High London prices – Capital vs Yield

by Readers Question

13:10 PM, 3rd January 2015
About 4 years ago

High London prices – Capital vs Yield

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High London prices – Capital vs Yield

In all the advice provided on this web site it states to target yield of 5%+. In some parts of Greater London, this is simply not achievable due to high house prices.

Is it realistic to buy lower yielding areas where 2 bed flats are £300-£500K with expectations of further capital growth compensating for the lower rental income (these areas have faster capital growth rates than higher yielding areas)? The assumption is that rents will grow over time improving cash flow until refinance.

This would mean I realise smaller income taxes (40% tax shield) and larger capital gains (18-28% tax instead) but more importantly means I can refinance faster for the next deposit and hence grow the portfolio faster.

I would keep 20-25% of all borrowed money available as cash (rainy day fund). As an example we are looking at a 2 bed flat for £330K with expected rent of £1,350pcm, gross yield 4.9%. Gross interest cover approx 1.45 (fixed for 5 yrs).

Opinions appreciated

Michaelprices



Comments

Sunny K

19:25 PM, 3rd January 2015
About 4 years ago

Good question Michael. I had similar questions 4 years ago when we started investing in Greater London properties in general and buy to let in particular. My thoughts:
1. Rental income: Although the gross rental yield gives a good estimate, I think the net calculator (available on this website) is much more important. This is a ratio of net profit to your initial investment. The net profit will be affected by extra expense in flats eg service charge etc. The initial investment is also likely to be higher (detailed below). Hence you might end up with a negative cash flow !!
2. Capital growth: The BTL mortgage lending is mostly determined by rental income and properties worth is secondary. Hence the initial mortgage amount and later additional borrowing might not achieve a high loan to value percentage (currently 75%). This leads to high leverage. For example I buy a flat for 320k with 240k mortgage (based on £1300 PCM rent) and 90k investment (deposit + buying expenses). After couple of year the property worth may rise to 400k and rent to £1400 in best case scenario. I will only be able to get 40k additional borrowing based on rental income. Now if I want to buy another similar property (now worth 400k) I will need 120k of which I have only go 40k for refinancing. Hence I will end up investing another 80k which is similar to first property in the best case scenario. I have not account for rainy day cash etc. The rental income is extremely important unless you are a speculative property investor.

Barry Fitzpatrick

12:58 PM, 5th January 2015
About 4 years ago

Rental income/cash flow is king, capital appreciation is speculation and should be treated as a bonus (if it happens).

Mandy Thomson

13:38 PM, 5th January 2015
About 4 years ago

I agree with the other comments - cash flow - i.e. rental income, is at least AS important as capital growth, unless you're purely looking to flip properties.

In order to maintain a good cash flow (and other reasons), you need to secure good tenants. As a landlord, you're running a business, and as with any business, you first of all need to consider your target customer.

I've being very successfully renting 1 bed flats to young professionals. They want somewhere close to amenities that they can feel at home in without having to make any changes themselves, but they don't want to pay extra for rooms they don't really need - they therefore rent 1 bed flats, and good quality studios.

However, two friends of mine who both let 2 bed properties in the same area have had very different luck to me - they just couldn't attract quality tenants. Young professionals (singles and childless couples) simply don't want to pay for two bedrooms, when they could get a 1 bed place for much less, so therefore, both my friends found themselves renting to a succession of bad tenants, including:
-an illegal rent2rent "landlord" who moved several people into the property (a 2 bed flat)
-after waiting for ages for a suitable tenant for a 2 bed terrace, he got someone who was running an unregistered takeaway business from the kitchen - in violation of the AST and using the extra room as storage
-the latest is a very troublesome "DSS" tenant who often skips rent payments, and has even been known to throw stuff from the window...

What I'm saying is, don't just think in terms of rental yield, but of who your potential tenants are.


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