You’ve taken the first step and decided to invest in property. The next step is working out what type of investment is right for you, there is no one size fits all answer and it will really comes down to your attitude to risk and your goals.
There are so many different types of property investment out there; they range from basic single lets to more complex lease options. Some choices you may face early on may include whether to buy houses or flats, what area to invest in or what market to target for example.
To avoid information overload this article will only cover some of the most common decisions you will have to make early on in your property journey.
Leasehold VS Freehold
When you start looking for properties you’ll often notice in the advert that they’ll be classed as either freehold or leasehold. So what does this mean?
The majority of houses are freehold, when you buy the property you are essentially buying the ‘freehold’ to the property which means you’ll own the bricks and mortar as well as the land associated with the house. Providing you do not default on your mortgage, this property is yours for as long as you desire.
When buying a leasehold property (usually a flat or apartment) you have very similar rights over the property as you would on a freehold house. In contrast to a freehold purchase though, you will not own the land the property resides on. Also, your ownership will be governed by a ‘lease’. This lease will have an expiry date, at which point you would need to renew with the freeholder to continue living there.
Leasehold properties will also have unavoidable ground rent and maintenance fees associated with them. Prices will vary based on location but in a popular city you could be looking at up to a few thousand per year.
Personally, I’ve only ever bought freehold properties. I like the control you get with them and would prefer not to be bound by a lease term and the associated service costs (which can change year on year!). That’s not to say I would never buy a leasehold property, I would, but the length of the lease would play a big part in my decision.
Typically, a 2 bed freehold house is going to cost more than a 2 bed leasehold flat and quite often you’ll see little difference in the rental returns. For this reason, leasehold properties are very popular, especially for new investors as they offer a cheaper way to get started. Just bear in mind the lease length and work any service costs into your calculations when you do your sums.
Single lets VS HMO’s?
The two most popular type of investment strategy are single lets and HMO’s (houses of multiple occupation). They both have their benefits and drawbacks so deciding which route to take can be tricky.
A single let is defined as buying a flat, an apartment or a house and renting it out to one entity, i.e. a family or a couple.
Single lets are by far the most popular investment, and because they are so popular it is far easier to get a mortgage. The application criteria can change from lender to lender but generally for a single let mortgage you have to be earning over £25k per year and be a homeowner with a residential mortgage. Also the house that you are purchasing must rent out for 1.25 times the monthly mortgage payments. To put it another way, if your monthly mortgage payment is £100, the house must rent for at least £125 per calendar month (PCM).
On top of easier lending, single lets also benefit from a quicker turn around time. There is no need to follow the strict HMO guidelines by installing fire proof doors and alarms in each room for example. There is also no need to move walls around and create extra space which is often common with HMO’s. Instead you can potentially get your new investment on the rental market with just a lick of paint.
HMO’s tend to appeal to younger single people and whilst this is a growing demographic they do not represent a segment of the market that are going to stay in your property for the long term. A couple, or small family, on the other hand are far more likely to stay put, especially if their children are in school.
HMO (House of multiple occupation)
HMO’s are generally houses that are being rented out on a per room basis, i.e, a 3 bedroom house will have three independent people living there on three separate tenancy agreements. They will share the kitchen and bathroom and common spaces. Most HMOs are not three bedrooms; in fact a three bedroom house would probably be converted in to five rooms by making use of the living room and dining room. It’s not uncommon for a landlord to redesign the inside of the property top to bottom to squeeze in the most amount of rooms.
I will use an example to demonstrate the massive difference in income that can be achieved by HMO’s. Let’s say a 3 bed house is rented to a family of 4 at £900 per month. This same 3 bedroom house could be bought and converted into 5 bedrooms by an investor, this investor could then charge say £100 per room per week, this then equates to £2000 per month on the same house!
Obviously there will be higher renovation costs involved to convert the house, and it is also worth mentioning that the landlord is generally responsible for bills so this should be deducted from the £2000. However, it’s clear to see that going down the route of HMO investment can be very lucrative.
One of the downsides to HMO’s is obtaining lending, mortgage lenders willing to lend on such purchases are harder to find, not to mention you are likely to pay a higher interest rate than with single lets which will eat into your profits. Another negative is management, there are not many letting agents that will take on a HMO, and if they do you could expect to be paying them 10-15% per room. This could leave you self managing, which I know from experience, is a completely different ball game to single lets! Finally, licensing may be an issue. Depending on your local councils regulations, you may need a HMO license and you will need to abide by all legislation relating to smoke alarms etc as mentioned, which can be quite an expense at the outset.
Taking on a HMO as your first investment would be either brave or stupid. Our first purchase was a 4 bed that we converted into a 6 bed HMO and looking back, it was probably a bad decision. We didn’t have enough experience and learning on the job with a HMO is a fast, and very hard, learning curve! In hindsight, we shouldn’t have been blinded by the high profits and should have stuck with a single let as our first purchase and this would be my advice to anybody starting out. By all means try a HMO for your second purchase, but to start off with I would advise learning to walk before trying to run.
Local area VS Further afield
When buying your first property investment one of the first decisions you’ll need to make is where to invest. Do you want to keep things local and buy a place close to home? Or are you willing to chase higher rental yields even if it means buying further afield?
The key benefit to buying locally is that you know the area inside and out. You know which parts of your town/city are highly regarded and which parts people tend to stay away from at night. You know where the popular places are for work and where good amenities are for shopping, healthcare and transport. You know of any expansion plans, future new transport links or possible new housing.
Although you’ve probably never thought about it, this inbuilt knowledge is extremely valuable when it comes to picking the right area to invest in. It’s a shame to waste all this information, essentially you are an expert in your area, and it’ll be very difficult for you to build up such knowledge for a town 300 miles away for example.
Whilst you may not know as much about the town 300 miles away, with enough time on the internet you can probably paint a pretty good picture! Many investors choose to invest away from home for a few good reasons, as explained below.
Firstly, higher rental yields may be available in other towns. For example in town A you may get a 2 bed house for £60k that rents out for £400 per month but in Town B, where the investor lives, a 2 bed house may cost £120k and rent out for £500 per month. In this scenario town A offers a 5% rental yield whilst town B is much higher at 8%.
Secondly, the capital growth in other areas may offer more potential. At my current time of writing (September 2015) house prices in London for example have seen huge growth over the past couple of years and it’s a common thought in the industry that these prices may plateau, or even fall, very soon. In contrast though, prices further north, particularly in the North East, have yet to see much growth since the recession of 2008. Many investors see these areas as having higher capital growth potential as they’re still at the beginning of their growth cycle.
Thirdly, investors may choose to invest in an area where they know of growth plans. Some examples of this include investment in locations where the new highspeed train line between London, Leeds and Manchester is due to be built. Likewise, in the lead up to the Olympic games in 2012, properties in the surrounding area were being snapped up in the hope that the games would boost the local economy.
It all depends on where you live. If you’re in central London, it’s unlikely that investing locally is going to be a good starting point due to the immense cost of property. My advice would be to stay as local as possible, even if you’re particular town doesn’t quite meet the figures you’re after, perhaps a town 30 minutes away offers a better return on investment. There will always be a location that promises higher returns but you need to factor in your ability to manage such properties considering the distance.
The first property we purchased was an hours drive from our home town of Milton Keynes. The rental yields were, and still are, far better than we could get in Milton Keynes but to this day we regret buying so far away and haven’t done so again.
I hope this post helps to answer some of the initial questions you may be faced with if you’re new to property investment. If you have any questions feel free to contact us or leave a comment and we’ll get back to you.