31

I have been thinking about taking a loan to buy a flat which I would rent out. My reasoning is that the loan would be paid off over time by the renters. After perhaps 30 years, I'd be left with a free flat.

Obviously this sounds too good to actually work as easily as described because if it did then everyone would do it. What I'm looking for are the reasons why this idea is unrealistic in real life.

  • 3
    The way this is asked is too broad. This depends on the interest rates, tax breaks as applicable, projected rental income, potential appreciation, property taxes, property management, etc of the property, some of these vary widely. This needs to be done for a specific property to arrive at the decission. – Dheer Oct 25 '18 at 6:40
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    Being a landlord entails more than cashing a check every month. – Nuclear Wang Oct 25 '18 at 13:03
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    For what it's worth, people do do this. Generally it's houses, not apartments/flats, but it can and is done with both. Some people will start renting out their first home, which is purchased through a mortgage (a special kind of loan.) More generally, using debt to finance business plans with higher rates of return than the debt's interest rate is standard practice from the smallest single proprietorship to the largest corporation. – WannabeCoder Oct 25 '18 at 13:03
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    Renters don't pay off your mortgage, you do, from whatever money is left over from the rent payment after you have paid the property taxes and the property insurance and any necessary repairs. If the renters are late with the rent check, you are still on the hook for the mortgage payment to the bank: the bank will not accept the excuse that the mortgage payment is late because the renter is late with the rent check. – Dilip Sarwate Oct 25 '18 at 15:24
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    Might consider rewording the title, I came here thinking you were asking about borrowing money to rent a flat for yourself. – Michael Oct 25 '18 at 16:24
48

It is certainly possible and people have done it before.

However, I can think of a few risks/problems:

  • Market fluctuations: It might just happen that you buy when the market is up, and over time it goes down (both the price for buying and for renting). So you cannot cover your mortgage any more with the rent and have to chip in yourself, effectively overpaying for a property that is not worth much any more. If you are unable to cover the difference between mortgage and rent yourself, then the property might even get foreclosed and you are left with a loss.
  • People tend to underestimate renting- and property-related costs/risks. This can leave you with a non-viable operation (having to subsidize the operation with more than you can afford), be it because it is unsustainable in general or because you get into liquidity issues because of the unplanned costs. Examples of costs/risks:
    • Vacancies
    • Repairs
    • Tax payments
    • Non-payment/eviction of tenants
    • Legal issues and administration costs
  • You have to come up with a reasonable down-payment (depending on your own income situation, credit situation, etc.) yourself.
  • Building standards and styles change over time: The "free" flat you get after several decades might not be so desirable any more because the way it is built is sub-standard or out of fashion at that point.
  • Overpaying: The people who are actually successful at doing what you describe have experience and a sense for the market and the opportunities it represents. Not everyone has that.

Doable? Certainly. But it's not free money. You will have to put in effort to learn (outsourcing everything is expensive), to manage things yourself and to solve critical problems in a creative way. The chances of success also highly depend on the state and development of the market we are talking about, on taxes and regulations in your country, on your personal skills and on the effort you are ready to put in.

  • 20
    A specific example of "taxes and regulations" is that until recently in the UK one could count the interest one paid on a mortgage as an allowable expense for tax purposes. That has changed, and individuals can no longer do that (though companies can). This also highlights another risk: the rules of the game can change. – Martin Bonner supports Monica Oct 25 '18 at 13:27
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    @MartinBonner Is that a rule that applies to individuals vs. companies or residences vs. investment properties? In the United States, interest paid on rental property that I own individually is deductible as a business expense for that property, just like management fees. – chrylis -on strike- Oct 25 '18 at 15:52
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    @chrylis If you as an individual own a property you used to be able to offset mortgage interest (but not capital repayment) payments against the income and only pay tax on the profit. They changed that rule a few years ago but only hitting small landlords. The government's buddies with vast portfolios of rental properties owned through companies weren't touched but the rest of us are now paying tax on "income" that only goes to cover the mortgage interest. – Tim B Oct 25 '18 at 15:57
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    @TimB That's some impressively dishonest regulatory capture. – chrylis -on strike- Oct 25 '18 at 15:59
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    Vacancy is one of the big risks that is very noticable to me/my experience, just because you have the flat for rent doesn't mean anyone is in it. – Draco18s Oct 25 '18 at 20:27
26

