Can you profit from buy to let?

How to calculate the costs and returns of buy to let (BTL)

Letting property can bring financial reward, but it’s important to do careful calculations about your returns and costs before you purchase a property to let. As an initial guide, you need to ensure that your turnover (ie rent) is in excess of the costs of buying, funding and maintaining the property. To do this, on average, your rent should exceed your running costs by about 25-30%.

To work out whether a property is likely to be a good investment, you need to work out all of the costs that you will incur and what the potential returns are. Start by correctly breaking down the costs including:

• the costs of buying the BTL property
• the costs of running the BTL property
• the costs of selling the property.

The costs of buying a property

As a rule of thumb, if you buy a property with a purchase price less than £250,000 the costs will be approximately 1.5% to 2.5% of its value, depending on whether you need to pay stamp duty or not. These costs include:

• mortgage set-up fees
• survey fees
• legal fees
• stamp duty (0% up to £125,000 and 1% from £125,001 to £250,000)

If you are buying a property worth more than £250,001, stamp duty will be at least 3% so you should budget between 3% and 4% of the property’s value.

In addition to these processing costs, you will need a deposit which is typically between 15% and 25% of the property’s value. Some new-build properties, especially city centre flats, currently require a deposit as high as 30%. This is due to the fact that mortgage lenders consider them higher risk following the credit crunch, and because there is an oversupply of flats in some areas.

The costs of running a BTL property

The running costs of a buy to let property can vary due to many differing factors. The highest cost of a BTL investment is typically the mortgage, so it is extremely important to make sure that you keep this as low as possible throughout your let. 

Take a typical BTL property worth £185,000. In this example, the capital requirements are:

• mortgage of 85% of £185,000 = £157,250
  
• deposit = £27,750
  

The ongoing financial costs will include:

• annual mortgage costs on an interest-only mortgage
  £185,000 at 6% interest rate = £9,435
  
• building and contents insurance = £338
  
• gas and electrical safety certificate = £150
  
• landlord’s insurance (bad tenants/damage) = £300
  

There will also be ongoing letting costs, such as:

• letting agent set-up fee = £200-£350
  
• cost of finding a tenant = 10% of annual rental income
  
• letting management costs = 2-5% of annual rental income

If you decide to manage the property yourself, you may be able to avoid the letting agent’s fees. However, you will still need to invest your own time to advertise the property, show tenants around and check their references and status. 

You will also need to buy or have a bespoke letting agent agreement and make sure you protect their deposit with one of the government-approved Tenancy Deposit Protection schemes. In addition, you will have to deal with any problems that occur during the let – whatever time of day or night. Typically it will cost you from £200 per property to do yourself. 

Whether you are letting via an agent or self-managing, it is essential that you have an inventory completed on check in and check out so that any disputes can be quickly cleared up. In some cases, the first check-in inventory fee is included within a letting agent’s set-up costs. Inventory fees vary but typically range from £75 to £150.

Miscellaneous costs

You may also incur other costs, although not necessarily on an annual basis. These can include:

• energy performance certificate – these cost between £50 and £100, but would be valid for 10 years
• deposit protection – depending on which scheme you use, this can be free, or cost around £35
• maintenance costs – these vary per property, but it’s wise to put aside £500-£1,000 a year for repairs.

Finally, you need to consider the fact that your property may be empty for a time. So it’s a good idea to budget for the loss of at least one month’s rent.

The costs of selling the property

When it comes to selling your buy to let property, there are a number of fees to consider, including:

• home information pack costs
• estate agency fees
• legal costs
• any removal fees.

As a rule of thumb, selling a property costs approximately 2% of the sale price where this is less than £250,000 and 2.5% for any sale prices over this amount.

Calculating the investment returns from BTL

Once you have all your BTL costs, it is important to ensure that your BTL property (or portfolio) is making a good return versus other types of investment, such as stocks and shares. To compare how well your property is doing, you will need to calculate the return on your investment – both on an annual basis and over the time that you intend to hold the property. 

The return is usually referred to as ‘yield’ and the way this is calculated can vary, but typically there are two methods that you need to consider:

• annual gross yield
• return on investment

Annual gross yield is an expression of the net income as a percentage of the capital investment. To calculate this, first work out your net rental income (the total rental income minus any letting costs). 

Then divide this figure by the amount of money you invested in the property including your deposit and any property purchase costs. The average annual gross yield for a BTL property ranges from around 4% to 10% depending on the type of let.

Return on investment is an expression of the total return, including all income and capital growth minus costs, as a percentage of your capital investment.

Once you have this information, you can then check whether these returns meet the financial investment objectives you have set yourself.

For more information on investing in buy-to-let property, including advice on mortgages, financing and insurance, buy the Property Investor's Handbook by Kate Faulkner.

 For information on the tax implications of buy to let, see our guide to tax basics.