Two Myths You Shouldn't Believe

The new owner of the property wants to keep the previous owner as a tennant, and indeed would like to sell the property back to him at full market price sometime in the future when he's got his finances in order. This way the landlord knows he's got a good tennant who'll pay the rent and who'll look after the property. The tennant gets to keep his home, and the landlord gets a 20% profit on the eventual sale. Win-win situation.

The tennant is given a 1 year lease only, because the landlord has used a mortgage to buy the property, and the mortgage provider will not allow him to grant a longer lease.

But if the tennant is paying the rent and is looking after the property, why would the landlord not renew the tennancy? Why would the landlord want him out?

Surely there are cases where the landlord does not play fair, just as there are cases where the tennant doesn't play fair, so there are risks, but sale and leaseback is not necessarily a rapacious contract. However, it does have to be profitable to the landlord... why else would he do it?

5753225 - 'But if the tennant is paying the rent and is looking after the property, why would the landlord not renew the tennancy? Why would the landlord want him out?'

If the landlord removes the tennant, sells the property and realises the profit then he/she can offer a similar deal to the next fool. The landlord has a limited amount of properties he/she can own (due to funding) so the faster they can buy & sell the more profit they will make.

Not an ethical/long term business model but not all people are ethical or in it for the long term.

DukeyG, good point - in a falling market, the unscrupulous needs to sell pretty quickly in order to turn a profit. I'd never give up that degree of control over my well being to a stranger, it's crazy.

If you are in negative equity then you cannot sell house at auction unless you have previously agreed with your lender, how the negative equity will be repaid. This also means thaT THE RESERVE PRICE HAS TO BE SET AT A MINIMUM OF THE BORROWINGS ON THE PROPERTY + LEGAL AND AUCTIONEERS FEES.


The advice should be that if you are heading towards problems sell sooner rather than later and before you are in NE.

Chas

The buy and rent back schemes are fraught with disasters. A friend went though this deal when in a fit of deep depression .He nows pays more in one week for rent then he did for a months mortage!! And the promised of maintence , well , I think its none
exsistent. Everyone should be wary of these schemes and investigate them thoughly before going ahead.

I agree with the sentiment that many of these schemes are fraught with danger for the seller.

For the older person looking to release capital however, there is an alternative which is much safer, which is equity release via a lifetime mortgage, or to sell all/part of their home to a home reversion company. These schemes do guarantee that the individual can stay in their home until they die (or go into long term care), and also include a no-negative equity clause providing they are members of "SHIP".

You should really see an independent financial adviser who is qualified in this area (ask if they have ER1 or equivalent) when organising this type of scheme though.

Oh yes, equity release. In other words, sell your property for 40/50/60% of its true value instead of 80%. Excuse me, but isn't this article complaining about people only getting 80% of its value?

To say that all these rent-back schemes are bad is wrong. The majority work very well and the landlords and tenants both are winners, but there will always be the problem stories on both sides.

Oh, and to answer truewordinjest, for many people, 80% of the value IS sufficient to pay their other debt and if they pay a market rent, they will still find they're paying a lot less than the monthly payments on all their combined debts. Also, if they sell at auction (or thru an estate agent) they still have to live somewhere, don't they? So they will end up renting either way, won't they?

This article contains the usual negative slants that we've grown to expect from Fool, with no real solutions. The answers are to (a) get people educated in how to deal with their own financial affairs so they don't end up in this state in the first place (but Fool put people off taking any action at all with their constant scaremongering) and (b) for the mortgage companies to accept tenancy agreements that can include a clause where the tenant can stay for life. At present, only a standard AST is acceptable for mortgage purposes so there's nothing we can do about Myth no. 2 from this perspective. Fool should know this.

I would prefer to try to sell my property at auction.

This is much, much quicker than selling through an estate agent and there is no way the sale can fall through. - unless it doesn't get a bid. You can set the reserve price at the level the sale-and-rent-back scheme has offered you, minus the rent you would pay for a year. That way, you won’t be out of pocket -- and hopefully you will achieve a much better price.

My boss is a property developer with an extensive portfolio and last week the 6 properties he entered into auction failed to sell. Listing fees of over £5k still had to be paid, so selling at auction is not necessarily a viable option. One property had an offer made on it after the auction closed for 20% less than the reserve but was rejected.

I have a friend who is in the buy to let market, and he seems to pay 80% - 90% of market value when he buys a flat. He wants the tenant to stay because it means he gets rent from day one, and they tend to look after the place. As discussed above, he can only offer a year's tenancy at a time because of his mortgage arrangements. At the end of the year, he gets the flat revalued (so far, this has always been up!) and draws down a new mortgage at the higher valuation, thereby taking out some capital gain, but having no CGT as he has not disposed of the asset. The tenant hopefully stays on and the rental stream covers the mortgage cost. He reckons the income broadly equals the cost so he doesn't have much if any income tax to pay, but will eventually end up with a capital gains tax bill if and when the property is eventually sold.

Unfortunately people are in a lot of debt today so will always be targeted and fooled into taking the easy way out, which is why these companies will prosper in the long run. some regulation is required but either way having a tenancy for life is no longer an option even for council tenants as the government are now looking into 'enabling' people to downsize when their families grow up an leave. Or the new one, dont work dont get a tenancy for both AST and secore tenancies.

