The National Landlords Association (NLA) recently surveyed 2,000 landlords and tenants and discovered that two fifths of landlords (some 40%) earn just enough from their rental property to break even.
This situation has potentially severe implications. If such a landlord were to experience an unforeseen emergency, such as a major repair or their tenant falling into rent arrears, they may find themselves in a vulnerable position – perhaps unable to meet the payments on their own buy to let mortgage.
These findings are particularly relevant in light of the recent estimation that some 30% of landlords are ‘accidental’ landlords, rather than professional property investors. Whilst larger-scale investors can often afford to have hedges in place to account for rent arrears and other such circumstances, this is not always tenable for individuals who own only one rental property.
The NLA said that landlords should communicate more with their tenants in order to reduce the risk of disputes over rent arrears. They also suggested that landlords should consider budgeting for arrears by assuming that as many as two months’ rent per year will be late or unpaid.
Accounting for rent arrears in your calculations
If you were to adopt the NLA’s rule of thumb that only 10 out of 12 months’ rent will be paid, you would need to alter your calculations when calculating the profit of your property.
When looking at gross yield, for instance, you would ordinarily divide your annual rent by the cost of your property. Assuming you charged your tenant £9,000 per year to rent your £150,000 property, your gross yield would be 6% (9,000 divided by 150,000 equals 0.06).
If adopting the more conservative outlook, however, you would first have to divide your annual rent by 12 and multiply it by 10. This would give you a rental return of £7,500 per year, and a yield of 5%.
When factoring in running costs in order to calculate the net yield, you would also have to account for this adjustment. If you are estimating your costs as a percentage of the rental return, do so before deducting the two months’ rent arrears. Assuming, for instance, that you anticipate running costs of around 40%, this will be 40% of £9,000 (£3,600) rather than £7,500 (£3,000).
Your net yield in this case will be 7,500 minus 3,600, and then divided by 150,000 to get 0.026, or 2.6%.
An alternative option is to consider the two months’ rent arrears as an anticipated running cost in the first instance; in this case, deduct 17% of your rent from the annual total.
The other main point to arise from the recent findings is the importance of communication between landlord and tenant. The Tenancy Deposit Scheme’s annual review for 2012–13 shows that the total number of disputes remains below 1%, despite having inched upwards; however, disputes only arise at the end of a tenancy when a landlord seeks to withhold some or all of the deposit, and this figure provides no indication as to the difficulties that may have arisen during the tenancy.
Discussing the results of the survey, NLA Chairwoman Carolyn Uphill urged landlords to carry out thorough checks on any prospective tenant. Whilst this does not guarantee that rent arrears will never be an issue, it does provide some assurance that your tenant is likely to pay their rent on time.
Ms Uphill added:
“In these situations, landlords should be sympathetic to their tenants’ needs.
“Part of this involves investing in good relationships with their tenants so that they are able to be open about any financial difficulties or future plans.
“If the landlord knows what’s happening, they can work with the situation.”
It is not encouraged to be intrusive in your tenants’ affairs; rather, attempt to develop a professional rapport and assure them that, should they encounter difficulties, informing you as soon as possible will be best for both parties. Tenants withholding rent very rarely do so maliciously; often, they are embarrassed, or hope to be able to rectify the situation without their landlord discovering that there was a problem.
For more information on good landlord practice, visit our Landlord Advice Centre; alternatively find out more about what to do when your tenant stops paying rent. To read about insurance policies that can help with rent arrears, visit our rent guarantee insurance page.