First big investment decision – low risk or higher risk?

by Readers Question

4 years ago

First big investment decision – low risk or higher risk?

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First big investment decision – low risk or higher risk?

I have a tricky property decision to make and would very much appreciate some advice. I have a central London flat, unencumbered by any mortgage, currently valued at £675,000. My husband and I currently have 1 salary of £50,000, and hope to have 2 salaries at about this level soon. We are looking to buy a family house somewhere slightly less central, at about £850,000. First big investment decision - low risk or higher risk?

We can do this 2 ways; 1) we sell the flat and buy, or 2) we move out of our flat into cheap rented accommodation, rent the flat at £2,700 pcm, and then get 2 mortgages, one on the London flat at 70%ltv, and another on the new house at about 50%ltv. With option 1) we would be leveraged at about 35% on one property. With option 2 we would be about 80% leveraged on the 2 properties, and so of course much more exposed to interest rate increases, but we would have the 2 properties. The flat is not a perfect BTL investment, but it is not bad, at about 4.2% yield. The major attraction of keeping the flat is the amount of investment going into the area at the moment, which is transforming the area and will mean a steep capital appreciation.

We could probably cover both mortgage payments with the rent from the flat, depending on what combination of interest only, repayment etc we went for (we have had several different offers). If we sold the flat, I doubt we would ever get back into the central London property market, but we would have much less personal debt and exposure, and could probably buy a bigger family house, too – which in turn, would appreciate in capital value faster than the flat.

I am concerned to make secure investments for the long term, as we hope to start a family soon. I think now is a good time of our lives to work hard and take on debt, in order to keep the London flat as a long term investment, and have our ‘eggs’ in 2 baskets rather than one. But my husband thinks we should take the less risky option of selling the flat to buy the house, taking on much less debt. He argues that that route could also leave us the chance to remortgage our house and buy a straight BTL investment elsewhere.

Thoughts please!

Many thanks in advance

Jemima



Comments

Mark Alexander

4 years ago

Hi Jemima

How do you arrive at your 80% leverage figure if you will be borrowing 70% LTV on the flat and 50% LTV on the house?

Putting that to one side, my perception here is that you are contemplating speculation as opposed to investment. You can solicit as many opinions as you like but the only thing that matters is the action you and your husband take. Only in years to come, with the benefit of hindsight, will you know the accuracy of your predictions and whether you made the right decision.

Based on the information that you have shared I am more inclined to agree with your husband. That said, I earn a living as a landlord first and foremost, I consider any capital appreciation to be a bonus and high risk speculation simply isn't in my nature.

Please see my series of articles on "How to become a respected and profitable landlord" >>> http://www.property118.com/how-to-become-a-respected-profitable-landlord/60765/
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Mike W

4 years ago

Jemima,

An interesting decision. In my view the answer lies in your view of the future, Take a look 5 and 10 and 15 years out. How do you see the environment? Interest rates? house prices? view of economy? rental demand? salaries? I find the exercise interesting particularly when, for example, people talk of 10-15% pa house price increases, to see what house prices actually are a few years out based on that assumption. Over the last 40 years or so I have never assumed house price inflation or rent increases being higher than general inflation. On interest rates I use the stock markets long term bank rate forecast 5years currently 2%, 10 yrs 3% and 15 yrs 3.5%. I also examine how I would handle economic shocks to ensure I wouldn't go bust. It tends to make me conservative.

John Daley

4 years ago

Hi Jemima,

Good advice above.

I think it makes sense to build on the work you have already done with some scenario testing. What I mean is to take your plans and map them out financially with different calculations for different things happening.

For example 'What happens when ?'

Base interest rates go to 3% or even 5%

You lose the second income when you have a baby

Your tenant turns bad, how many months can you get by with no rent from the flat

Whats the plan if you have a big repair bill, say £10k for a massive service charge bill.

This stress testing will tell you how robust your planning is and how long you have before a drama in your letting plan causes problems in the rest of your life,

You also need to model what the real excess of income over costs is. You should put a value on your time managing the letting, ongoing maintenance repairs and replacements, taxes, licensing, planning etc etc etc.

Think it through first. A few weeks ago we had a case study here where the landlord was letting five properties and actually losing money over time.

Reply to the comment left by "Mark Alexander" at "31/07/2014 - 11:16":

Many thanks Mark. 80% leverage is a worst case scenario, rounding up, since there are so many different mortgage options and variables to consider.

Many thanks John and Mike, too. Excellent advice, we will model the various risk scenarios as suggested and weigh it up. If it is any use to others, we can share our decision here later.

Mark Alexander

4 years ago

Reply to the comment left by "Owner > buy to let - er?" at "31/07/2014 - 13:05":

Yes please, not just the decision but the applied logic too if you don't mind 🙂
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Mark Alexander

4 years ago

Reply to the comment left by "Owner > buy to let - er?" at "31/07/2014 - 13:05":

PS - to assist you with your number crunching please see our FREE to use Landlords Calculator >>> http://www.property118.com/calculating-rental-yields-and-returns/
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David Mensah

4 years ago

I don't quite understand your percentages & figures -- if you sell and have 675K and then buy a 850K home then you only need 175K, or about 21%

If you get a BTL at 70%, then that frees up £472.5K which is about a 50% loan as you say. You'll need two salaries to get a big enough loan for other half for your own home, but you will own
1.525M in property with still 675K equity so about 56% leveraged.

Add stamp duty, subtract off costs for letting fees (voids are rare in central London, but refurbishment can be expensive). I agree with Mark that predicting capital appreciation is a mug's game, but if your area is being transformed, it is likely to keep climbing w.r.t. other areas.

Based on these numbers I would do it for sure.

Abasiakara Etteh

4 years ago

I'd go option 2. Take the equity, have some in the bank as a buffer, then start investing outside London where returns are more like 10% (yields). Then you build an income and a portfolio.

Mark Alexander

4 years ago

Reply to the comment left by "David Mensah" at "02/08/2014 - 09:04":

Hi David

Based on the logic you have applied I can see how you would make that decision.

The reason I felt if was too speculative is from a serviceability perspective.

We are advised that likely rental income is circa £2,700. I would discount that figure by 35% to allow to lettings, management, maintenance, ground rents, service charges and voids. This would leave a net figure available to service mortgage interest of £1,755 pcm.

To work out the break-even interest rate of a loan of £472,500 I would then divide the annual available rent (£1,755 X 12 = £21,060 by the loan amount and multiply by 100. This equates to a breakeven interest rate assuming zero cashflow at only 4.457%. That's just too tight in my humble opinion, even for speculation, and especially for a newbie landlord with no other reserves for any of the other contingencies mentioned in this thread by other members.
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