Deals like this are not automatically "good" or "bad".

An honest buyer/landlord playing fair with a prospective seller/tenant will almost certainly provide a "good" deal for both parties.

On the other hand, if the prospective buyer/landlord is lying to the prospective seller/tenant from the outset (as described in the article), the chances that the deal will be "bad" strike me as being exceptionally high.

Toad,
Your friend has been playing a very risky game as he has been depending on the equity increase in a rising market to pay his way, the problem is that when prices go down and he has to remortgage, he will not have enough equity to get a cheapish one and will possibly find himself paying an extra 2% interest. If he can't fund this from the rent then he is a bit stuck, There is not much use in selling any of his properties as he does not have any equity in them. eventually the whole pack of cards will collapse and he will be left with nothing but debts to his lenders. Not a good position to be in.

Chasbmw - I only just saw your post and feel I have to respond regarding your view of the investment property strategy described by Toad and myself.
You are correct that there is risk with this strategy - but then no investment is without risk. However you are being unreasonably fatalistic with your assessment in this instance.
This is a relatively safe property strategy:
1. It is long-term
2. Funds borrowed are used for existing/current investments

Yes property values may drop in the short-term, but I am fairly certain they will be higher in 20-30 years time, which is my investment timeframe.
Yes interest rates may go up, but if they do then the cost of living will go up for everyone - including rents, that will offset the landlord's extra interest - bottom line is people have to live somewhere and will pay what it takes to do so.
Most importantly, investors need to have a buffer in place to meet the problems described above - i.e. at least in the short-mid-term, e.g. don't borrow to your limit/keep liquid redraw funds in an offset account for the first; fixed interest rates for the second. Btw, quite why anyone would remortage (as you suggest) with -ve equity is a bit of a mystery...?

Finally, to minimise the risk the property you buy is critical:
a. Location, location, location - High % of Home-owners; High Demand; Limited Supply.
b. Cheap end of the market (i.e. location) determined in a. above - the cheaper the property, the greater the potential demand - most of the population cannot afford expensive places, which is where many investors get burnt in downturns.
c. Occupany/Good tenants critical - look after your tenants - 100% occupancy and 90% market rent is better than the other way round

Darcy,
The investment policy adopted by many investors over the last couple of years is to buy properties at very low yields 4-5%, where the rental income barely covers costs and to extract as much equity out of these properties in order to provide an income (Toad's friends case) or to invest in further properties (your case).

These are highly leveraged, high risky stategies as you are depending on being able to remortgage to take out capital growth to cover any shortfalls in revenue.

There is no equity left to cover changes in interest rates or lending conditions, repairs, void periods etc etc.

S&P have predicted that UK property prices have a further 17% to fall in addition to the estimated fall from August's peak to now. Those investors who have been expanding 'their' portfolis by extracting equity are going to find it impossible to remortgage at affordable rates as they will not be able to meet lenders revised LTV or Income/Interest cost ratios. They may be able to continue with existing lenders but at high rates 8% plus as they will be flagged up as very high risks.

A near doubling of interest costs on a 95% interest only loan means that 'investor' will be left with revenue costs that will not be met by rental income (tenants can't pay, couple this with capital value sinking the rate that they are, then the investor is in a very hard place.

I have run the figures on student flat investment properties in my home town, making a realistic assumption as to costs, 25% equity and a reasonable real income return on my investment, then I need the capital value of typical student houses in my home town to drop by about 30% before it starts to make any sense to invest.

I have lived through various booms and busts in property markets and prices take a long time to recover, in the UK boom of the late 80s it took until 1999 for the peak prices of '88 to recover in real terms, the same period for the dutch market in the early '80s, The Japan market took a similar time frame.
Holland and Japan are small countries with a limited amount of land for housing supply, but when their markets crashed they stayed crashed, so don't believe that supply and demand will dig the UK market out of a crash, because once the speculative demamnd is burnt out of the system you will find that supply and demamnd will reach some form of equilibrium at a much lower price level.

You may find this disheartening, but i think that this is the reality.

Charles

We considered this option about eight months ago when we were trying to sell our house.

We weren't in debt, but our home had a history of noise disturbance which we were concerned would make it difficult to sell on to an 'ordinary' purchaser. We wanted to make a quick sale as we wanted to get the house sold before the market crashed completely.

The auction route in our area was not an option as there was no history of that sort of sale except for very very cheap properties which ours was not.

In the end we decided against it as the offer made was more than £60,000 less than the market price.

Eventually we sold it to a developer for £30,000 less than the market price who took into account the noise issues.

The buy to rent people were very pleasant and were going to let us stay in the house rent free until we were ready to move.

Given the profit they could have made by selling it on without disclosing the noise problems I suppose they could have afforded to do that.

But the company were very up-front about the disadvantages of their scheme as far as our situation was concerned.

"If I had enough time, I would prefer to try to sell my property at auction.

This is much, much quicker than selling through an estate agent and there is no way the sale can fall through"

This statement is misleading, inaccurate and wrong. Whilst you are less likely for the sale to go through, you still get people who cant or won't complete. who delay payment and completion. I do know all about the safe guards put in, but this does not prevent people smply not paying. We would not need the court system to sort out the disputes if your statemnet were true.

All fools should remember, 'in life only death and taxes are guranteed', nothing else