MONEY COMMENT
Buy-To-Let Doesn't Add Up

By Maynard Paton (TMFMayn)
October 14, 2004

Statistics from the Association of Residential Letting Agents (ARLA) suggest buy-to-let investing no longer adds up.

The numbers concern rental yield. As anybody who picked up a bevy of blue chips during the equity bear market will know, a relatively high yield is a proven indicator of value in financial markets. Trouble is, today's property landlords are captivated by the prospect of sizeable capital gains and are forgetting the income basics.

In the fourth quarter of 2003, ARLA claimed the typical gross rental yield on an average buy-to-let investment was 5.7%, or 5.2% after voids, for an outright cash purchase. The gross yield was also 5.7% for a geared investment (25% deposit/75% mortgage), which came to 3.9% after voids. So back then, tenants could provide an income roughly in line with the 4% on offer from normal savings accounts.

But roll on to the third quarter of 2004, and the continued boom in house prices combined with rising interest rates have weakened the buy-to-let mathematics dramatically.

ARLA's latest report shows the cash purchase buy-to-letter can obtain an average gross rental yield of 5.1%, or 4.7% after voids. Not too bad, but not particularly attractive when there are presently 5%-plus savings accounts available.

However, today's geared landlord has seen his prospective gross yield collapse to just 0.7%, or a negative 0.8% after voids. In other words, many housing newcomers are effectively subsidising their tenants -- clearly not a sensible way to make a living from property. From ARLA's example, the geared investor buying a £290,239 home with a £78,365 deposit would -- after five years, with rents rising 2% per annum -- have received a total net income of... £135.

What's even more worrying is that none of ARLA's reported yields factor in other costs associated with letting. Agency fees could knock at least 10% off the incoming rent, plus there's insurance and maintenance expenditure to consider as well. In addition, ARLA assumes the geared landlord takes out an interest-only loan (and is thus not repaying any capital).

All in all, ARLA's rental yield statistics indicate a bleak future for today's buy-to-let investors. No doubt property bulls believe continued rises in house prices will offset any subdued (or non-existent) rental yield. But if risk-free (and hassle-free) savings accounts can now produce a far greater annual income than a tenant, what rational buy-to-let investor will want to buy in and push house prices even higher?