The economics of being a landlord

Read what you have to know before becoming a buy-to-letter.

Landlords have plenty to worry about. In 2008 we had falling property prices and in 2010, while landlords managed to put up rents a fair bit on average, there was also an increase in rental arrears.

Prospective landlords should take these as warnings and consider some basic maths.

Why property investing can be economical

The reason that property is such an attractive investment is that for a relatively small up-front sum you can buy a massive asset.

If you put £20,000 into a fund of shares which rises 10% after costs, you've made £2,000. But let's say you invest that same £20,000 into property instead, in the form of a deposit on a £200,000 home. If the property price rises 10%, you've make £20,000 – that's ten times the profit for exactly the same investment.

Greater reward, greater risk

Those are beguiling numbers but, as you well know, it's not that simple. There are bills to pay and tenants find, the property market isn't a one-way elevator, and buying an asset mostly with debt – and large amounts of it – makes it much more risky. The trick is to tightly measure costs and rewards and ensure you have a margin of safety.

Here are some of the costs you need to consider before you become a landlord:

• The mortgage deposit
• Mortgage payments (while assuming out of caution that interest rates will rise)
• Costs of finding and checking tenants
• Periods of vacancy
• Rental arrears, bad debts and property destruction
• Routine legal costs
• Landlords' buildings insurance
• Legal-protection insurance or a savings pot for extra legal costs
• Getting an energy performance certificate
• Maintenance costs, including annual boiler check, repairs and emergencies
• Income tax if a profit is made from rental income and capital gains tax on the sale of the property

OK, those are the costs, now what about the income to offset that? Here's the complete list:

• Rent from the tenant

Notice anything interesting about these two lists? That's right, the one is much longer than the other, and it's why new landlords take such a big risk. The first list is negative and comes with lots of variable costs that you can't wholly predict, while the second and positive 'list' shows your single source of revenue – which also happens to be unpredictable.

Related how-to guide

Become a buy-to-let landlord

How to pick the right property, get the right mortgage, take out the right insurance, choose the right letting agent and most importantly, unravel all that red tape!

See the guide

For your first property you're relying on finding one tenant (or one household) who you hope will reliably pay all or most of your costs as a landlord through a fair and competitive rent.

This is one reason why being a landlord is not for most people. You could potentially take a year to evict a tenant who becomes a squatter, so you need a large safety net of cash in the bank and/or sufficient and reliable income from other sources to cover any costs that aren't met during long periods of missed rent.

There's an insurance against rental arrears, but having analysed the exclusions in the small print I don't think it's worth the price for most landlords.

Seeing it through to the end

Yet if you can comfortably handle the ongoing operational costs of your mini property empire, over the long-term you can expect to get a good return.

To start with, it could well be that the mortgage and other costs aren't entirely met by your tenant, even if you find a tenant swiftly who then pays the bills without fail. It's not unusual for a competitively-priced rent to fall a little short, so that the landlord must pay part of the ongoing costs themselves for many years.

If your projections show that might happen to you, it shouldn't necessarily put you off. I equate it to putting a lump sum into a shares portfolio and then continuing to invest modest amounts on a monthly basis.

As time goes by, two things should happen. Firstly, the rent you charge should gradually rise, making it easier to meet your mortgage payments and perhaps even giving you a steady and increasing monthly profit. Secondly, while the economics aren't as safe for landlords as homeowners (read Now is the time to buy property), the property price should rise over time. This is the big one for most landlords, who expect and hope to sell their properties, pay off their mortgages and get a big bonanza gain at the finish.

There are no certainties with property prices, but the history of rising prices is a good one. If a landlord bought at the highest point of any of the peaks in the past 50 years and held on, the property should later have been sold for a good profit. I expect that in the long term we'll find the same will happen to most landlords who bought at the peak in 2007, so long as they can meet all their costs in the early years.

What economics won't tell you

Being a landlord is not only about getting your basic number-crunching right. I should know: due to an unusual chain of events I was once an accidental landlord for about two years.

Being a mean negotiator and a good judge of character is the best way to reduce your risks and costs, and therefore increase your margin of safety and your potential profits. You need to be organised, have a reasonable eye for small print, and have a level head for disputes with tenants or late night calls about boiler problems. The ability to be polite and professional helps reduce headaches too, as well as being clued up on landlord legalities.

There's an alternative, which is to find and hire a good agent, but that will increase your costs and risks yet further, perhaps by 15% per year, so it may be unwise for new landlords to impair the economics of their new business in this way.

More: Compare mortgages | Housing market is fairly priced | The sneaky mortgage trick to save you money