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Are investors buying smaller, cheaper properties?

Posted on 2017-06-14

When landlords look to expand their property portfolio there are a multitude of factors to consider. As well as things like whether the local market has the requisite demand and if the property is suitable to be let, there are also several financial aspects to think about which will determine whether the property will yield a good return on investment.

One of the principal objectives of a buy-to-let investment is to generate steady financial returns while providing quality accommodation for tenants. If you don't carry out the required research or you get your numbers wrong, it could be a lot more difficult to be successful.

It can be beneficial to look at market trends and how other investors are approaching purchasing decisions and one recent study concluded that landlords are increasingly looking to purchase smaller, cheaper properties.

According to data from Mortgages4Business, during the first quarter of 2017 there was a significant drop in the average loan amount and property value across all buy-to-let purchases.

In the 'vanilla' buy-to-let market, for example, the average loan size during the first three months of the year dropped to below £200,000 for the first time since Q3 2015.

The same can also be said for Houses in Multiple Occupation (HMOs) and Multi-Unit Freehold Blocks.

So why might this be?

The most likely reason for this move could be due to the rising costs faced by landlords. Recent changes to the way landlords can claim interest tax relief on their buy-to-let mortgages, as well as a 3% stamp duty surcharge introduced last year have most likely had an impact on many investors' returns. What's more, the prospect of a ban on letting agent fees charged to tenants could also affect landlords' finances if and when it is introduced. These factors are certainly considerations, but they're not putting off all landlords. Our 2017 landlord survey showed that 89.5% of landlords plan to buy and expand their portfolio or stay the same in 2017.

Interestingly, 17% of landlords with two or three properties and 20% of landlords with four or more properties are looking to expand this year. 

And, one way landlords could expand  their portfolio, while keeping costs down and maximising returns, is to buy a smaller property at a cheaper price.

Smaller properties are more likely to have lower running costs. On top of this, cheaper purchases will cost less in stamp duty and have the potential to generate higher yields.

Factors that could affect your property investment

As mentioned above, there are a number of conditions that could have an impact on the success of your portfolio expansion. Below, we take a look at some of the most significant, explaining how buying a smaller or cheaper property could help to minimise their effect.

Incorporation

Changes to the way landlords can claim interest tax relief on their buy-to-let mortgages were introduced in April 2017 and a full restriction of the tax relief will come into force by the end of 2021. This restriction will have a significant impact on the returns of many higher tax rate paying landlords.

That's why an increasing number of buy-to-let investors have been incorporating their portfolios into limited companies as this means they only have to pay corporation tax, which is currently at a flat rate of 20%. With this in mind, landlords looking to cut costs while expanding could consider going down this route. Here is our expert tax advice on incorporation as well as some tips on how to adapt to the changes to mortgage interest tax relief.

Stamp duty

In April 2016, a 3% stamp duty surcharge was introduced on the purchase of all buy-to-let and additional properties. This means, that for over a year now stamp duty has become one of the main considerations for investors looking to expand a portfolio. The bill at the time of the purchase is of course going to be higher, although many people argue that due to capital gains, the effect of the surcharge over a long period of property ownership may turn out to be minimal. When it comes to purchasing, landlords may look to pick up properties at the lower end of the scale, meaning they'll have to pay less tax.

For example, a buy-to-let property worth £275,000 would cost £12,000 in stamp duty. Meanwhile, a purchase at £150,000 would cost a much more affordable £5,000 in stamp duty land tax. There’s a big difference and it’s something all landlords need to think about.

Yields

When landlords consider an investment, working out the potential yield is all-important. A yield is defined as the potential returns that can be generated from an investment, expressed as a percentage. Gross yields can be calculated by dividing annual rental income by the purchase price of the property and then multiplying this by 100 to give a percentage. You then have to factor in running costs and things like landlord insurance to work out your actual yield.

Cheaper properties have the potential to offer a higher average yield. However, areas with lower house prices are likely to have lower average rents. It's therefore beneficial to find a reasonably priced property in an area with high tenant demand and potential growth. And this is why more affordable cities with thriving rental markets like Manchester, Newcastle and Leeds remain popular with investors.

Rental hotspots

Another beneficial method of pre-investment research is looking into current and future rental hotspots and market trends. Most hotspot reports will focus on potential yields, although some will focus on average annual rental growth.

Predominantly, these reports will highlight cities and towns in the North as the most profitable locations to rent. This is due to more affordable purchase prices, which can lead to higher potential yields, providing that the local rental market is active and growing.

Being a successful landlord may well have become just that little bit harder over the past few years, but that’s not to say that buy-to-let investment can no longer be profitable. With the right research, approach and tools, landlords looking to expand their portfolios can remain safe in the knowledge that they are maximising their chances of making a shrewd investment.

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