Rent-to-Rent (R2R) as a strategy has proliferated over the past few years. But what does it mean? Does it work? More importantly, does it make sense for you to do it?
R2R is a relatively new strategy that is often pushed towards newcomers to property investing, primarily because it requires much smaller amounts of money to get started. Does that mean you should do it? The answer is: Maybe.
In this article I will cover:
- Exactly what R2R is and how you make your money.
- Why I don’t think it is property investing, however.
- The inherent instability in the strategy.
- Why R2R is not for beginners.
- The barriers you face in doing it properly (and the consequences if you don’t).
- When and you SHOULD consider R2R, if the circumstances suit.
Put simply, Rent-to-Rent is:
- Finding a landlord willing to rent a property to you for market rent (or close to it).
- Agreeing a management contract with the landlord for a given time period (1-7 years typically) and for an agreed monthly rent.
- Onward letting the property for a higher rent, usually achieved by renting the property by the room (as a House in Multiple Occupation), or as Serviced Accommodation (short term lets to holiday makers and other guests).
- Your profit is the difference between what onward rental payments you make (minus expenses) and the (hopefully lower) amount you pay the landlord.
This is an example of what I call Use Intensification. Making a margin over and above a standard Single Let strategy by sweating the asset in some way. In the case of Rent-to-Rent, this is most usually by converting the property to a House in Multiple Occupation (HMO) and renting out the bedrooms to separate (and usually unrelated) tenants.
The key part of Rent-to-Rent is the first reference to “rent” in the name: You find an existing landlord to rent the property from (at a rent similar to that for a Single Let) and then you rent the property by the room on the open market.
Your profit margin is the difference between the rents received via the HMO strategy (minus costs such as management, maintenance, voids and so on) and the rent you pay to the landlord.
Since you don’t have to actually buy the property in the first place, you avoid needing funds for:
- Stamp Duty Land Tax (SDLT). Plus the possible surcharge if you already own a property.
- Legal fees.
This is a substantial outgoing on a property suitable for an HMO, which would typically be a large family home with associated price tag.
What you will need to outlay will be largely dependent on negotiation with the landlord, but would typically include:
- Refurbishment, especially to meet HMO regulations around fire safety (e.g. fire doors, mains wired fire alarms and so on.
- Furnishings. Typically, HMO’s are rented fully furnished, including white goods in the kitchen.
- Deposit to the landlord.
- First months rent up front.
- Legal fees in drawing up the appropriate agreement with the landlord.
Whilst this will add up, it is still significantly below what you would need to outlay if you were to buy a property outright to use as an HMO.
Following that, you would have all the normal running costs associated with an HMO, such as:
- Advertising costs for tenants.
- Ongoing maintenance.
- Management costs.
- Void expenses (or detriment to cash flow).
- Paying the rent due to the landlord (the R2R equivalent of a mortgage).
On the surface, what’s not to like? You get all the benefits of an HMO without anything like the same expense of buying one.
Let me burst that bubble a little!
Rent-to-Rent is NOT Property Investing!
Perhaps my biggest bugbear is that Rent-to-Rent is advertised (usually by those with a course to sell) as a property investment strategy.
It simply isn’t, as you don’t have a stake in the property and therefore you don’t have a stake in any capital growth. It is not investment in the usual definition.
In fact, what you have become is essentially a glorified letting agent, with a different risk / reward structure. For a start, the clue is in the type of agreement you have with the landlord. It should not be an Assured Shorthold Tenancy (AST) agreement, but a Management Agreement.
You are acting as the Property Manager. The usual fee agreement with a High St. letting agent is a flat fee set as a percentage of the rent (typically 8-12%+VAT, depending on where you are located).
Now, if the property is empty, then as a letting agent you don’t get paid. But importantly, you don’t lose money either. Your income just goes to zero during void periods.
As the principal in a R2R strategy however, the payment structure is altered. You get a higher profit when the property is full (as you get to keep the difference between the net rents you receive and the rent paid to the landlord).
But this comes with higher risk. If the property is empty or you are suffering non-paying tenants, killing your cash flow, you are still contractually obliged to pay the landlord his agreed rent, unlike a standard letting agent contract. In this scenario, your cash flow and income goes negative.
So your income can fluctuate more dramatically than as a letting agent.
But this is not property investing! You have no stake so cannot get the benefit of forcing appreciation, adding value or capital growth, some key principles and advantages to investing in property over any other asset class.
Rent-to-Rent has Inherent Uncertainty
The R2R agreement negotiated with the landlord will be for a fixed period. Again, this is down to what you can negotiate but can be as little as 12 months or as long as 7-10 years.
