Money Makeover: Our experts are divided on whether Michael and Natalie should build their buy-to-let portfolio in London or in northern cities
Telegraph Money readers Michael Gilden and his girlfriend Natalie are in their 30s and ready to start a family. They are planning to have up to three children over the next few years – a move they know will hurt their bank balance.
The pair are based in London and have built successful careers in the arts. Michael is a house music producer who also has a full-time job as a postman, while Natalie is a self-employed sculptor who spends her days crafting intricate headwear.
They plan to leverage their income to the maximum to build a buy-to-let empire to fund their new family. They hope this will provide a steady income stream of £2,000 a month within two years so that Michael can give up his job as a postman and both can focus on their creative careers without worrying about paying the bills. He also has a small £20,000 share portfolio that he would be willing to liquidate to help with this plan.
Michael’s total income is about £40,000 a year as he earns extra from freelance projects as well as two music studios he renovated and now rents out. He makes £5,000 a year from the studios and describes running them as “hassle free”.
They live in Hackney in a property worth around £600,000 that Michael bought in 2010 for £320,000. However, they are about to downsize. In doing so, Michael will release £400,000 equity, which he will put towards his buy-to-let property portfolio. He hopes this will bring his maximum budget to around £750,000.
Natalie’s income is volatile and she has an “arty relationship” with money.
Michael said: “My previous occupation as a music producer and musician was risky. Now, as I move into a role as family provider, I see property investment as the best way to provide in the long term, and create a little more freedom for Natalie and me.
“Property makes the most sense to me as an investment – I’ve spent a lot of time trying to understand stocks and shares, and it feels quite counterintuitive, although I bought shares in Royal Mail and Gap and I did all right.”
Michael is considering buying three or four properties and is looking around Liverpool and Manchester, which he thinks offer good value.
He has looked into houses in multiple occupation (HMO), where you buy one property and rent it out to several people, but thinks it’s too risky. He is willing to accept risk, as long as he has the cash flow to cover investment losses.
Minesh Patel, financial planner at EAF Solutions, said: The most pressing issue for Michael is the repayment of his residential mortgage in 2016 guaranteed by his father. His current income of £40,000 is verging on insufficient to remortgage his property, as the maximum multiple is five times your income for mortgages, and he requires £210,000.
Michael needs to be aware that any buy-to-let property income he earns beyond £11,000 a year (the capital gains tax exemption for 2014-15) will be subject to CGT at either 18pc or 28pc, depending on whether he is a lower or higher-rate taxpayer in that year.
Rather than buying multiple buyto-lets in Liverpool and Manchester, has Michael thought about converting his current property to a buy-tolet mortgage? That would give him equity for a new home and he would be able to retain access to one of the most successful property markets in the world. Although other cities and towns in the UK are good markets for investing in properties, London’s reputation as one of the leading financial centres in the world, with its stability, means that property returns will always be strong.
They say they need £2,000 per calendar month in income. My initial estimate is that a two-bedroom flat in London rents for £1,800 per month. If this income was divided between Natalie and Michael, it would all be taxed at either nil or a lower rate of income tax.
If Michael invests mainly in UK residential property, his wealth will not be very diversified, as it will be concentrated in the UK. I would recommend selling the Royal Mail and Gap shares and investing the money in a Vanguard 100pc LifeStrategy Equity Fund, which he should hold in a stocks and shares Isa, which is the most taxefficient way. This is an index-tracking fund following equities worldwide, which would help his wealth to be less biased towards the UK.
Another safe bet for Michael would be to increase his workplace pension contributions to the maximum that his scheme allows. Pensions are efficient arrangements and Michael will obtain 20pc tax relief on the contributions. It would also be worth Natalie setting up a pension plan for herself.
I also think these two need to set aside more money for emergencies.
Ying Tan, managing director of The Buy to Let Business, said: My advice to Michael is be very careful. The buy-to-let sector is doing very well at the moment, but if he makes even a small mistake it could still prove very costly.
As a new investor you are right to avoid HMOs. While they can prove profitable, particularly in the student market, they can make things much more complicated and costly, with the need for HMO licences etc. The amount you can borrow is driven by the rental income, so it is vital you can identify a property with a good yield that rents out easily.
Buy-to-let rates are at the lowest for many years, and for the right property and the right person you can get rates below 3pc. Given you will have about £400,000 cash for the investment, I would recommend a deposit of 40pc. This is because rates are at their most competitive at this level, and it will ensure you have plenty of equity if the market stagnates in the future.
The rental market in the North West is particularly buoyant at the moment, especially in your preferred areas of Liverpool and Manchester, so I think you’re right to be looking to that part of the country.
A recent report into the property market in Liverpool found city centre property prices rose by 5.3pc in 2014, with average prices now back to prerecession levels. The average city centre apartment is now £147,800, while in the docklands that rises to £171,110. Elsewhere in the city, the average price is £90,000, with rents around the £500-a-month mark, giving an impressive rental yield of around 6pc-6.5pc. In Manchester, you could achieve yields closer to 8pc, with average prices around £105,000 and rents around £700.
By selling your London property and releasing £400,000 in equity from the sale, you have a very good starting point.
How to build a buy-to-let portfolio
Given you are happy to use borrowing, I think you are in a comfortable position to build your portfolio, Mr Tan continues. Bear in mind that a salary of £25,000-plus is usually the minimum requirement for most buy-to-let lenders. The exact lenders that will give you a mortgage depend on your wider circumstances. If you aim for properties priced around £150,000 with rents of £750 a month (a 6pc yield), funding with a deposit of 40pc or £60,000 would mean a mortgage of £90,000.
Rates are very competitive at the moment and, at 3pc, your interest-only monthly mortgage payments would be around £225. This would give you a monthly cash flow (not including other costs, such as repairs, service charges etc) of £525. Replicate this four times and you could achieve your target of £2,000-plus income per month.
You would have used £240,000 of your £400,000, giving you plenty of excess cash for further investment, a rainy day, decoration costs etc.
As Michael and Natalie are planning to start a family, I think it would be sensible for them to consider buying life insurance. Since they are investing so much time and money in building wealth, it’s equally important for them to identify ways to protect it. If they have spent years building a successful property empire, their family could face an inheritance tax bill of 40pc, which they would have to pay within six months of the death. This might mean they would have to sell the properties quickly, possibly at a discount. That is why it is important to look for policies that will offer protection against inheritance tax or forced sales of your portfolio if you die.