A Look At Realistic Returns On £250,000 Invested In London Residential Property
Introduction – A Middle Class BTL Investment
In this piece, we delve into the London housing market on the footing that we’re a buy-to-let investor with a quarter of a million pounds at our disposal. The assumption is that this is our own money, or at least that we’re not having to borrow part of it from a lending institution. The central question is, what can we buy in London for £250,000 and what could we expect to gain from it. By ‘gain’, we’re talking rental income rather than a capital gain, though we’ll run that up the pole also before we close.
According to a useful tool published by the BBC in November, covering housing prices for the July-September quarter in 2012 and using data supplied by the Land Registry of England and Wales, the average price for a home in Greater London – all property types – was £461, 018, well above our investment stake. That figure was strongly influenced by prices at the top of the scale – the average for Kensington & Chelsea was nearly £1.7 million. But this is rarefied air, in which few mainstream residential property investors can survive. Our attention is more focused on the middle of the road – while there’s no standard definition of the term, ‘buy to let’ connotes investment by the hard-working middle class rather than Arabian oil.
Barnet – Greater London’s House Price Ground Zero
And speaking of ‘middle of the road’, the borough whose average price for housing in the survey period was closest to the Greater London average – a sort of ‘ground zero’ for house prices in the capital – is Barnet to the north of the centre, with Finchley and Golders Green its most prominent areas and with an average price of £465,297. But this is the average across all types of residential property, grouped in the BBC tool as ‘detached’, ‘semi-detached’, ‘terrace’ and ‘flat’.
With our quarter of a million, we’re going to focus on flats as a buy-to-let investment. Interestingly, at £271,979 the average price for flats in our focus borough of Barnet was just 70 percent of the Greater London average. Ignoring the distorting effect of Kensington & Chelsea and the City of Westminster, it’s apparent that other boroughs with similar overall average house prices to Barnet have significantly higher prices for flats. In ‘born-again’ Islington, for example, the average price across all property types was, at £526,314, just 13 percent above Barnet’s, but the average price for flats was £406,238 – nearly 50 percent higher. And even in neighbouring Brent, whose average all-types house price was only 90 percent of that in Barnet, flats on average were eight percent higher.
Beware the Role of SDLT
For the investor with a quarter of a million pounds to put into a buy-to-let flat, either own funds or financed, there’s a surprising amount of real estate on offer in London these days. Before exploring that proposition in more detail though, we note that, for the investor in the market around the £250,000 mark, there’s something to be said – £5,000 in fact – for doing the deal at or under rather than just over that figure. Because at £250,001, SDLT – stamp duty land tax – jumps from one to three percent, the largest increase in the progression until you get above £2 million. And you pay that three percent on the entire purchase price, not just the portion above the £250,000 threshold.
What About Barnet Then?
We proceed on the footing that Barnet is as good a locale as any in London on which to focus our £250,000. There are of course trendier parts of London, and parts which are closer to the centre – it’s about a 30-minute Tube ride on the Northern Line from Hendon Central, at the northern fringe of zone 3, to Charing Cross. But it’s got a lot going for it, does Barnet – there’s the retail and entertainment centre at Brent Cross, home to London’s original mall, and the Welsh Harp Reservoir home to a sailing club, a mecca for bird watchers and surrounded by spacious playing fields. And for football fans, Wembley stadium is near at hand, on the northern shore of the Welsh Harp, albeit in the neighbouring borough.
According to borough-specific information provided on primelocation.com, Barnet is well above the national average for tertiary-educated residents and for the proportion of younger people (15-44) in its population. It’s also indicated at that source that council tax in Barnet is markedly lower than the national average across all bands but this seems debatable. According to the borough’s own website, properties in band D – which is where our target investment is likely to be located – are currently rated at £1,420. Yet the website for UK Communities & Local Government puts the national band D average for 2012 -13 at only a shade more – £1,444 – with the average for London lower than Barnet at £1,304.
