With high property prices and low rental yields, buying to let in Britain is a lot of bother. But there is value to be found if you know where to look. Phil Oakley explains.
We've already made our views on buy-to-let pretty clear. In general, we don't think it's worth the hassle. To sum up, rental yields are too low. And that's because property prices are too high.
But, as several readers pointed out beneath my piece last week (Rising rents are a red flag for the property market), we based our views on average rents and average house prices. That's true: clearly, like most markets, the average level can be made up of high and low values.
For example, you might think that the stock market as a whole looks expensive and so you wouldn't want to buy a tracker fund, say - but that doesn't mean that some individual shares cannot be cheap.
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Probably not. In the stock market, one of the best money-making strategies is to look for shares where others don't, and to buy stuff that's unloved.
Large markets such as the FTSE 100 are too crowded to know anything of value that others don't. This means it can be difficult to make money. Moving further down the market value scale to smaller companies has often been a good place to invest.
The same logic can be applied to the property market. If you are looking to make money, then buying property in leafy suburbs from the local estate agent is probably not the best thing to do. So where can you find properties with decent rental yields?
There are a few places to look for bargains. Property auctions are a good place to start. Here you will find lots of properties that might be difficult to sell through more traditional routes.
They might be in poor condition, with problems such as subsidence, or they may have planning issues. Other examples are ex-council houses or repossessed properties. These types of properties could have the potential to be reasonable or even good investments.
Where are these properties?
I've had a look around some property auction websites and looked at the results of some recent auctions. One striking feature is that there are lots of investment properties up for sale - often with sitting tenants.
We know what these properties have sold for, and what their current rents are. So we can calculate the gross rental yield (before expenses or voids) on the selling price. The table below gives some examples of what we found.
Swipe to scroll horizontally
3-bed terraced
Grimsby
30,000
3,840
12.80%
July 2012
Terraced
Liverpool
55,000
6,300
11.45%
July 2012
Semi-detached
Morpeth
55,000
5,400
9.82%
July 2012
Flat
Stoke-on-Trent
40,000
4,760
11.90%
July 2012
Flat
Walsall
48,000
4,740
9.88%
July 2012
Terraced
Worksop
38,000
4,200
11.05%
July 2012
Flat
Leeds
70,000
7,850
11.21%
May 2012
Terraced
Manchester
54,000
6,000
11.11%
May 2012
Flat
Birmingham
29,000
3,700
12.76%
March 2012
Terraced
Manchester
60,000
6,000
10.00%
March 2012
Terraced
Manchester
60,000
6,900
11.50%
March 2012
Terraced
Sunderland
40,000
5,520
13.80%
March 2012
As you can see, there are some quite big yields out there. According to LSL Property Services, the average gross rental yield in England and Wales is 5.3%. On the face of it, it looks like you could get more than double that amount at auctions. But is that really true?
Well, it might be. But usually these properties need some work done to them. So the cost of getting the property into a decent state has to be added to the cost before you work out your rental yield.
As we said last week, when you take away all the other costs and factor in the possibility that sometimes the property will be unlet (the dreaded void' periods), your actual return can be a lot lower.
But there is one trait that these higher-yielding properties share. Most are in the north of England. And you won't find them in prime residential areas either. The cost of these properties reflects that. These are the kind of properties that unemotional, professional property investors are currently buying.
What auction prices reveal about the true price of property
What's even more interesting, though, is to compare the selling prices at auction with the previous selling price of the property. You can get this sort of information from websites such as Rightmove.com or Zoopla.com.
For example, the semi-detached house in Morpeth sold for £54,000 at auction in July this year. It had previously been bought for £115,000 in 2008 - implying a fall of 52%. A terraced house in Manchester selling for £54,000 in May 2012 had been bought for £100,000 in 2007 - a fall of 46%.
These examples highlight what we've been saying at MoneyWeek for some time now: the 'mainstream' property market (where most of us buy and sell our homes) isn't functioning because the banks and the government are trying to stop distressed properties from being sold. So prices aren't being allowed to reach clearing levels.
An auction, on the other hand, allows the market to do its job and set prices that buyers are willing to pay. So these properties and the yields they are selling for are more indicative of where house prices would be if the mainstream market was functioning. This is why we maintain that most properties in the UK which offer much lower rental yields are still overvalued.
Tips for the property auction
So we'd stick with our view that UK property is generally overvalued. We'd also note that these sorts of double-digit yields usually come with problems that only experienced landlords are likely to be able (and willing) to deal with and still make a worthwhile profit. And remember that if a value stock goes sour on you, you can sell it that day a property is a much bigger commitment.
But let's say you still want to buy a rental property at an auction. What should you do? Here are a few pointers.
1. Do your homework. Get the catalogue from the auctioneer and go and look at some properties. Find out about things such as structural issues and sitting tenants.
2. Get your financing in place. If you buy at auction, you have to complete the transaction within 28 days. Cash is easy but not a luxury that everyone has. Bridging loans can be expensive.
3. Find a solicitor that can work quickly.
4. Successful bidders have to pay a 10% deposit on the day plus fees to the auction house.
5. Look for bargains in unsold property lots. There can be good deals to be had from properties that do not sell. Unsold lots usually have a reserve price and often the auction house will be keen to complete a sale.
Recommended video
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Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.
After graduating with a MSc in International Banking, Economics & Finance from Liverpool Business School in 1996, Phil went to work for BWD Rensburg, a Liverpool based investment manager. In 2001, he joined ABN AMRO as a transport analyst. After a brief spell as a food retail analyst, he spent five years with ABN's very successful UK Smaller Companies team where he covered engineering, transport and support services stocks.
In 2007, Phil joined Halbis Capital Management as a European equities analyst. He began writing for MoneyWeek in 2010.
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