One of the questions landlords with one rental property ask themselves most often is: “Should I buy more?”. Building a property portfolio sounds attractive — and there is no doubt it can have financial benefits. But there are also big holes down which the unwary property investor can fall.
This article offers great tips for how to build a property portfolio from your first rental to letting three (or more) properties. But remember, everyone’s situation is different, so be sure to seek independent financial advice to ensure that growing your portfolio fits in with your wider financial needs.
What is Your Goal?
Before considering how to build your property portfolio, you must be clear about why you are doing it. Maybe you have taken a look at interest rates and decided property is the best place for your money to be for the middle-term. Alternatively, you may be enjoying the income from your first property, but realise you will need several to fully finance your retirement.
The best thing to do is work backward from your goal. Calculate how much money you need (per month for retirement, or in annual gains if investing in property to sell later), then work out how many properties you will need, and how well each will need to perform.
If your goals seem achievable given how well property is likely to perform, then let’s look at your options.
Financing to Build a Property Portfolio from One to Three
The most common way to expand your property empire is by refinancing your first rental. This means borrowing money secured by the equity you own in your existing property. Assuming you don’t have a spare lump sum of cash laying around, you will need to raise most of your purchase prices with buy to let mortgages.
Even if you have the cash, using it all to purchase one or two homes still may not be the most sensible approach. Yes, you don’t have to pay back loans, giving you more income, but you will have gobbled up your liquid capital.
Refinancing your first rental
When looking to buy again, you can usually find buy-to-let finance that extends to 75% of the property value (this is known as loan to value (LTV) ratio). Your aim is to find the remaining 25% to use as a cash deposit, plus purchase fees, like stamp duty, and any costs for bringing the property up to rental standards.
Let’s look at an example of someone refinancing one rental property in order to release enough cash to buy two additional rental properties. For simplicity, we will assume your existing rental and the two properties you intend to buy are worth £150,000 each.
As mentioned, 25% is a normal deposit size for a buy-to-let mortgage. For a property worth £150,000, that means a deposit of £37,500 for each of two new properties. This totals £75,000, plus costs. If you’re lucky, you can release built-up equity in your first rental. That, too, is worth £150,000, but your mortgage might be small as you have been paying it off and hopefully the property has benefited from capital growth.
Let’s say your current mortgage is down to £50,000, meaning you have £100,000 of equity in the property, whose value is £150,000. If you remortgage at the standard 75% LTV, then you would receive 75% of the value of the property in cash. That’s £112,500.
Because you still owed £50,000 from your previous mortgage on the property, you would subtract £50,000 from the cash you received when you remortgaged, leaving you with £62,500. Meanwhile, the rent you collect from your first property will be used to cover the payments on your remortgage, with some money left over.
The deposit for each of the two new properties you hope to add to your portfolio are £37,500 each, or £75,000 in total. You have found £62,500; but how will you find the extra £12,500 you need?
Refinance your residential mortgage
In many cases, you can remortgage your primary residence (i.e. your home) to release some extra cash. Speak with your provider, because there may be conditions attached. And while a tenant might be paying down your buy-to-let mortgage, you have to pay off this one yourself. A personal loan over a shorter repayment period is another option, but securing the loan against a property will usually give you better terms.
Cash or Credit
If you have the savings or cash in other investments, this is the easiest route to finding your remaining balance. You might also consider putting it on a credit card, though you must have a plan on how to repay it because the interest will be far higher than other loans.
You might consider bridging in limited circumstances, where you get finance over the short-term and then pay it back in full, plus interest. Most people only do this if they are buying a property to which they expect to add significant value quickly. This way, they can sell for a profit and repay the bridging loan. Or they can add the value and then refinance with a higher buy-to-let figure that will also repay the bridging loan. Take independent advice before taking out bridging loans.
Financial Implications to Consider
You will only get the finance for your new buy-to-let properties if the lenders consider them a good enough investment. To be sure their money is safe with you, they will want to know how much rent you will get and establish that you have the security in place to cover void rental periods.
Assuming you get approval, you must also ask yourself some searching questions:
- Can you afford incremental rises in interest rates across multiple loans?
- Have you worked out your new costs and income tax liabilities in full, including your landlord expenses?
- Will you use a management agent to look after finding tenants and claiming rent? If so, have you factored in their fees?
- Might you have been better off investing your spare cash elsewhere?
You must be honest at every turn because doing so can help you avoid expensive and painful lessons down the line.
Interest-only or repayment mortgages?
Assuming you have gone down the buy-to-let route, have you considered getting an interest-only loan? While this will give you more income, your loan never reduces. When it comes to the end of the term, you must repay it in full, or remortgage again.
You also run the risk of there being a property price dip. In this case, you could be in negative equity because your mortgage balance never decreases; the house value could fall below your outstanding mortgage.
With a repayment mortgage, you pay off the monthly interest and a capital sum. Therefore, your mortgage arrears reduce every month until you finally pay it off at the end of the term. While you take a hit with more significant payments, you build extra capital equity in the property each month, helping you refinance again in future for your next phase of growth.
How to Build a Larger Property Portfolio
If you’re thinking of five or more properties, you might wish to consider incorporating a limited company and channelling all the purchases through it. There may be tax savings in doing so. But running a company also brings more regulation and red tape.
If considering this move, you should seek professional advice. In general, you should always start small, and don’t try to run before you can walk. You will likely make mistakes along the way, so going slowly means you can adapt before a small mistake becomes a big one.
Also, always buy at a good price, giving you wiggle room to spend a little cash to add more value. The more added value you have in the property, the easier it is to leverage the equity you have in it to invest in the next purchase.
As a final piece of advice, we would recommend buying local where you can. It’s much easier to have all your properties within easy reach where you can keep an eye on them. It also means you can always use local builders and tradespeople, plus you can build a good working relationship with local buying agents – ideal for getting information about properties before they go on general sale.
Seek Advice, Reap Rewards
We cannot stress enough how important it is to seek advice before jumping into the market to expand your portfolio. Speak not just to your financial advisor but also, if you have one, your accountant. Then chat with other landlords and agents to get a feel for your local market.
With the right advice, you will make smarter decisions, and get the maximum returns for your investments.