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Press Release 3-11-2014

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Q3 2014 Buy-to-Let Profitability Index
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  Buy-to-Let Index Q3 2014 The Model Works 3 November 2014 Five year, geared, buy-to-let investments have continued to provide excellent profits with an annual rate of return of 11.43 percent last quarter. This is the fourth quarter where returns have exceeded 11 percent. However, for many these returns are a result of continuing property price inflation. To understand what is going on and what might happen in the future, particularly in the volatile London market, we must look beyond the headline figures says Brian Hall, founder of The Model Works. 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 London Market The graph below expresses London five year, cash investor and geared buy-to-let profitability over the past 10 years and five year property price inflation levels expressed as a compound annual rate. Cash investors returns in London had been falling from the early 2000s until two years ago, when they began to recover. However, even taking into account overheads, fixed costs and provisions, cash investors have consistently made positive returns from buy-to-let. These have typically been higher than prevailing deposit rates and have not been wholly dependent on property price inflation. This is not the case for geared investors. The figures have been volatile and even gone negative on two occasions. This unpredictable behavior is a result of gearing (buying the investment with a mortgage) where the ups and downs of property price inflation and rental yields are multiplied. Given these facts, it is interesting to speculate what will happen if market conditions change, now property prices are beginning to cool, particularly for geared, buy-to-let investors buying today. Because geared investor returns are so dependent on rising property prices, perhaps the limiting factor to continued inflation will be the affordability of rising rents for private sector tenants. When the pension system changes next year, many will turn to buy-to-let. This may cause an asset price bubble, but it could also cause competition with an increasing supply of rental properties. Yields in London are already lower than the UK generally, at 4.37 versus 5.08 percent, according to the Association of Residential Letting Agents. With geared investments, even relatively small negatives in the profitability calculations can have a significant adverse effect. Prospective landlords need to consider the widest range of influencing factors when making their investment decisions.  Buy-to-Let Index Q3 2014 The Model Works 3 November 2014 Repayment Geared Investor 5 Years 10 Years 15 Years 20 Years 25 Years Purchase Price 128,732 120,796 55,618 39,027 49,039 Opening Balance -34,114 -32,011 -14,183 -9,952 -12,505 Closing Balance -41,194 -49,900 2,704 15,495 -18,356 Selling Price 153,490 153,490 153,490 153,490 153,490 Redemption Amount -86,641 -69,573 -24,582 -10,368 -759 Closing Equity 66,849 83,916 128,908 143,122 152,731 Final Balance 59,768 66,027 145,795 168,568 146,880 Return (100% = Break Even) 175.20% 206% 1028% 1694% 1175% Compound Rate of Interest 11.87% 7.51% 16.81% 15.20% 10.36% Interest Only Geared Investor 5 Years 10 Years 15 Years 20 Years 25 Years Purchase Price 128,732 120,796 55,618 39,027 49,039 Opening Balance -34,114 -32,011 -14,183 -9,952 -12,505 Closing Balance -29,919 -29,814 15,600 27,575 2,015 Selling Price 153,490 153,490 153,490 153,490 153,490 Redemption Amount -98,480 -90,597 -42,548 -29,856 -37,515 Closing Equity 55,010 90,597 110,941 123,634 115,974 Final Balance 59,205 65,089 140,724 161,160 130,494 Return (100% = Break Even) 173.55% 203% 992% 1619% 1044% Compound Rate of Interest 11.66% 7.35% 16.53% 14.94% 9.83% Cash Buyer 5 Years 10 Years 15 Years 20 Years 25 Years Purchase Price 128,732 120,796 55,618 39,027 49,039 Opening Balance -132,594 -124,420 -56,731 -39,808 -50,020 Closing Balance -108,011 -73,500 9,501 35,026 33,196 Selling Price 153,490 153,490 153,490 153,490 153,490 Redemption Amount - - - - - Closing Equity 153,490 - 153,490 153,490 153,490 Final Balance 178,072 204,409 219,721 228,323 236,706 Return (100% = Break Even) 134.30% 164.29% 387.30% 573.57% 473.22% Compound Rate of Interest 6.08% 5.09% 9.45% 9.13% 6.41% 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  Buy-to-Let Index Q3 2014 The Model Works 3 November 2014 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 o   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 Society i      Mortgage rates from the Bank of England ii      Deposit rates from the Bank of England iii      Rent and void levels from ARLA iv      Stamp Duty rates from HMRC v  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    Buy-to-Let Index Q3 2014 The Model Works 3 November 2014 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 investor’s account.  Rental income and deductions, including mortgage repayments, are calculated quarterly and applied to the buy-to- let investor’s 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. i  Regional quarterly series by buyer type - First Time Buyers (Post 1983) ii  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  
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