Buy-to-Let

Index Q4 2014 - New Entrants Need Expert Guidance

Commentary by Brian Hall - founder of The Model Works:
"Five year, geared, buy-to-let investments have continued to provide excellent profits with an annual
rate of return of 11.28 percent last quarter. This is the fifth quarter where returns have exceeded 11
percent. Once again, these returns are principally a result of continuing property price inflation.
Compared with recent history, when returns fluctuated wildly following the credit crunch, returns
have now stabilised at a relatively high level, compared to other forms of investment. Even without
the effects of gearing, cash buyer landlords saw returns of 5.93 percent over the same quarter.
Pundits in the buy-to-let sector see further growth in 2015. Our figures suggest the market is
continuing to offer consistent returns. However various factors could cause this to change.
Amendments to the pensions system from April may cause an inflow of cash buyers, triggering an
asset price bubble in an already overvalued market. This would result in further capital gains for
established landlords in the short term with other, perhaps unforeseen, effects subsequently.
The graph below expresses quarterly five year, geared and cash investor buy-to-let profitability levels
since Q4 1987, and five year property price inflation levels expressed as a compound annual rate.

50.00%
40.00%
30.00%
20.00%
0.00%
-10.00%
-20.00%
-30.00%

Q4 1987
Q1 1989
Q2 1990
Q3 1991
Q4 1992
Q1 1994
Q2 1995
Q3 1996
Q4 1997
Q1 1999
Q2 2000
Q3 2001
Q4 2002
Q1 2004
Q2 2005
Q3 2006
Q4 2007
Q1 2009
Q2 2010
Q3 2011
Q4 2012
Q1 2014

10.00%

-40.00%
-50.00%
House Price In;lation

Interest Only

Cash Investor

This graph highlights the volatility of the market, particularly for geared investors. Between Q1 1992
and Q1 1996 an average five year, geared investor would have found themselves in negative equity.
The reason for these losses was a boom and bust in the market caused by mass buying following the
telegraphing of the end of joint MIRAS in August 1988. Buy-to-let investors buying at the peak
suffered the consequences selling five years later. There are parallels between this influx of new
buyers and the possible influx of new buy-to-let investors following changes to the pension system.
The boom and bust of 1988 was followed by interest rate spikes as a result of Black Wednesday in
September 1992. It took the market 10 years to recover. Such huge fluctuations seem unlikely today
but rising rates are definitely a factor to be considered when making investment decisions.
Prospective new entrants to buy-to-let must consider all the issues. Most would benefit significantly
from professional guidance from experts including mortgage brokers. History tells us that periods of
stability, like the one we are currently experiencing, are the exception rather than the rule."
Our index uses Bank of England, Nationwide and Association of Residential Letting Agents data to
calculate the historic returns over 25, 20, 15, 10, and 5 year periods, for a cash buyer or a geared
investor, with a repayment or an interest only mortgage, selling today.

The Model Works 24 January 2015

Buy-to-Let Index Q4 2014 - New Entrants Need Expert Guidance

Repayment Geared Investor
5 Years

10 Years

15 Years

20 Years

25 Years

Purchase Price

136,822

126,059

61,191

38,912

46,707

Opening Balance
Closing Balance

-36,258
-45,042

-33,406
-52,437

-16,216
-1,057

-9,923
19,276

-11,910
-8,351

Selling Price
Redemption Amount
Closing Equity

162,856
-92,203
70,652

162,856
-72,259
90,597

162,856
-26,879
135,977

162,856
-10,248
152,607

162,856
-710
162,145

61,869

71,565

151,135

181,805

165,705

170.63%
11.28%

214%
7.92%

932%
16.05%

1832%
15.65%

1391%
11.11%

5 Years

10 Years

15 Years

20 Years

25 Years

Purchase Price

136,822

126,059

61,191

38,912

46,707

Opening Balance
Closing Balance

-36,258
-33,192

-33,406
-31,159

-16,216
13,351

-9,923
31,513

-11,910
11,121

162,856
-104,669
58,187

162,856
-94,544
68,312

162,856
-46,811
116,045

162,856
-29,768
133,088

162,856
-35,731
127,125

61,253

70,558

145,611

174,524

150,156

168.94%
11.06%

211%
7.76%

898%
15.76%

1759%
15.41%

1261%
10.67%

5 Years

10 Years

15 Years

20 Years

25 Years

136,822

126,059

61,191

38,912

46,707

-140,927
-115,792

-129,841
-78,145

-63,026
5,799

-39,690
38,223

-47,642
38,320

Selling Price
Redemption Amount
Closing Equity

162,856
162,856

162,856
162,856

162,856
162,856

162,856
162,856

162,856
162,856

Final Balance

187,991

214,551

231,681

240,769

248,817

133.40%
5.93%

165.24%
5.15%

367.59%
9.07%

606.62%
9.43%

522.27%
6.84%

Final Balance
Return (100% = Break Even)
Compound Rate of Interest

Interest Only Geared Investor

Selling Price
Redemption Amount
Closing Equity
Final Balance
Return (100% = Break Even)
Compound Rate of Interest