I love this question on a few different levels. This is exactly how the majority of rental properties become available in many markets. If your landlord is a person rather than a property management company the chances are quite high that your rent pays their mortgage.

Why isn't everyone doing this?

  • There is a high cost of entry: rules around home loans are often much more favorable when purchasing your primary residence than rental properties. In Canada you can get a mortgage for 5% down on your primary residence but need to put 20% down for rental properties.
  • Vacancy is a major long run risk: how long can you float your property without a tenant. In the 5-20 year time frame the fortunes of a community can change drastically. If there is a glut of new flats built or if a major local industry dries up you may have a hard time finding renters leaving you to pay the bills out of pocket.
  • Major repairs: You need to have enough of an emergency fund available to handle a major unexpected repair. If you are unlucky that repair may come along with a vacancy and an unrentable unit. One of my good friends purchased his first rental house and in the third month drove past to find it abandoned and all of the windows broken out. He didn't have the money to immediately bring it back to rentable condition and so it sat boarded up for three months until he was able to scratch up enough cash to replace the broken windows.
  • Inconvenience: Being a landlord is different from other types of investments in that there is a very active component to it. Either you are paying someone to collect rent and do minor repairs which cuts into the profitability of your investment or you are doing it yourself which cuts into your free time.
  • Tenant rights: As per the excellent comment from vsz, a bad tenant can be very hard to get rid of. Where I am the laws are designed to be heavily in the favor of tenants. So much so that once someone stops paying rent it can take 4 to 6 months to be rid of them from the home and require legal fees, a sheriff fee for removing them from the property, up to 1 year of storage fees should any of their personal effects be left behind, and on top of that the people you are kicking out will not be kind to the property. I had a moron of a neighbor who rented his house out at well under market rate and got a meth dealer for a tenant. Between the process of kicking him out for non-payment and getting the house back into rentable condition he saw 2 months of rent in a 10 month period on top of the fact he had to pay thousands for repair. That whole tenant situation would likely take years of quiet uninterrupted rental to break even on.

It's a fairly common and successful investment strategy but don't oversimplify it. It's easy to get wrong and a lot of people have gone broke trying it.

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    What also many people underestimate is the problems with evicting nonpaying tenants. Depending on the jurisdiction, it can take a long time. Especially if the tenant has small children, is pregnant, has a chronic illness, and is a member of a protected minority. You might lose several months or year's worth of rent, and lawyer's fees you will never get back if your tenants are unemployed. And even if you win, you might be unlucky and be featured on the front page of a newspaper (or on a viral social media post) as the heartless greedy scum who put that poor starving family on the streets. – vsz Oct 26 '18 at 9:58
20

Here's a real life example: My tenant just gave their notice. We needed to redo the house completely after they moved out. Repainting, new carpets, various fixing up etc.

Even doing a lot of the work ourselves it still cost nearly £3000. In addition we couldn't start advertising for new tenants until that work was done which took a couple of weeks so it's now been empty for a month. Which means no income for that month. And no I couldn't take most of that from the deposit (we kept a bit back) as most of it was just wear and tear. After a few years things need replacing.

There's no guarantee as to when a new tenant will be found (we had one accepted offer but they never signed the paperwork and just ghosted the agency so we assume they went elsewhere) so it could potentially be sat there for any amount of time, but with me still paying the mortgage.

So it's costing me X per month. I'm getting no income. And I just had to splash out thousands of pounds to get it ready in the hope of finding a new tenant.

