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Using The Bank's Money

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I posted this on another thread, but after thinking about it a bit, would like to attempt to get a discussion going.

With BTL, there are a large number of factors controlling whether or not it is profitable. If we ignore capital appreciation, then one thing to consider is whether or not it costs you money to use the banks money (mortgage) to buy a house, or whether you make a profit from using the banks money. If the net rental income on a property is higher than the mortgage cost, then the landlord makes a profit on the portion of the house that the bank owns, the difference between the income received and the interest paid. If the net return drops down below the cost of servicing the mortgage, then the difference needs to be paid out of the return on the part of the property owned by the landlord, their investment. So in the latter case, the larger the mortgage, the lower the return (including negative).

As a rough estimate, assume that the cost of the mortgage is 5%. Then the net return needs to be 5% to break even. I'll estimate that including voids, maintenance, and other costs, the gross return would need to be 7%. Once gross yields fall below 7%, profiting from using other peoples' (the banks) money becomes a poor strategy.

Now, if we have an interest rate rise, the effects of this rise will be different depending on what degree a landlord is leveraged. If the landlord owns the property outright, then interest rate changes will make no difference to them, apart from increasing the degree to which they can out-compete highly leveraged landlords. But a landlord with a 90% mortgage will feel considerable pain. If the mortgage rate rises 0.25% from 5% to 5.25%, and they have a net yield of 5%, then previously they were getting 5% on their investment. To make it clear, I'll say that the property is worth 200K, of which 180K is the mortgage, and 20K the landlord's equity. They are receiving 10K per year net income from rent. They are paying 9K per year interest on the mortgage. If the mortgage rate goes up to 5.25%, then the amount of money paid to service the mortgage goes up to £9450, and the amount of profit is reduced to £550, or just over half. If there are two more interest rate rises so that the mortgage rate rises to 5.75%, then the cashflow goes negative. If I was a highly leveraged landlord, then I'd be scared by any interest rate rises, as each one would cut into income considerably. And one rise will probably create the sentiment that others will be possible.

So if we start talk about BTL landlords heading for the exits, then not all landlords will be equal. Highly leveraged landlords are going to be in a much tougher situation than others. They are more exposed to additional costs due to interest rate rises, and where house prices are decreasing, they are exposed to the full extent of the price decrease, not just the capital loss of the portion that they own.

So, highly leveraged BTL landlords to be the first ones to panic?

Billy Shears

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If they don't walk to the door themseleves, i'm sure someone will force them - like the banks!


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Judging by the number of chain free properties which were not BTL properties, simply vendors unable to sell, but desperate to move to secure their next property so the chain doesn't fall through (there are three like this within half a mile of here and those are the ones with the biggest price drops) - I think we might also see a little desperation in the way of "forced sales" (forced price reductions) here too.

Given how the market has slowed here to the point where almost nothing ever sells (but the VI press probably tempted those vendors to believe that a sale would not be far away and it was a reasonable thing to do) and people have been trying to sell for three years now, something has to give eventually with two mortgages to pay.

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