Two-bed BLTs in Barnet – Price and Rent
A search of property websites for two-bedroom flats in Barnet reveals plentiful choice – some 177 on zoopla.co.uk, for example, listed in the past 30 days. Confining the search to our price range for an own-funds purchase – in the vicinity of £250,000 – the selection narrows considerably but with 66listings within the past month the prospective investor still has plenty to compare. Indeed, this price range – we used from £240,000 to £275,000 – represents just over a third, 35 percent, of all 2-bed listings in Barnet borough.
What then of rents? Again using zoopla.co.uk, the following picture emerges for asking rents for two-bedroom flats in Barnet. In listing terms, the single biggest rent range is £250-300 per week (£1,083 – £1,300 pcm) – some 20.29 percent of all listings in the past month were in this category. Next largest is the next highest range – £300-350 per week – with 14.65 percent of all listings. And then the next highest again – some 11.28 percent of listings are in the £350-400/week range. So something approaching half of all Barnet 2-bed flat rental listings are in the range of £250 to £400 per week. Narrowing that spread to £250-350 per week, the proportion of total listings is just under 35 percent.
So there’s something of a correlation here – the purchase price range of £240-275,000 covers 35 percent of all 2-bed flat listings in Barnet, which is the same percentage of 2-bed flat rental listings in the £250-350 per week (£1,083 – £1,516 pcm) range. But of course it doesn’t follow that we can use this ‘macro’ data to identify the rent which will be achievable for a specific property purchased with our £250,000.
Drilling Down – To £300 a Week
At that ‘micro’ level, a number of variables come into play. The most important – as the old real estate adage has it – is location. Barnet is a large borough, London’s second largest in fact, covering a number of postcodes and a diversity of residential areas, from the ethnic mix and vibrancy of Finchley and Golders Green to the leafy and affluent Whetstone and Totteridge in the north of the borough. But Barnet also has its fair share of run-down residential areas.
Beyond location, there’s the amenities offered by a specific rental property – from off-street parking to proximity to public transport to ‘ambience’. Such property-specific factors can have a significant impact on achievable rent, though given two largely comparable properties it will invariably be location which is the ultimate determinant.
Nevertheless, we suggest that a two-bedroom flat in an attractive part of Barnet with a market value of £250,000 is more likely than not to attract quality tenants either side of £300 per week. The trick for the BTL investor is of course to buy for that money a property worth substantially more on the market, and so command a higher rent. But assuming we are ‘in the market’, let’s take a look at how that rent would translate as a return on our investment. In other words, the yield.
The Yield – Gross and Net
Right off the bat, we can say that the gross yield is 6.24 percent (annual rent of 52 times £300 divided by the purchase price of £250,000 multiplied by 100). Which looks excellent relative to current returns on equity and debt securities. But of course a gross yield is not what the BTL investor will actually receive. It’s necessary to calculate – as carefully as can be – and add up all the upfront expenses of the purchase and then factor in the ongoing cost of maintaining and tenanting the property. Not the least of which is ‘void’ time – the periods when the property is vacant. A prudent measure here is considered to be 10 percent of each year’s rent. Put another way, for that one item we reduce our gettable rent per week by £30, to £270 and the yield drops accordingly, to 5.6 percent.
The accuracy with which gross yield will be converted to net yield is likely to be strongly influenced by the investor’s prior experience in buying and running tenanted property. A first-time BTL investor will inevitably be on a steep learning curve and the message must surely be – as with the costing of any new business venture – to err on the side of caution. Even to the extent of rigidly applying the ’20 percent rule’ – having calculated net income, reduce it by 20 percent and, with outgoings, increase them by 20 percent. If the investment remains viable, you’re onto something.
Let’s say that we end up with a net income figure around 30 percent lower than the gross rent our London investment will support. On a £250,000 purchase price and a gettable rent of £300 per week, that translates to a net yield of 4.37 percent. Put in reverse, the price-rent ratio (the number of times the net rent divides into the purchase price) is 22.9. That’s not a brilliant outcome – buy-to-let investors should be looking for price-rent ratios of something well under 20 – but it’s worth having, if it can be had religiously, year in, year out over the term of the investment.
Who Can Afford It?