In addition to all that in order to get a decent mortgage I actually paid half the cost of the house myself. So I've invested thousands of pounds up front.

The return on investment for all that is actually reasonable over time. You need to be able to take the rough with the smooth though - it's certainly neither "free money" nor risk free.

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    If you thin kthat is renovation - I had a tenant die that lived in an appartment for 51 years (got the appartment with his contract). Had to spend around 60000€ in totally redoing it. We do not talk wear and tear - we talk legal. The wires in his appartment where not legal anymore for rental units (fabric covered alumium). We had to basically rip everything out (51 year old kitchen!) and... I get 4 tims more rent than the mortgage costs me ;) – TomTom Oct 26 '18 at 11:48
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    @TomTom Sure. I was describing what's to be expected every 5 to 10 years when renting - not worst case scenarios. The usual case is more useful to a prospective investor than the extreme cases, particularly when (I assume) in your case you took the project on budgeting for that renovation being needed once the current tenancy ended. – Tim B Oct 26 '18 at 13:18
8

People do, in fact, do exactly this. The reason why "everyone" doesn't do it, is that (generally speaking, in the UK) you can only get a buy to let mortgage for 75% of the value of the property. So if the property you are buying costs £300,000, then you could only borrow £225,000 - and would home to come up with an additional £75,000 yourself. Most people simply don't have that much cash available.

4

Actuall a LOT of people can do it and depending when you do it people made millions with it. Problem obviously is that you will not rent it out for 30 years most likely, so you need interim repairs, upgrades, downtime searching for renters.

But yes, this is how many people make money and make their retirement. Once you hit 5+ appartments thigns get more smoothly.

1

Overall, buying a property isn't a bad idea if you're sure you want to (and will be able to afford to) hold on to it for a long time.

Other investments may get you more return at less risk, depending on your timing and whether your country offers any tax benefits.

There are two useful concepts for you to look up here: opportunity cost and future value of money.

These are important, because to obtain the loan to buy the property in the first place, you'll need some initial capital.

You can then make a spreadsheet to help you explore this.

First, add up the following for a year to get your expected income after loan repayments for the year:

  • Expected appreciation/depreciation in vaule of the property
  • Purchase costs for the property (e.g. having it surveyed)
  • Tax (and tax benefits)
  • Agency fees
  • Maintenance costs
  • Likely rental income * proportion of time property is fullied occupied
  • Interest on the loan

Next, express that as a proportion of your initial capital outlay to get your annual rate of return.

Play with the assumptions in your spreadsheet a bit to see what might happen in different circumstances. For example, if the interest rate on your loan goes up, or if rental prices crash.

You can compare this rate of return to what you would expect to earn from other investments.

Don't forget to look into risks as well as returns!

1

I'd just like to provide an anecdotal reference, as we're doing exactly this; please check other answers for in-depth considerations.

We bought a three-room apartment in a panel building (cheaper than normal brick houses, but also somewhat cheaper to rent) a year ago. We took a 5 years loan, and rent the flat out for about 5% more than the loan payments, plus water/gas/etc. After considering the 20% down-payment in addition to the the loan, and the necessary initial renovations, we expect to earn about 9% equivalent per-year interest, compared to the 5%-at-best rates for 5 year deposits. This is however without accounting to two important and unpredictable things: vis maior events, and the change of real estate prices in 10 years from now. Also, that's not money, but real estate, not as easy to access to it as it's for a deposit.

So I'd say it borderline worth it, but risky. This is however in a real-estate-vise relatively cheap country (Hungary)*, in a city other than the capital (Szeged), and which is an university city with a high density of students. And even there, we got the apartment about 15% cheaper than usual, it was a really good deal. Whether it worth it or not has to be calculated for the individual house, based on the interest rates, comparing the price of the flat with for how much could you rent it out, and how much you need to spend on it.

*The price of the house is about the same in as e.g. 1.2 times the list price of a new Ford Mondeo in local currency (as of 2018).

