The buy-to-let purchase process


Whether you want to increase your capital or secure future income, buying a property to rent out is now a normal activity and an accepted part of a balanced investment portfolio.

After the falls of the '90s and the rapid increases in recent times, property prices in the UK have now returned more closely to their long-term norms. It is even more important, therefore, to closely analyse every deal.

There are always good investment opportunities in the letting of properties providing you stick to two rules:

  1. A business-like approach is taken
  2. Each individual prospective deal is fully appraised.


There is much less emotion connected with the purchase of a Buy-to-let property than buying a home for yourself. By following the method shown below, an objective business appraisal can be made.

As the first rule in business is:

NO CUSTOMER = NO BUSINESS

Start with the customer (the tenant), not the property.

THERE ARE SIX SIMPLE STEPS:


Step 1 – The Prospective Tenant
Survey the type and number of prospective tenants within your chosen area and determine rental levels.

Step 2 – Location
Identify where your prospective tenants want to live.

Step 3 – The Property
Select suitable ‘property types’ in these locations and forecast future property growth.

Step 4 – Short Listing Properties – Finding a profitable Deal
Make a short-list of suitable properties.

Step 5 – Analysing the Deal
Analyse financial returns for each potential deal.

Step 6 – Making Decisions and Taking Action
Make a decision and take effective action.

STEP 1 – THE PROSPECTIVE TENANT

In any business, marketing should be at the core of the enterprise. Usually the biggest challenge is in finding sufficient customers. That is, to establish a customer base in order to generate enough cash flow to support the business.

With property, it is much easier.

Take an average flat rented out at £500 per month. By finding one tenant who lives there for a year, the business will generate £6k. If we keep that tenant happy for three years say, the business will have generated £18k. All of this revenue comes from just one customer, in one property.

If the first rule in enterprise is, no customer=no business, then the second is:

KNOW THE NEEDS OF CUSTOMERS AND SUPPLY THEIR WANTS.

To protect our cash-inflow, if the prospective tenant’s needs and just as importantly, what he/she wants is defined, we will increase the odds of holding on to that good tenant and reduce the odds of having an untenanted property later.

If we identify and meet our prospective tenants’ needs and wants, we are likely to hold onto a good tenant. We therefore reduce the odds of having an untenanted property and thus protect our cash-inflow.

An introductory paper on Marketing is in the Reading Room.

Who are the prospective tenants?

Develop a Tenant Profile, describing who your prospective tenants are. A good letting agent will indicate rental demand with ease and typical tenant applicants details: age range, status, income level, couple, both working, no children, young professional, student etc.

Here is a simple ‘customer profile’ that we use in one of our favourite locations:

  • A young adult couple
  • Approximately twenty five to thirty five years old
  • Both with professional jobs
  • One works in the city, the other works locally in a caring profession
  • Joint incomes total approx. £30k-£35k p.a.
  • Relationship is fairly new, under three years
  • No children yet
  • One vehicle
  • One travels to work by public transport
  • Frequently eat out, or use local take-aways
  • Have friends around regularly
  • Tend not to cook elaborate meals
  • Shower/bath facilities are used for speed and convenience and considered important
  • IT literate


Although no one tenant will exactly match this profile, it is very different from that of a full time student, or retired person.

STEP 2 – LOCATION

Once you have identified your prospective tenants (Step 1), it is essential you carry out detailed research on locations. This is in order to match your property to your tenants’ needs and to ensure each property is suited to your investment portfolio.

One way to define the local rental market is to ask the local specialist letting agents.

They speak to prospective tenants every day; they view rental properties every week. They know which properties, in which locations, let easily and they know the current market rental values.

They also have the best incentive to help; you may become one of their client-landlords, in the future.

The second half of the location research is to forecast the future growth in the price of properties. An estimate should be made of local and national trends by type and location.

A good letting agent is an important asset as they will know the pitfall of a particular area and its letting potential.


Property Assess uses sophisticated forecasting techniques and social and economic data to predict property prices, sometimes years ahead. It is arranged on a postal district basis and simply requires a property postcode.

STEP 3 – THE PROPERTY

What do your prospective tenants want?

Typical Property Profile:
(to match the wants of the target tenants)

  • Market rental range: £400-£500 per calendar month
  • Preferred property: Flat (not in a block).
  • 2 bedrooms min.
  • Transport: Close proximity to public transport.
  • Gas central heating.
  • Bath and power shower and modern bathroom.
  • Off-street parking.
  • Ground, or first floor.
  • Size of kitchen is not important.
  • Easy to maintain and clean.
  • Minimalist décor.
  • Local area populated by similar to the tenant profile.


Attractions for Prospective Tenants

Don’t forget that we have already assumed a decision to buy residential properties. However, much the same process would be followed, had we decided to buy a commercial, or industrial, property.

Taking the typical property profile mentioned above, which we know will match the tenants’ needs, we can now identify the type of property our prospective tenants will find attractive.

Taking this information we can now survey the market for:

  • A flat
  • Ground or first floor
  • Two bedrooms
  • Public transport close by
  • Pub, shops and take-away facilities within a short distance
  • Bathroom is modern with a power shower
  • Size of kitchen is not important
  • Off street parking space, if possible
  • Area where young single adults are in the majority

Located in:

  • Trevor Terrace
  • Bamborough Street
  • Belford Avenue
  • Etc., Etc.,


We can now search all estate agents, their websites, national websites, the local press, agents’ boards and most importantly, we can be fairly specific about our requirements to them.

