There has been considerable press coverage on how the UK residential market has been little affected by the Covid 19 outbreak. International buyers are still buying and in large numbers. The ability to obtain finance through a Buy-to-let Mortgage, which is not solely subject to one’s income but secured against the property’s revenue, creates buoyancy in the market. Disclosure of income is required for anti-money laundering purposes and in order to determine there is adequate mortgage cover should the property not be rented. So let’s have a look at the requirements, costs and returns of buying a UK residential property for investment through a Buy-to-Let Mortgage.

Returns on Residential Property

What are the likely returns on Residential Property, for if the estimated returns are not worth it then it’s a pointless exercise. Property returns comprise: capital gains, through asset appreciation and yields, through rental income. Most investors are looking for capital gains over a set period, usually 5 to 10 years, depending on where we are in the property cycle.

Best Moments to Buy Residential Property

Residential Capital Gains vs The Stock Market

Source: Property vs Shares, Which is a Better Investment

Samuel Jefferies’ article on Property vs Shares surmises that a good property investments outperforms equities, particularly when leverage. In other words, using a mortgage to buy investment properties increases your capital returns. An option not readily available to most when it comes to buying shares.

The Art of Leverage

Leverage allows the investor to buy an asset at significantly below its market value. For example, a Property worth £500,000 would cost an investor £172,500 with leverage. The leverage comprising a 70% Loan-to-Value (LTV) mortgage on the property. The costs of property purchase would, in this illustration, comprise;

• £150,000 for the 30% Deposit on £500,000 Property
• Stamp Duty at 3% (£15,000) for Buy-to-Let Properties (Revised England Covid19 Rates)
• Mortgage Arrangement Fee at 1.5% (£4,750),
• Legal & Conveyancing Fees circa £2,000 and
• Valuation Fee at £750
• TOTAL INVESTMENT: £172,500

If the property price increases by the  2.8%, which is yearly average for England, (London and the East Midlands are currently averaging 3.5%) the market value in 5 years time would be estimated at £574,000. Assuming an interest only mortgage, your investment of £172,500, on a sale of the property, the Return on Capital Employed (ROCE) is;

• £574,000 less repayment of the 70% LTV mortgage of £350,00 = £224,000 gross return
• £224,000-£172,500, your original investment= a £51,500 net return
• which equates to a 30% Return on Capital Employed (ROCE), the capital employed is the £171,000 cash invested.

You have made a 30% return in 5 years on the £172,500 investment because of leverage.If you had used your own money and paid £500,000  plus costs 0f £22,500 your ROCE would have been circa 24% for the same period, assuming a gross rental income of £1,700 per month over the five years, with 10% management fee and a tax rate of 20%.

On this 30% return there will be a UK Non-Resident Capital Gains Tax, no matter your country of residency, at 18% for gains up to £50,000 to 28% on the additional gains over £50,000 In this illustration, assuming allowable costs are £10,000 and the statutory individual personal allowance of £12,500, totalling £22,500 is deducted from the £51,500, realising a taxable capital gain of £29,000, which is below the £50,000 threshold, so taxed at 18%, equating to £5,220 capital gains tax payable. The total post-tax net return is £46,280, reducing the ROCE to 26% on the leveraged deal and to 23% if the purchase had been made with 100% of your own capital.

Rental Income and Mortgage Repayments Rates

There are two types of Buy-to -Let Mortgages available comprising either ‘Repayment”  or “Interest Only”.  The Repayment mortgage includes capital and interest. Many shrewd investors look for a high investment yield and utilise an interest only’ mortgage, in order to keep repayments low.

For a Buy-To- Let Mortgage the  Interest Cover Ratio (ICR), which is the amount of times the rental income on the property you wish to buy can cover the mortgage payments. This needs to be 1.45x more than the mortgage payments, or 145% of gross rental income.

Lenders look at the ICR based on a guided ‘Stress Rate’, rather than the actual Mortgage Rate you are looking to get. As a rule-of-thumb a current Stress Rate of 5.5% is used, whereas your Buy-to-Let Mortgage may be anything between 3.25% to 4.75%. Buy-to-Let rates are always higher than standard owner-occupier mortgages.  This universal ‘Stress Rate’ allows us to work out the ICR;

As you know the deposit you can afford, you can work out the amount required. In the illustration, on £500,000, @70% LTV it is £350,000. The ‘Interest Only’, Stress Test Rate @5.5% on £350,000 = 19,250 p.a  The £19,250/12 months = £1,604 per month x 1.45 for ICR =£2,325. This is the required gross monthly rental income required to obtain a Buy-to-Let Mortgage for £350,000 @70% LTV. If you increase your deposit to 40%, with £300,000 @60% LTV, then doing the same calculation, the required gross rental would be £1,993 per month for a Buy-to-Let Mortgage.

If you want to know the average residential rental rates in the UK have a look at Rent Barometer (per week), Home.co.uk (per month) and for trend lines the Index of Private Rental Housing UK

There are a number of online calculators that you can use to work out the ICR and other related ratios, see:

Money Facts

PATMA Property Calculators

SPV Mortgage Calculator

Other Sources:

1. https://tradingeconomics.com/united-kingdom/housing-index

2. https://www.skiptoninternational.com/sites/default/files/uploaded/forms/UKBuytoLetRates.pdf

3. Property VS Shares – Which Is The Better Investment? By Samuel Jefferies

4. UK House Price Index: August 2020