-1

You are unlikely to pay mortages for property from rental income alone as this would lead to a massive case of arbitrage. People would get mortages for properties and rent them out for no real cost, this would in turn lead to massive influx of rental proprties that would tank the rental market overnight. Also if your mortage is equal to rent why are you renting?

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    Totally not true, the basic mortgage payment is often lower than the rent on a property--if it were not, there would not be ANY rental properties...not only that, but done properly long term it will eventually cover all the other house expenses, too. Exhibit A in "why the poor stay poor while the rich get richer". The difference, as many people have pointed out, is that to buy you have to have the down payment in the first place and you have to be able to afford the risk that you can't rent it or some catastrophe happens. – user3067860 Oct 25 '18 at 18:43
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    @user3067860: Wait what? I am used to base rent getting up to the mortgage price being a sign of a sick market. If it's cheaper to pay mortgage than rent then almost nobody would rent. – Joshua Oct 25 '18 at 21:18
  • Currently I own four properties, live in one, rent out three. The rent on the three is above the mortgage. . . I suspect this is the case for the vast majority of owners. the real issue is how much above so that in addition to being able to "take a profit" you're also socking away savings for the inevitable repair. "Massive case of arbitrage". . . yeah, that's essentially the entire rental market. – iheanyi Oct 25 '18 at 22:34
  • As for why you'd own a property that you rent out to others while renting yourself - the answer is simple. It's a money returning investment. If you're not at a stage to live somewhere long term, it is a lot of the time cheaper to rent than constantly buying and selling properties on a short term basis. Meanwhile, the property you own but rent out is earning income for you. Since it is rented out, it doesn't matter that you're moving regularly. In some ways, it's like renting while owning stock. Investments and residences are two different concepts, despite the popular commingling. – iheanyi Oct 25 '18 at 22:41
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    Rent has properties that a mortgage doesn't - it's not inherently long-term. And a mortgage has properties that rent doesn't - which is that you own a house once you finish paying it. I would assume that the rent should cover the interest on the mortgage, but I wouldn't naturally expect the rent to cover the entire mortgage, because the owner is the one getting the benefit from the mortgage (he gets to own the house), not the renter. But then rent has to cover maintenance and other expenses as well, whereas a mortgage payment doesn't. – user253751 Oct 25 '18 at 23:25
-2

The answer is NO!

There is one thing that is always true in financing. You must always pay every loan you take. That's certain.

Now, what you are about to do is to take loan (that you must always pay) and use the financing to purchase a risky asset.

What are the risks in buying a flat?

  • Market risk. Sometimes, all of the houses in the entire world may decrease in value. The Economist has called the high house prices the biggest bubble in history.
  • Building risk. What if there is water damage in the entire apartment building or a single flat? There may be toxic mold, thus leading to high tenant turnover and possibly legal costs for you if you knowingly rent out a mold-damaged flat.
  • Energy usage risk. What if all of the countries in the world start to really combat climate change, thus increasing heating and/or air conditioning costs to levels you can't afford. Of course, this means new buildings will be built according to strict energy standards but that's no consolation if you have a flat in an old building.
  • Area risk. The area you buy the flat from can go out of fashion.
  • Size risk. Sometimes, some size of flat goes out of fashion and people will want a bigger or a smaller flat.

Some of these can be eliminated away by diversifying, by purchasing let's say 100 flats. But no bank will give you a loan for 100 flats. So the only option to diversify is to buy shares of a real estate fund.

In the country where I live, the biggest drop of house prices in recent history is 50%.

The biggest drop of a well-diversified stock portfolio (worldwide diversification, company size diversification, sector diversification) is also about 50% (ok, the Great Depression had a larger drop, but then again that isn't recent history, it's ancient history).

So, according to the recent history, houses are approximately as risky investment as stocks, if both investments are well-diversified.

A single flat? Much more risky than a well-diversified stock portfolio.

My advice would be to not limit yourself to one type of economic activity (housing), but rather invest money into various different companies in different sectors.