 

STEP 4 – SHORTLISTING PROPERTIES – Finding a profitable Deal

It is possible that that you may have to look at the details of 100 properties to select 10 to view, to financially appraise three, to buy one.

Once we have established who our prospective tenants are, have listed their needs and wants and have identified areas/streets where there may be properties that will match their requirements, at a rent they are prepared to pay, we can then focus on finding the right property for our customers.

It is vitally important that inside the small number of possible deals you financially examine, that you also analyse the sellers. Often, good deals can be made when the vendor is motivated to sell, (e.g. because of relocation due to a change of job).

With such a deal, the benefits to the vendor are often very different to those of the buyer. For example, the vendor may want an easy and quick sale, whilst the buyer wants a realistic price.
From the investor’s point of view, only by doing the sums will the deal be shown to be good, or not so good.

STEP 5 - Analysing the Deal

This is the most important step in the process. Only by analysing the financial aspects of the deal in depth can we come to a valid investment decision, and below we have detailed the method for appraising each deal on a financial basis.

It needs to be able to compare returns with other properties and returns on other investments such as bank accounts, shares, commodities etc.

If you would like to save time and work, Property Assess can carry out this process for you as part of our Level 2 package. This requires the completion of a simple on-line form from which we can provide you with a detailed report on the suitability of your chosen property.

If you would prefer to do this analysis yourself, there are four essential measures to be assessed when investing:

1) The pre-tax cash flow

2) The after-tax cash flow

3) The net income

4) The rate of return on the invested capital


CASH (1 & 2)

Cash In
The ideal situation is for the property to have the ideal tenant who is satisfied with their home and will therefore stay there for a considerable amount of time and continue to pay their rent.
It is, however, wise to build in the possibility of the property being empty for a few weeks or a month each year when calculating the annual rental income.

Cash Out
The following are some of the more common costs you will come across when computing cash flow:

  • The Cost of the Property itself, at completion of the sale. (Note that this may, or may not be the market value. If we have chosen the property wisely and the vendor carefully, there is a good chance that the property may have already increased in value.)
  • Closing costs
  • Surveryor’s fees
  • Structural survey
  • Electric & plumbing survey
  • Damp & infestation survey
  • Solicitor’s fee
  • Local Authority search fee
  • Land Registry fee
  • Bank fee
  • Loan costs
  • IFA fee
  • Lender’s fees:
  • Arrangement fee
  • Lender’s legal fee
  • Lender’s valuation fee
  • Sealing fee
  • Refurbishment costs
  • Painting & decorating
  • Floor covering
  • Plumbing
  • Electrical installation
  • Plastering
  • Damp proofing
  • Soft furnishing
  • White goods
  • Others
  • Annual Expenses
  • Cleaning
  • Insurance
  • Letting fees
  • Maintenance-external
  • Maintenance-internal
  • Gardening etc
  • Pest control
  • Council tax (due to voids)
  • Boiler/gas inspection/testing


DEPRECIATION

It is useful to keep a list of the ‘fixtures and fittings’ in the property and their values, so that depreciation can be calculated for tax purposes:

  • Air conditioning
  • Carpets
  • Curtains
  • Light fittings


Note: As stated previously unlike the computation of profit, cash flow does not include notional payments, such as depreciation.

3) Net Income (Both pre-tax and after-tax)

This is essential information in order to make a rational buy/sell decision.

A number of people have been known to buy properties at auction, sight unseen, that is without having even seen, let alone fully viewed, the property. It is rare to see buyers using business appraisal techniques. In the main, they rely on the market moving upwards while they are developing, but this is not a very rational approach to investing.

4) Rate of Return

The rate of return is the core of the matter.

The Internal, or project, Rate of Return (IRR), is the rate that indicates whether or not an investment is worth pursuing.

IRR allows an investor to find the interest rate that is equivalent to the monetary returns expected from the project. Once the rate is determined it can be compared to the rates that could be earned by investing in other properties, or indeed in other projects. That is, it is non-dimensional and expressed as a percentage.

(Most spreadsheets have an IRR facility that can be used with cash flow computations.)

 

STEP 6 – MAKING DECISIONS AND TAKING ACTION


There are two kinds of decision those that are expensive to change and those that are not.

Divide the activities about which you have to make a decision, into three categories, similar to the ‘80/20 Rule’ we used previously.

A – Key decisions which will be crucial to the project and costly to change.
B – Moderate decisions which will have some impact, but can be changed at reasonable cost.
C – Decisions of little consequence with low cost implications.

Choosing a location for your property investment, or carrying out due diligence on a possible tenant, will be A type decisions.
Selecting the brand/colour of paint to decorate a bedroom, or which light fitting to install in a kitchen, will be C decisions.


Try to avoid these common mistakes:

  • Taking too long to make decisions
  • Trusting seller’s data
  • Trusting valuations commissioned by others
  • Fiddling the numbers to make the deal fit
  • Overestimating the market rents
  • Inflating the property value
  • Getting bogged down in process, rather than taking action
  • Taking a too detailed inspection at the first view
  • Underestimating the time it will take to sell a property
  • Doing too much analysis but then failing to commit to a deal