Thursday, 23 April 2020

Is cash king when it comes to buy-to-let property?

Title graphics with stack of coins‘Cash is king’ is an expression that has come back to the fore in these troubled times for a couple of reasons. The obvious one is where businesses and individuals are struggling with their cash flow and wishing they had some reserves to call upon. In another camp are those with cash on hand, looking to take advantage of falling commodity and asset prices.

In the 2008 financial crisis, cash certainly was king in the property market. As banks withdrew offers of lending, those with cash were able to purchase properties at reduced prices from those needing to sell.

In normal times however, whether you’re buying property with cash or a mortgage tends to make very little difference. There can be some leeway in negotiations if you’re a cash buyer, given the speed and certainty you should be able to offer compared to someone reliant on a mortgage, but most sellers will seek out the highest possible price, regardless of where that money is coming from.

The question then from the buyers perspective, is whether it is in fact better to buy with cash or a mortgage in the first place.

The mortgage relief changes to the tax system have nullified some of the tax advantages of using a mortgage to buy investment property, but that is still one side of things to consider.

The other, and historically the more impactful, is leverage. Put simply, (and ignoring all other buying costs) if you had £200,000 in the bank you could buy one £200,000 property outright. OR you could buy four £200,000 properties, using £50,000 of your cash on each as a 25% deposit and borrowing another £150,000 four times over from the bank, to leave you with mortgage debt of £600,000.

Using all your cash to buy one property means you don’t have to worry about paying a mortgage, so any and all rent received is pure profit. This is a pretty comfortable, low-risk place to be then. Meanwhile, with four properties you have four sets of tenants to deal with and four mortgages to pay. From that point of view it seems a no-brainer as to which route to take. BUT, this is where leverage comes into play.

If property prices increase by 10%, the cash buyer will see their one property increase in value by £20,000. Whereas the buyer using mortgage finance will see each property increase by £20,000, for an overall gain of £80,000, whilst their mortgage debt remains the same.
cash in, mortgage debt,  properties, value of properties, 10 percent house price increase
Record low interest rates are causing more people with cash savings to seek other investments such as property, rather than earning a pittance in the bank. Perversely though, those same record-low interest rates mean the leveraged buyer is earning much more on a monthly basis too from their multiple rents, as interest rates on the mortgages are also low.

From that point of view then, the no-brainer suddenly becomes a different question - how much risk do you want to take on?

Because, you need to bear in mind the financial crisis came about as people were overleveraged with too much debt. Once asset prices started to drop, the same formula of multiple gains in the good times started to work against them. And if rents drop (or aren’t paid) or interest rates rise, you may struggle to pay the mortgages; that would be game over - which is very rarely the case for the king with the cash…

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