Rising interest rates are squeezing returns for buy-to-let investors and anyone considering entering the market now should think carefully about how they are going to make money.

The UK´s long-running property boom has resulted in thousands of people becoming first-time landlords, as they try to find alternatives to pensions or simply want to ride the wave of rising house prices.

The number of buy-to-let mortgages jumped from nearly 702,000 in 2005 to almost 850,000 at the end of 2006 - an increase of more than 20 per cent - with many more people still keen to jump on the buy-to-let bandwagon. Similarly the amount advanced to landlords in 2005 reached £24.5 billion, but that had risen by more than half to £38.4 billion in 2006.

Mortgage lenders traditionally required a ‘buffer’ of rental income cover in excess of the mortgage interest repayments. This was 130 per cent between 1998 and 2004 but fell to 127 per cent in 2005 and 125 per cent in 2006, according to Council of Mortgage Lenders (CML) figures. This suggests that landlords are stretching themselves further in a bid to try to make money from their investment, and that lenders are becoming more lenient in the way they apply their criteria.

This is a situation that needs to be observed. Certainly, any would be buy-to-let investor needs to do the sums carefully. This year interest rates have risen four times, so landlords with variable rate mortgages will be facing more expensive repayments, while new borrowers will find it harder to meet the lenders´ criteria.

There are mixed signs from the mortgage market. Some lenders have tightened criteria whilst others have made the terms much more flexible with easier access to the market for all investors.

Quite simply, as with any investment, it is very important to plan. Use spreadsheets to assess all the variables. Values, mortgages and rental yields all have a variable factor. Rental yields will automatically go down when interest rates rise, unless landlords have protected themselves by using fixed-rate deals to keep their payments constant.

Unfortunately rental income is not linked to the Bank of England base rate, so you cannot simply put up the rent to cover any increase in mortgage repayments.

Rental yields depend on a variety of factors, including the area where your property is located, the local demand for rental property and even the type of property. New build apartments offer easy access to the market for the overseas investor. Inclusive packages that consist of guaranteed rental periods and provide furniture packs can ease the stress. It is important to check that the value for the new property is accurate.

As well as checking the value, a would-be buyer needs to look at the rental yield forecast and also associated costs. If you choose to use a management company to deal with your property, you can expect to pay between 10 per cent and 15 per cent for the privilege - a cost you can claim against tax on your self-assessment return, along with any maintenance costs. If you do clear a profit after deducting mortgage interest and other permitted expenses from the rent, tax will be payable on the surplus.

But if you have not built any margin for such costs into your rental income, you will be out of pocket.

There is nothing wrong with being out of pocket – as long as it is part of the plan. Certainly, not making a profit is very good for tax efficiency planning. Some landlords prefer to have a shortfall between the rental income and the mortgage. Or having one property making a profit and another making a loss can add balance to a portfolio.

These are the more sophisticated investors who are in buy-to-let for long-term capital growth rather than short-term income, so are happy to do this and see it as being a bit like contributing to a pension on a monthly basis. In effect, their property is their pension.
Although house price growth is starting to slow in some areas, if you hold the property for 20 or more years it should appreciate in value and you will be able to release cash for your retirement.

Although the recent rate rises do not suddenly make buy-to-let a no go, would be landlords need to do their maths carefully to make it a profitable exercise. If you are looking for capital growth for the long term rather than monthly income, then simply covering the monthly costs might be acceptable. Think and plan long term.


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