Investing into a buy to let property is often a good decision, but it is wise to do your homework before you make a commitment. There are a number of ways that you can analyse a deal that are quick and easy, and this post will show you the best ways to find that diamond buy to let in a sea of also ran’s.
It’s All About Cash Flow
First and foremost, the numbers need to stack up. Put simply, your cash flow on a buy to rent property is what you have left after all of the expenses have been paid. So if your rental income is £1,000 a month and your outgoings are £800 a month then you have a positive cash flow of £200 a month.
Some people are tempted to factor in the appreciation of their properties into this equation. It is obviously a great thing when the value of your property goes up, but you cannot rely on this. It is best not to use it in any analysis that you do. Just treat it as a very welcome bonus if property prices continue to rise.
A good way to estimate cash flow is to assume that the expenses on a buy to let property, excluding the mortgage payments, will account for 50% of your rental income. This is best illustrated by an example.
Let’s assume that you are interested in a buy to let property that you know can bring you in £2,000 a month in rental income. The reason that you want to factor in 50% non mortgage costs, is because over the long term you have to take into account maintenance and other costs, and cover for vacancy periods where you will not be earning rental income.
So if your mortgage payment is £500 a month, you can fairly accurately predict a £500 monthly contribution to your net operating profit (cash flow). You may be thinking that 50% is a lot for non mortgage expenses, but experienced investors tend to use this for their calculations. Some months the expenses will be a lot lower and others will be higher.
Use Return On Investment To Assess Whether A Deal Is Right
Return on investment (ROI) is a concept that you really need to grasp, and it is pretty simple to do this. If you invested £1,000 over a year and you made £100 at the end of the year, your ROI would be 10%.
So if you put down a £30,000 deposit on a buy to rent property and you were able to realise £500 a month in net operating profit this would mean £6,000 per year. Your ROI on this deal would be 6000/30000 or a 20% return.
This ROI of 20% does not include any appreciation on your property, or any other factor such as tax breaks and other incentives. It is simply a “cash on cash” ROI. It is better to keep it simple like this, so that you can compare it with investing your money in other ventures.
Test The 1% Rule First
This rule states that you should be able to earn rental income from a property that is at least 1% of the price that you paid for it on an annual basis. So if your buy to let property will set you back £200,000, then you must be confident that you can earn at least £2,000 a year in rental income from it. It is recommended that the minimum monthly income on any buy to let property should be £200 a month.
You will want to use your own rule here. Maybe 2% is more comfortable for you, or possibly more. Whatever rule you make, if the buy to let property doesn’t pass this test then just walk away. This is a very quick way to analyse a buy to let property investment.