It's easy to buy let's say only $10000 of stocks. I don't think you can find a flat for $10000 in any decent area (except perhaps in very poor countries).

So, by investing in stocks you don't actually need the loan anymore. You can start with small sums and accumulate your investments to larger sums. If you really want to, you can select one of your investments to be a real estate fund.

Edit: calculation of house discount yield in Greater Helsinki region:

  • 2500 EUR / m2: cost to construct an apartment building
  • 2000 EUR / m2: cost of bureaucracy and the land to build the house on
  • 4500 EUR / m2: cost of a newly built house to the buyer (newly built so that there is no renovation debt)
  • 50 EUR / m2 / year: larger renovations, to keep the building up-to-date (increases with inflation)
  • 42 EUR / m2 / year: property tax, heating, administration, etc. (increases with inflation)
  • 200 EUR / m2 / year: rental yield (increases with inflation)

Over an extremely long timeframe, building prices, rents and costs rise according to inflation which is 2% per year in Eurozone. I have seen a long-term statistic of house prices in a single area in Netherlands I think (yes it was Netherlands), and over about 400 years the house prices have risen exactly according to inflation (plus or minus 0.1% per year or so). Sometimes house prices were high, other times they were low, but there was no other general rising trend than inflation.

Paying the costs from the rental yield leaves 108 EUR / m2 / year (which rises 2% per year). Investment required is 4500 EUR / m2. This makes the real yield 2.4%. Nominal yield is real yield plus inflation which is 4.4%. Taxes not subtracted from the yields.

Compared to stocks, real yield consists of economic growth (2.5%) and dividend yield (3.5%) which is 6% and nominal yield is real yield plus inflation, i.e. 8%, taxes not subtracted from the yields.

A single flat is of course more risky than a well-diversified flat portfolio. If you buy a single flat, I would demand 9% real yield to take into account the greater risk of a single investment compared to a well-diversified flat portfolio. You can't do that, as you obtain only 2.4% real yield.

If you can diversify by buying let's say 100 flats (like you can buy stocks of 100 companies), 6% real yield is okay. But I calculated only 2.4% real yield in my area...

YMMV. In some areas, you can obtain 6% real yield. That makes investing into a well-diversified flat portfolio or into a real estate fund a good idea.

In other areas, you can obtain 9% real yield. That makes investing into a single flat a good idea.

In my case? I live in a state-subsidized housing, which costs 133 EUR / m2 / year (far from the 200 EUR / m2 / year rents typical of the area), and invest in stocks, yielding 6% really or 8% nominally per year. I'm never going to buy a house, even for living in it myself.

  • Flat out wrong and a good reason poor people stay poor. – TomTom Oct 26 '18 at 6:44
  • @TomTom What part is wrong and why is it wrong? – gerrit Oct 26 '18 at 11:25
  • The fact that it looks like noone ever did that. Been there, done that, made lots of money. Heck, still there. Which indicates that the answer is yes. WHich makes your answer no. – TomTom Oct 26 '18 at 11:45
  • @TomTom If I buy 200 000 USD worth of a single stock on borrowed money, and the single stock yields 8% per year, and I pay 4% interest, that makes a profit of 8000 USD per year. But it's not risk-free. Risk-adjusted, there is zero profit for a well-diversified portfolio and negative (yes, negative) profit for a single stock. Even more to the point: should I buy bitcoins on borrowed money? I'm pretty sure there are lots of people who did that and are now rich. What they did is foolish. But they're still rich. – juhist Nov 1 '18 at 17:27
  • Yes, but rent is different. Even if you "only" pay the mortgage, 3 things happen. One, you pay down the mortgage over time. Two, rent goes up over a 10 year timeframe. Three, property prices ALSO go up over long time.20 years later you have a brutal large rent on a property you own. Yes, it is a long game mostly for rich, but it IS a game playable. – TomTom Nov 1 '18 at 17:32

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