Cash Buyer

Purchase Price
Opening Balance
Closing Balance

Return (100% = Break Even)

Compound Rate of Interest

Gearing 75% LTV, arrangement: 2% of mortgage, provisions for arrears, voids and management, maintenance and
insurances: 2.5%, 5.75% and 15% of rent, interest at B0E rates, property prices from Nationwide, yields from ARLA

The Model Works 24 January 2015

Buy-to-Let Index Q4 2014 - New Entrants Need Expert Guidance

Methodology
The Model Works Buy-to-Let Profitability Index provides a simple, quantitative assessment
of the returns on investment in the private rental sector over time.

The index provides profitability data for:

5, 10, 15, 20 and 25 year investment periods

Cash buyers and geared investors with:

A range loan to value ratios

Mortgage types:
o

Repayment

Interest only

The index is published quarterly and provides profitability data back to 1983.
Future releases will include mortgage interest tax relief and capital gains tax calculations and
produce data on a regional basis.
In addition to the index, which provides historic data, a model based on systems thinking
principles will be published to project future outcomes.
This paper documents where the data is sourced and how the index is calculated.

Overview
The index is founded on the following source data:

House prices from the Nationwide Building Societyi

Mortgage rates from the Bank of Englandii

Deposit rates from the Bank of Englandiii

Rent and void levels from ARLAiv

Stamp Duty rates from HMRCv

Mortgage repayment and balance calculations are from Mortgages Exposed.vi

The index incorporates additional allowances for:

Mortgage arrangement fees set to 2% of loan

Provisions for arrears set to 2.5% of rental

Management fees set to 15% of rent

The Model Works 24 January 2015

Buy-to-Let Index Q4 2014 - New Entrants Need Expert Guidance

Structure
The index is based on two linked sets of calculations:

Capital Gain

Cashflow

The Index works back from the selling date. For example, if the selling date is Q2 2012 and
the index is calculating a five-year investment, the period under review will commence at Q2
2007. The calculation will take the average property price at this purchase date and any
stamp duty and acquisition costs that apply at that time. This will create a negative balance
on the buy-to-let investors account.
Rental income and deductions, including mortgage repayments, are calculated quarterly and
applied to the buy-to-let investors account, before the appropriate interest rate is applied
to the resulting debit or credit balance. Finally the index identifies the property price as well
as any selling costs, including the cost of redeeming any mortgage, at the selling date and
calculates the resulting closing balance. If the closing balance is greater than the opening
balance, this signifies a profit and the compound rate of return over the period is then
calculated. If the return is negative, then the word Negative is entered.

Comparisons
The Model Works Index differs from other buy-to-let indices in several ways. Most indices
concentrate on the net rental yield. A typical calculation will simply divide the annual rental
income by the initial property price to produce a yield figure, but this is inadequate on
several counts and the calculation excludes:

Mortgage repayments and the opportunity costs of using funds that could be
invested productively elsewhere are not incorporated

A raft of other acquisition, maintenance and management costs, voids and arrears
costs and selling costs are not taken into account

Generally other indices are far more optimistic and less volatile than that of The Model
Works, which takes more factors into account and applies true historic data rather than
assumed values.

Regional quarterly series by buyer type - First Time Buyers (Post 1983)
Post 1995 IUMTLMV, Bank of England, monthly, combined bank and building society (from 1983 to 1995 BSA Yearbook
2011-2012 New Mortgage %)
iii
Post 2009 BoE IUMB6RH, Monthly interest rate of UK resident banks (excl. Central Bank) and building societies' sterling
fixed rate bond deposits from households (in percent) not seasonally adjusted - 2 year (1996-2009 - BoE IUMWTFA, Monthly
interest rate of UK monetary financial institutions (excl. Central Bank) sterling fixed rate bond deposits from households (in
percent) not seasonally adjusted, 1995 - UMWTTA, Bank of England, monthly, sterling time deposits rates, from 1983 to 1995
BSA Yearbook 2011-2012 Ordinary Share %)
iv
Association of Residential Letting Agents - Buy to Let Review
v
www.hmrc.gov.uk/stats/stamp_duty/00ap_a9.htm
vi
www.mortgagesexposed.com/Book_Contents/Other_Formula.htm
ii

The Model Works 24 January 2015