Buy-to-let: Risk or return?
Investors are increasingly using residential property occupied by third parties as a means of investment: Buy-to-let is becoming popular. This is illustrated by the 2020 Credit Suisse real estate study. Find out whether buy-to-let investment is worthwhile and what risks you should factor into this form of investment.
Private investors turning their sights to real estate investments
Driven by the current environment of negative interest rates, many private investors are following the example of financially savvy investors and participating in the real estate market. This is illustrated by the 2020 Credit Suisse real estate study. The key phrase here is buy-to-let: Private investors purchase residential property in order to then rent it out.
They mainly buy condominiums, and sometimes single family dwellings. Direct real estate investment gives investors the final say and allows them to obtain sizable returns thanks to low mortgage interest rates. Its popularity is reflected in the numbers: In 2019, one-sixth of all newly owned properties were rented out.
Buy-to-let financing steadily rising since 2004
Share of buy-to-let financing out of all new mortgage contracts by segment, in CHF.
Source: Credit Suisse
Last data point: 2019
Returns on real estate vary significantly from region to region
Buy-to-let properties are most frequently found in city centers and their suburbs. But beware: Buy-to-let investments do not generate a positive return in all cases. The ratio of local residential property prices to locally achievable rents is crucial. Real estate is so expensive in some sought-after locations that only minor returns are generated. That's why it's important to carefully examine the local market conditions before investing.
Is buy-to-let worthwhile? An example.
This simplified sample calculation compares income and expenses for a buy-to-let investment in the municipality of Dietikon (canton of Zurich). The purchase property is priced at CHF 1 million and is an average new-build apartment with 4.5 rooms and 110 square meters of habitable floor area. The monthly rent for an average new-build rental apartment of the same size is CHF 2,400.
Deductions:
- Mortgage interest (66.7% debt financing; 1.2% interest rate)
- Tax costs (household income of CHF 250,000)
- Operating costs (4% of rental income)
- Maintenance costs (6% of rental income)
- Repair costs (10% of rental income)
- Allowance for vacancy risk (2% of rental income)
This leaves an annual profit of CHF 9,100.
Based on the use of CHF 333,000 in equity capital, this is equivalent to a 4.3% return on equity in today's negative interest rate environment (2.7% after taxes). Future increases in value that are not reflected in the calculation above are also anticipated in a central location such as Dietikon.
Income and expenses for a buy-to-let investment
Simplified case study for the municipality of Dietikon (canton of Zurich), in CHF per year.
Source: Credit Suisse
Last data point: Q3 2019
Real estate investments involve risks
Even though the sample calculation above looks appealing, it is merely a snapshot. The following potential risks should certainly be considered as well when deciding whether to invest.
Risk factors of a buy-to-let investment
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Rising interest rates
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In the future, rising interest rates could greatly reduce potential profit or even turn it into a loss.
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Lack of geographical diversification
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89% of private investors own only a single buy-to-let-property, leaving them susceptible to regional imbalances.
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Vacancy risk
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Vacancy leads to a loss of rental income and immediate income problems.
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Illiquidity
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Selling a residential property takes time and money. Short-term sales are only possible with financial losses, if at all.
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No sole ownership
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With condominiums, prior consent from the co-owners is required for structural changes and renovations. Any conflicts of interests will result in delays and additional costs.
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Personal outlay and costs
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Since it is often not worth it to hire external management, owners are forced to take care of the rental themselves. If insufficient provisions are set aside, renovations and an upkeep backlog can become a challenge.
Demand for buy-to-let will remain high
Despite increasing market risks, buy-to-let properties will remain in demand in the future. After all, as long as the environment of low interest rates persists, purchasing residential property in search of returns will still be attractive. Excess supply in the rental apartment market is likely to continue to rise, however.
Investors should make sure a buy-to-let property is marketable in order to be competitive and prevent vacancies. This involves not just the location, but also a suitable standard of construction and a floor plan that meets the preferences of today's consumers.
