London is the largest and most dynamic city in the UK and it is home to a disproportionate number of the UK’s higher paying jobs. As a result it has a thriving property market for both sales and rentals. Demand typically outpaces supply leading to faster rental and sale price rises than elsewhere in the country.
The dynamic market and high prices provide ample scope for development projects while ever-increasing demand for property creates an ideal environment for buy-to-let investors.
Buy-to-let investors treat property rather like a blue-chip stock in that they hope for long-term capital growth alongside the regular ‘dividend’ payments generated by rental income. Investing in property has the added advantage of owning something tangible and is often perceived, rightly or wrongly, as safer than investing in financial instruments.
In this blog post, we review the data over the past 10 years to determine which buy-to-let strategies would have led to maximum Return-on-Investment (ROI).
Capital Growth in London (Jan 2010 to Feb 2020)
Over a ten year period, capital growth is likely to provide the bulk of any ROI so we started by identifying the best and worst performing locations.
Using the Bricks&Logic Index we were able to analyse sales prices in every area of London over the past 10 years to identify the best and worst performing areas for capital growth.
London postcode areas have performed very differently over this period. We discuss the varied reasons behind this in a previous blog post:
London property prices over the last 10 years
Leyton in E10 was found to be the best-performing area in London over the past 10 years with an average price increase of nearly 120%. South Kensington in SW3 was the worst-performing area with an increase of just 15% (Figure 1).
We then looked for the best and worst rental yields within those areas and set our initial pot at £200,000 in cash.
|Annual rental income||10 out of 12 months of Bricks&Logic estimated monthly rental price. The remaining 2 months cover agent fees and small refurbishments.|
|Legal fees||£2,000 per property per purchase.|
|Stamp Duty||Rates applicable at time of purchase.|
|Interest on cash||1% per annum on any cash held.|
|Tax on income||All rental income after costs subject to 40% tax.|
|Mortgage rate||1.5% above Bank or England (BOI) base rate|
|Mortgage amount||75% Loan to Value (LTV)|
|Mortgage fee||1.5% of mortgage value.|
|Tax deductions||100% of mortgage interest tax deductible until Jan 2017, 50% thereafter.|
|Re-finance||Every 2 years at 75% LTV|
Worst and best ROI scenarios
|Worst Scenario||Best Scenario|
|Type||1 bedroom period flat||3 bedroom ex-council flat|
|£650,000||4 x £180,000|
|Stamp Duty & legal fees|
|Total cash spent|
|Gross rental income|
|£1,900 pcm||4 x £975 pcm|
= £3,900 pcm
|Monthly Net Income|
(Jan 2010 - Jan 2020)
(35% after inflation)
* We’ve taken best-case assumptions with the very real risks for landlords and assumed no gaps in tenancy or any major works required and successfully achieving the Bricks&Logic rental estimate every year.
Both scenarios return the same overall value until 2013 with the additional capital growth in SW3 offsetting the additional rents being received from the cheaper, higher-yielding properties in E10.
However from 2013 onwards, the rapid price growth in E10 enhanced by leverage and reinvestment (more below) and the poor (and after 2014 declining) performance in SW3 leads to a massive divergence by 2020.
The power of leverage, reinvesting and resulting compound growth
We have shown that investing in property in London’s North East 10 years ago would have proven to be a very wise investment. But how much of this £2M profit was down to leverage (and therefore additional risk) rather than capital growth, with rental income staying safely in the bank?
We can illustrate this by looking at three more scenarios where all the properties purchased are 3 bedroom ex-council flats in Leyton.
|Scenario 2A||One flat purchased in 2010 for £180,000 with no mortgage|
|Scenario 2B||Four flats purchased in 2010 and re-mortgage every 2 years but leave cash in the bank|
|Scenario 2C||Four flats purchased in 2010, re-mortgage and re-invest every 2 years|
Leverage v No-leverage (Jan 2010 - Jan 2020)
So had we a crystal ball in late 2009 and the capital to get started, we would have enjoyed some truly spectacular returns by the start of 2020 with £175k in the bank, a healthy monthly net income of £10,750 and a portfolio with a capital value of £8.3M, comfortably in excess of its debt of £6.2M.
Furthermore, while the property market faces some uncertainty as we come out of Covid-19 lockdown, interest rates are very unlikely to start moving up for quite some time so this debt would likely remain very manageable.
It’s worth noting of course, that had we a crystal ball, we could have made many times these returns in other markets.
Of course, we didn’t have a crystal ball and these returns rely on very fast capital growth in our chosen area and low mortgage rates allowing us to reinvest aggressively.
Had the UK recovered more quickly from the last recession and the Bank of England rate moved back towards 4 or 5% , it may have reduced returns and higher ‘value’ property may have performed considerably better.
Had there been a sudden downturn in property values alongside a spike in bank rates, as has happened in the past, our whole portfolio could have collapsed.
Predicting the future is impossible but understanding the past is a good start.