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Buy-to-Let vs. Hotel Room investing… part I
July 31, 2018Article by Paul Avery
UK buy-to-let still offers returns on capital that are hard to beat, particularly in today’s favourable interest rate environment. But a string of regulatory changes and the spectre of Brexit are also making this a prudent time for investors to consider their alternatives – which is never a bad idea.
On balance, the great reasons to invest in the UK residential sector have not diminished, and far outnumber the recent challenges. But for those investors with a more cautious view on the present environment, and for others seeking an always-sensible dose of diversification, hotel rooms present a strong and quite different investment case.
Here we review the basics of buy-to-let and hotel room investing, and compare the benefits afforded by each.
Residential property is as safe as houses: an extremely stable, immovable asset with demonstrable profitability since records began. In the Federal Reserve Bank of San Francisco’s 2015 study of The Rate of Return on Everything, looking back from 1870 to the present day, property offered average annual inflation-adjusted returns of 7.05% – the highest return of all the asset classes measured.
In the UK, residential property is particularly lucrative owing to the immense shortage of supply, with the shortfall estimated to be widening by a further 150,000 units every year (Gov.uk). Its record for capital growth is impressive, with the average property appreciating by 224% over the last twenty years (Land Registry to May 2018). Yet capital growth is considered a happy bonus, with rental returns forming the substantial and dependable element of this investment class.
Rental yields for residential tend to be lower than for hotel rooms, student accommodation, and alternative asset classes within the property space, but the potential for capital growth is unquestionably higher because the market to sell is so liquid and homes are always in demand (that does not mean, of course, that prices do not go down as well as up).
Another key advantage of buy-to-let is the ability to leverage the investment. Because the market for buying and selling homes is so well-established, so is the market for mortgage financing – meaning that few investors struggle to obtain it. Typically, you can borrow up to 75% of the value of the asset, so that your return on capital employed (the income received, after deducting mortgage interest, expressed as a percentage of the amount of actual cash paid) can be very high.
For example, with a pot of £100,000, many investors elect to purchase four properties, depositing £25,000 in each, and letting the rental income pay off the mortgage debt, rather than buying one in cash. If each property cost £100,000 and produced £7,000 in gross rental income, the percentage return on capital by leveraging four properties at a 3% interest rate would be 19%, as opposed to 7% for buying a single property in cash. With today’s interest rates sitting comfortably below 2.5% for a buy-to-let purchase, the benefit of gearing is particularly attractive.
So buy-to-let offers potentially limitless returns with the security of owning a useable physical asset, and the flexibility to sell it at any point. But it also has some drawbacks.
There is a comparatively large degree of strategy involved in buy-to-let, with important decisions including whether to invest in new build or existing stock, HMOs, houses, or flats, where to buy, when to enter the market, and when to exit. This makes it slightly more hands-on than fixed investment products like hotel rooms, with their defined timeframes and minimal variation, but tenant-finding and day-to-day management can be as hands-off as an investor wishes, with various management options offered for a fee by lettings agents.
The market at the moment is characterised by prices that are rising, or have risen, faster than rents, meaning that yields are compressed in many of the obvious locations investors might wish to buy – like London, for example, with central Manchester and Birmingham appearing to be going the same way. So there is a need to look harder, beyond the old favourites, to achieve strong yields. Many investors find this exciting, but it is undeniable that the buy-to-let landscape doesn’t offer easy money the way it used to.
That is also a result of a string of regulations introduced by the previous government line-up, which attempted to free up the housing market for those who wish to buy, by disincentivising the purchase of second properties and investments. An additional 3% stamp duty tax, and the reduction of the ability to deduce mortgage interest costs from taxable income, are the main examples of this.
Buy-to-let: the verdict
The environment has become slightly more challenging of late, but none of these changes cannot be overcome with thorough research and smart decision-making. Moreover, the alternatives to property (for example FTSE stocks and shares) have become no more compelling in the meantime.
So buy-to-let remains an excellent choice for people with access to financing, who are looking for long-term growth or a nest egg in addition to ongoing income, and want the flexibility to have ongoing involvement or to pull their money out at any time. It is an established model in a stable market, with plenty of available information.
However, diversification is a central plank of investing and attractive new products are appearing all the time, so it is advisable for investors to look beyond the tried-and-true buy-to-let model. One of the more prominent alternatives is hotel room investing.
To be continued in part II…