It so happens that the assumed gettable rent for our £250,000 flat purchase in Barnet – £1,300 per calendar month – is mid-way between the all-London average and median rent for two-bedroom accommodation as computed by the VOA – the Valuation Office Agency – for the 12 months to 30 June 2012. The average rent for such a property is put at £1,392 per calendar month, with the median being £1,230. (No distinction is made between flats and houses.) And in a March 2012 report by UK housing support charity Shelter – entitled ‘London Rent Watch: Rent Inflation and Affordability in London’s Private Rental Market’ – the authors calculated that, to afford the London median rent, a family would need a net income of £41,100 per year, or around £51,900 gross. The report further noted that London’s median gross household income was £34,200 and asserted that a family on that income ‘would find the median rent for a two bedroom home unaffordable in 26 of 32 [London] boroughs’. We can be pretty sure that Barnet – in London’s genteel northern reaches – is amongst them.
We mention these propositions by way of reminder that the potential market for a buy-to-let investment – the pool of prospective tenants – is constrained first and foremost by affordability. Whether the investment is in Barnet at £250,000 or one borough closer to the centre of London, in upmarket Camden, for twice that amount or more (the average price of a Camden flat is over £600,000), the investor needs to pitch the asking rent to attract the greatest number of desirable tenants. It’s apparent that our target tenant needs to be earning well above the London median income. We want that overhang to provide comfort that the selected tenant isn’t going to be struggling each month to make the rent payment, causing us a lot of aggravation.
Which surely means, amongst other factors, that we need to make sure our investment property is as attractive as we can possibly make it, relative to other offerings in our rent range, so as to attract the top end of home-seekers in that range.
Before closing, some thoughts on the prospect of making a capital gain on our Barnet BTL investment. That prospect shouldn’t have figured in our selection of the property, though we may have high hopes for a nice accretion in value when, at some point in the future, we come to sell.
It will need to be a substantial gain, though, if we’re to end up ahead of inflation and the impact of capital gains tax. According to the Office for National Statistics, in its UK House Price Index, all-London housing increased in value by 7.2 percent for the year to May 2012. And the data published by the BBC shows Greater London housing having increased in value 4.7 percent year on year for the July-September 2012 quarter. For flats in Barnet, the rise was more modest – 3.7 percent. Much larger gains were recorded in two boroughs with similar average flat prices to Barnet’s – Hounslow at 13.8 percent and Ealing at 10.2 percent.
But such data are at best snapshots and do little to predict future movements in London BTL properties, especially as Britain continues to experience low economic growth and continuing ‘austerity’. For the sake of illustration, let’s assume our Barnet BTL investment appreciates in value at an annual rate of 3.5 percent for the next five years. This gets us to nearly £297,000, for a gross gain in value of £47,000. But if annual inflation runs at, say, two percent over that period, the real value of the gain is just £19,300. This may attract capital gains tax – of 18 percent – on the portion above the standard exemption, currently £10,100, so reducing the gain by around £1,650 to £17,650 – or £3,530 per year. Nice if you can get it but hardly a rationale for the investment decision.
We Could Do Worse Than Barnet
That decision needs to be anchored firmly in the income-generating potential of the selected property. Focusing on a two-bedroom flat in Barnet, we’ve projected a net annual yield of just under 4.5 percent. Undoubtedly, there are better performing parts of London. A recent Daily Telegraph rating of the ‘Top 10 buy-to-let hot spots’ across Britain included three London boroughs – Ealing, Southwark and Wandsworth – but in all three the average price of a two-bedroom flat is well above that in Barnet (Ealing is closest at £289,000), and effectively out of our quarter of a million range.
A Word on Mortgage Finance
We’ve deliberately left out of this analysis the impact of financing the purchase but plainly the greater the amount financed, as opposed to own-funds, the lower the net yield. To illustrate, a BTL mortgage loan at 60 percent of our purchase price of £250,000 could, on currently offered terms, cost us around £800 per month in capital and interest payments, reducing our net yield nearly to zero – just half of one percent. At this point, the investment becomes unviable for income-generation and we are punting on a – highly uncertain – future capital gain.
These are indeed uncertain times for property investment but a buy-to-let investment in London, if not ‘as safe as houses’, is probably the next best thing.