction on mortgage loans used to buy the property, depreciation of the property, local and long-distance travel associated with the business, and salary deductions for employees and independent contractors.
Disadvantages of Buy-To-Let Investing
While there are many advantages to being a landlord, there are many disadvantages too. For starters, you must be willing to commit large sums of money to property for long periods of time. If the real estate market fluctuates, or bottoms out (as it did in the 2008- financial crisis), then you may find yourself upside down on your investment – in fact, you could lose everything you’ve put into your properties.
Also, if you ever want to sell your property, you can’t call up a real estate broker and have it sold the next day. It can take months, and sometimes years, to sell a property, and you won’t always get what you want for it.
When pipes burst, tenants lose their keys, boilers go on the fritz, or there are any other problems with the property, you are 100 percent responsible for fixing them. Even when property management companies are willing to do the work for you, you must show up with the money for the repairs.
This requires setting aside money in advance for such repairs, which cuts into net profits. Finally, while many expenses are tax deductible, not all of them are.
For example, repairs and maintenance may not be, depending on what is being done, getting an energy efficient certificate is usually not tax deductible, nor is outfitting the interior with furniture, carpet, or decoration. And then there’s tax on rental fees, which also reduces your net return.
The potential returns for buy-to-let properties is almost unlimited. However, in the U.K, as well as the U.S., and other countries, many landlords barely break even. For example, the National Landlords Association estimated that, in 2014, 27 percent of landlords who let out single properties break even or run at a loss. Roughly 19 percent of landlords who let out multiple properties break even.
This resulted in a gross yield for the industry of just 5.1 percent, with 1.5 percent yields in Taipei and 11.7 percent yields in Moldova.