What is an acceptable gap between finance costs and rental income?

Discussion in 'General Property Investment Discussion' started by Longterminvestor, Oct 12, 2018.

  1. Longterminvestor

    Longterminvestor Administrator

    When looking at buy to let investments, what is an acceptable gap between finance costs and rental income? I would be interested to see some practical examples where possible.
  2. diyhelp

    diyhelp Active Member

    As a rule of thumb I work on 20% headroom, i.e. rent should always be 20% higher than finance and upkeep costs of a buy to let property.
  3. FWL

    FWL Member

    I think 20% is a decent rule of thumb but it can vary from project to project - its not set in stone.
  4. lookinginvest

    lookinginvest Member

    You need to be careful when calculating acceptable “headroom” because this figure will change over time. It is not simply a case of setting the “headroom” at the point of acquisition - you should be monitoring this on an ongoing basis. Also, if possible you should put the surplus income into a separate account for a rainy day.
  5. Longterminvestor

    Longterminvestor Administrator

    You need to monitor your "headroom" between income and financial liabilities as this figure will change over the years.
  6. Peter Davis

    Peter Davis New Member

    .When I started in the business over 35 years ago, my Bank manager told me that every property "had to wash its own face". What he meant by that is that the net rental had to be equal or above the total cost of interest the property had to pay Obviously one had to put down a deposit. If it was 20% of the total cost, then you would make a 20% profit assuming the net income and financing costs balanced Personally I used this money towards the deposit for the purchase of another property.

    This is not the fastest method and I was fortunate enough to run my own business which made money. I had a business overdraft which I used to find the deposit for another property. As the money I made from the business plus the surplus from my rental income reduced my overdraft quite quickly, I was soon able to fund another property. In addition, if and only if, I got a decent offer for an existing property, and it broadly meant that we could sell at a profit without any great CGT implications, we would take the money.

    Having an overdraft meant the money was working all the time and there was a reasonable window between being able to purchase a new property (as the overdraft came down) and having paid off the overdraft. Several times I did use money from my overdraft to reduce the amount of a loan on a property,thereby keeping the overdraft working.

    Remember the 3r's of property.

    There is always risk which you have to be comfortable with
    There is always responsibility which you cannot offload though many BTL's try to do.
    Finally there are the rewards, which always come after the other 2 r's.

  7. Longterminvestor

    Longterminvestor Administrator

    Hi @Peter Davis

    Well said - I could not agree more. Interesting to hear the term "wash its own face" as I heard this quite often in my previous career in stock broking. The bottom line is a BTL asset should cover its own financial expenses from rental income and a bit more for unexpected expenses. Any capital gains are but a bonus :)
  8. FWL

    FWL Member

    It probably makes sense to review your "headroom" on an annual basis just to make sure you have enough insurance in reserve. Remember, property investment is fluid and can change fairly quickly.
  9. Peter Davis

    Peter Davis New Member

    Disagree strongly that property investment changes quickly. It is long term and stable compared to other asset classes. Your income stream from existing tenants can change very quickly, but fundamentally the market rental rate has never yet gone straight to zero, unlike my shares in Northern Rock. Housing is one of the 3 necessities that all of us have and are prepared to pay for. In the spirit of the current season, I believe Mary and Joseph had problems securing a roof over their head even though they were prepared to pay

    When looking to invest everyone should be able to finance 18 months of mortgage payments on the property. You might need this if a tenant defaults. If they work the system and trash the property then it will be this expensive by the time you factor in time with no rent, court and professional eviction fees, and refurbishment costs.

    Headroom is purely theoretical whereas having to make those mortgage payments is not. If you own property, then over time, you will have to expect serious problems at some stage. Managing evictions is a skill nobody wants to learn, but it does affect your bottom line. See attachment. Before everyone panics with my Eeyore view, a very large percentage of rentals are problem free.

    Attached Files:

  10. Dan Veo

    Dan Veo New Member

    Depends, Estimating the rental income can be tricky. Your rental has to be competitive with other rental properties in its market. Find out how much similar nearby properties are renting for and adjust for things that make your property more or less appealing to a prospective renter. For example, if your property has a hot tub for the renters' use, that might add to your rental income. Take into account neighborhood desirability, proximity to schools, parking -- anything that sets your property apart from others.
  11. realdeals

    realdeals Active Member

    I have read on numerous occassions that when doing your income/cost figures you should work on 10 months rental income to give yourself a little headway on buy to let properties. Is this a cautious strategy any people have used?
  12. Peter Davis

    Peter Davis New Member

    Personally the problem has never been knowing the OMR (Open Market rental) or indeed getting good response rates. We normally use Gumtree and the views are never less than 250 in our area. Responses are typically 40-60. Whittling it down to 3 is not so easy, and the final choice is made using our best judgement. Hot tubs are not an item I have ever dealt with. All items supplied by the landlord have to be maintained by the landlord. The 2 top questions asked by renters are
    1. How much are all the bills?
    2. What is the Landlord like?
    We always get the existing tenants to show round prospective new tenants. What tenants want to know is if their boiler fails, when will it be fixed by?
  13. Peter Davis

    Peter Davis New Member

    Greetings to realdeals

    In 4 evictions I have never yet lost more than 7 months income. Very few people take on a property who are positively evil. What normally happens is that circumstances change and tenants mange their money and situation very badly. There are situations where it is cost effective to pay bad tenants to leave, rather than to go down the full legal route.

    You will never gain their sympathy. (You not only have your own home, but you are taking a very large slice of their net income every month, from a second property.)

    Personally I think 10 months income is a fairly safe position.It does of course depend on how much your mortgage is.

    The lowest risk approach is to buy yourself a very tired house and improve it, then sell it, and do the same again without moving upmarket. This will rapidly increase the equity you have. so by the 3rd move, you will need very little BTL mortgage. Further it will enable you to acquire skills. You can also keep all the gain with no CGT as it is your PPR.

    Ultimately everyone has to manage their own risk

  14. lookinginvest

    lookinginvest Member

    I have lived in rented accommodation when I was younger and was sent out on project work to other offices. In all my time I think I saw two bad tenants although in hindsight I think drugs might have been involved with at least one of them. Are you an active landlord or hands off?
  15. Peter Davis

    Peter Davis New Member

    I am active.

    Sadly the property business is full of incompetents and total amateurs.

    Most Estate Agents (though not all) are useless at managing properties. They ignore problems and fail to keep the landlord in the loop. Tenants then resent the fact they are being ignored, and hold a grudge. Last week I heard of a case where a Landlord visited a property that was being vacated by good tenants. All their reasonable complaints had been ignored by the Agents for years.They ended up doing the jobs themselves. The Landlord knew nothing of this.Not content with this, the landlord had no knowledge of 2 rent increases in the last 2 years. The extra money had not found its way to the landlord either.

    Good communications and relationships with tenants are key to success.

    Why pay someone else to do a job badly?

  16. Longterminvestor

    Longterminvestor Administrator

    I see where you are coming from Peter and the best landlord/tenant relationships I have seen have never involved agents. Being human, understanding and also business like is appreciated more by tenants than bland, none-descript communication which makes you feel like a number and not a person.

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