Graham Norwood Journalism

So you want to be a property investor?

Daily Telegraph

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Buy-to-let may be the first casualty if the housing market goes belly up in 2008 but one leading analyst says new landlords can still do well - and has even calculated how much they should pay for a home and how much rent they should charge, too.

"You used to be able to buy a flat, let it without worrying much about rent levels, and rely on capital appreciation. But those days have long gone" admits Richard Donnell, research director at property consultancy Hometrack.

Now he says so-called 'Rational Investors' must forget capital appreciation and instead seek a minimum rental income. From that, everything else follows.

"He or she must firstly calculate the rent and annual yield required to make their investment produce a profit. That then determines the maximum they should pay for the home. That in turn decides where they should buy" says Donnell, a former head of research at Savills estate agency who now advises housing associations, developers, local authorities and regeneration quangos.

In research prepared exclusively for The Daily Telegraph, Donnell assumes a rational investor will want 7.5% annual yield - that is, will want to recover 7.5% of the purchase price of a property each year in rent, before tax. With this target in mind, Donnell has analysed:

• local property prices especially for two-bedroom flats, the typical rental home;
• demographics, especially where there are clusters of under-35s - the single young professionals, student and frustrated would-be first time buyers who end up renting;
• average income of renters and how much they would typically pay in rent.

Using this data Donnell has calculated how much his Rational Investor should pay for a two-bed flat in 15 locations across Britain (see box).

The results provide an easy guide for would-be landlords.

In Leeds, for example, they should buy a two bed flat for £124,800 or less and rent it for £180 per week - then they get that target 7.5% yield. For the same result in Brighton they should pay no more than £149,067 and rent for £215.

But investment buyers will have to know where to look in these locations to find properties on sale at these prices. The likely tenants at these levels will be frustrated first time buyers saving for a deposit, or students.

"Basically investors should ignore new builds in city centres and go to secondary areas and buy good quality second hand properties, either flats built a few years ago or conversions or older properties. That way they don't pay a new home premium and don't compete in a location over-supplied with flats to let" explains Donnell.

The problem with most big city centres is clear - there are too many flats.

Estate agent Knight Frank says 87% of homes in central Leeds are one and two bed flats with 40% privately rented. Some 70% of new homes in central Manchester since 2001 have sold to landlords. In Sheffield the figure is 65% since 2002, and there are similar statistics and trends from Liverpool and Newcastle, and to a lesser extent in Birmingham and Bristol too.

"An over-supply situation is unlikely to be corrected in the near future. Many buy-to-let investors have to top up their investment each month without the prospect of great capital gains" warns central Leeds estate agent Allsop.

Now other analysts are supporting Hometrack's contention that would-be investors should give up on city centres and head for the suburbs.

Mortgages for Business, a financial consultancy, says lenders are making it hard to get buy-to-let mortgages on new city centre flats. "Shrewd investors in 2008 will avoid this property type in favour of terraced housing in up and coming areas" says Mortgages for Business spokesman Jonathan Moore.

Veteran property investor Neil Coutts, a 61 year old semi-retired businessman from High Wycombe, has owned six buy-to-let properties since the mid-1980s and agrees with Donnell's analysis.

In 2004 and 2005 Coutts bought three apartments in Oxford, one of the 15 hot spots identified by Hometrack as still capable of turning a profit this year.

"One of my flats is a second hand unit in prime North Oxford and two were new and in the centre. That made sense back then but if I bought today I'd look at secondary areas. In Oxford this means Cowley or Headington, slightly less attractive but up and coming. They're now much better value than the centre or North Oxford" he says.

"New-build properties currently coming to the market in the centre are a bit 'toppy' - just too expensive to make sense for an investor" he adds.

Coutts says a key component of any landlord keeping their financial head above water in the current climate - where credit is being squeezed and personal disposable income for tenants is under pressure - is to hire a good lettings agency. He uses John D Wood and says any reputable agent of that kind is essential for checking prospective tenants' bona fides.

This 'tenant viability' as lettings agents call it is now crucial. One defaulting renter, leaving a flat empty for two months, will turn a profitable buy-to-let unit into a loss-making one. These narrow profit margins and the high cost of buying a suitable property to begin with, are deterrents to many prospective landlords.

"Would-be investors who've missed out on the impressive returns of previous years are now finding the hurdles to property investment are higher than they imagined" says David Stubbs, senior economist at the Royal Institution of Chartered Surveyors.

Today investors need an average deposit of £65,600 or 30% of a home's value; this compares with just £10,100, or 8%, six years ago.

"Existing landlords should be able to use equity from past investment properties to fund the deposit needed for new ones, which should ensure the buy-to-let sector does not dry up entirely" says Stubbs.

If buy to let does contract markedly it is feared it will trigger wider housing market volatility. This is particularly the case in urban areas where, according to figures from the Home Builders' Federation, the proportion of new-build homes that are flats - often designed with investors rather than owner-occupiers in mind - increased from 21% in 2000 to 49% by the end of 2007. As a result, prices of flats in centres with big over-supplies are falling fast.

"In two to three years this city centre over-supply will have been absorbed. The big test is to see if we can get to that stage without the rest of the market collapsing" says Richard Donnell.

"By becoming a Rational Investor you look to other areas, seek more modest returns than in the past but with more modest purchase prices too" he says.

That way you might make buy-to-let pay. And you might just save the rest of the housing market, into the bargain.

Where to buy - and for how much:

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