You’ll often hear property experts say that an investment property needs a different approach to buying a home to live in.
One of the reasons for this is because, when buying your own home, you may well stretch yourself to get the best - and highest-priced - property you can afford.
But with an investment property, a higher price does not always achieve your aim of a higher rental return.
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How cheaper properties can bring in bigger returns
This becomes clearer when looking at how a yield on a buy-to-let property is calculated, which - in simple terms - is to take the annual rent and divide it by the property value.
By increasing the property value in this calculation, the resulting yield falls.
In other words, if a buyer has the choice of two properties that produce the same rents, an investor can maximize their rental yield by choosing the cheaper priced one.
It seems obvious when laid out that way, but if you’re buying your investment properties with your heart rather than your head, it’s easier to go for the one that you personally prefer, rather than the one that will bring in the most.
It is perhaps no surprise that, in an era of tax hikes and tax relief reductions, landlords are looking to maximise their yield - and are doing so by buying cheaper properties. (Of course, if they are looking for capital growth, a different investment approach may be required).
Are investors buying cheaper properties?
Buying cheaper properties is exactly what landlords are doing, according to new research from Mortgages for Business.
They claim that the average buy-to-let property value was £391,008 in the three months from July to September last year. This figure has dropped by a significant £80,000 to £310,918 during the three months from April to June this year.
And yet the yields have remained relatively static, dropping marginally from 5.6 per cent to 5.5 per cent during the same time periods.
Steve Olejnik, of Mortgages for Business, said: “Landlords have been selective with their purchases this quarter, choosing properties that maximise their income with minimal investment.
“This strategy is likely to remain common as it allows landlords to maintain profitability while HMRC phases in restrictions on income tax relief for landlords.”
HMRC’s plans for landlords
In 2015, the then Chancellor George Osborne announced a series of measures that he claimed would rebalance the housing scales in favour of first-time buyers and away from landlords.
These included the introduction of a 3 per cent purchase on stamp duty payable on the purchase of buy-to-let properties and second homes, the scrapping of landlords’ wear and tear allowance and the phased reduction of tax relief on buy-to-let mortgage interest.
The first two changes are already in play, but the third is being phased in over the next few years and being replaced by a 20 per cent tax credit.
How do you choose your investment properties? Let us know in the coments.