Buy-to-Let Viability Assesment

The government’s Private Landlords Survey 2010 showed that 69% of private landlords regarded the rental dwelling as an investment or pension.
ARLA’s quarterly review of residential investment asks landlords how long they have held each property for. Bearing in mind that buy-to-let mortgages only became widely available about fifteen years ago it is quite remarkable that the average length of time given in the most recent survey at the end of 2013 was 13.5 years.

Almost twice as many landlords expected to be buying further properties during 2014 than were planning to sell (25% compared with 13%). When ARLA asked how many years from acquisition they expected to keep the properties for, the average period was 19.9 years. This might indicate a 20 year discount period. It all depends on each individual landlord’s intentions.

Discounted cash flow has three variables: the amount invested, the discount rate, and the discount period. NPV calculates the amount that can be profitably invested. IRR calculates the discount rate at which the investment becomes profitable. The final measure is the ‘payback period’ which is the number of years a given investment would have to be held before it becomes profitable, ie the break-even discount period. It is much less commonly used than NPV or IRR.

In practice a buy-to-let landlord would most probably expect to sell the property on the open market when they wished to withdraw their investment. To include this, we need to estimate how much it might have increased in value by the time we plan to sell up, and add that amount, net of the costs of sale, into the cash flow at the end of the final year. We can then use IRR to estimate the full rate of return on the investment. Payback then becomes a very important consideration. It tells us how long we should expect to have to hold the investment before it could be sold at an acceptable level of profit.