This brings inherent instability into your business. At the end of the contract period, perhaps the landlord would be happy to renew. But they could also terminate the contract for a variety of reasons, such as:
Even if they seek to renew the agreement, you are likely to have to pay an increased rent if local room rents have increased over the same period. Therefore you lose the benefits of natural rent inflation as the landlord will want a cut of that for themselves.
If the landlord does not renew the agreement, then your cash flow goes instantly to zero and you have no asset to boot. Any gain from a refurbishment or market growth belongs entirely to the landlord.
Rent-to-Rent is NOT for Beginners
Due to the relatively low entry costs, R2R is often hailed as a strategy suited to beginners with little capital of their own to invest.
This is dangerous advice:
- You will be contractually obliged to pay the rent each and every month. Indeed, this steady, uninterrupted monthly payment is the chief reason a landlord will enter into a R2R agreement. You will need sinking funds that you can draw on to pay this rent, even if you are struggling with voids or tenants not paying rent.
- Equally, a R2R agreement will usually oblige the operator to cover maintenance issues. You will need reserves to cover this, when needed.
- Running an HMO is a significant step-up from managing a Single Let. Not many letting agents will manage an HMO and the profit margins are such that usually the R2R operator must be the manager to make the numbers work. As a beginner with zero landlord experience, this will be a tall order, especially alongside a day job.
Presumably, a R2R operator will look to have several R2R properties under management. All the above is amplified when dealing with multiple HMO’s.
In short, this is not suitable for a beginner with zero property management experience.
Rent-to-Rent has Barriers to doing it Properly
It is not straight-forward to secure appropriate properties with which to use a R2R approach:
- You will need to get past the natural objections of a landlord, who is likely to have never heard of this approach.
- This is doubly-difficult if you are trying to secure such properties through a letting agent, who will have the same objections and whom you will need to get onside in order to approach the landlord with a proposal.
- Most mortgage companies will not allow this arrangement. Going ahead without the mortgage providers permission will likely invalidate the mortgage and put the landlord in a predicament.
- A standard landlords building insurance will also likely not be valid. Without checking or changing this, any claims are likely to be declared void. This could be super expensive for the landlord. Further, if the property is on an R2R agreement in violation of the mortgage terms, an insurance company could use this as a reason to not pay out.
- If you are looking at doing this with a flat, it is most likely a lease will forbid letting the property except to a single family. Going ahead will put the landlord in potential breach of their lease with the freeholder.
- Any sensible landlord will look at your experience, credit rating and assets. If you have no money and no assets to back up the monthly rental commitment, why should a landlord hand the asset over to you?
- Landlord credit risk. If the landlord gets into difficulty paying their mortgage, you could lose the property (and your cash flow and business), through no fault of your own.
- Market risk. If, over the duration of the agreement, the market dynamic changes such that the HMO is less attractive to tenants (e.g. the increase in Purpose Built Student Accommodation over the last few years), then you could find yourself with falling profit margins if lower rents or longer voids become the norm.
In summary, executing R2R compliantly and profitably is difficult. Ideally you want freehold, unencumbered properties with landlords willing to enter into such an arrangement and who are willing to change their building insurance where necessary.
Such landlords and properties are difficult to find.
Serviced Accommodation Suffers the Same Problems
The other option for a R2R approach, given it is primarily about use intensification as a yield enhancement strategy, is to let the property as Serviced Accommodation. This just means letting the property to holiday makers by the week or to guests on a nightly basis, on a premium rate with hotel-like service levels.
Again, this is not a strategy for beginners. Serviced Accommodation is moving away from operating as a traditional landlord and is much closer to the hospitality industry, with all the service levels that implies (and is what the guest is paying for). The property P&L is open to wider fluctuations, depending on the property and its location. For example, a holiday cottage in Cornwall may be relatively easy to let over the summer, but will be virtually empty over the winter months.
R2R as Serviced Accommodation will also suffer from all the exact same problems listed above as barriers to doing R2R compliantly.
Rent-to-Rent: When SHOULD You Consider It?
With all that said, is there a situation when you should consider Rent-to-Rent?
Absolutely. This is a cash flow enhancement strategy after all, just remember this is not about property investment, but good and efficient property management.
You should consider R2R if:
- You are already an experienced landlord with a good understanding of the regulations and requirements of being a good one.
- You have self-managed your own properties or have good systems, people and processes in place to do so.
In which case, R2R is another useful tool to add to your toolbox. Note it is really a tactic, not a strategy, which is why I am describing it as a tool (I discuss other advanced tools here).
It can be an entirely legitimate approach, if you fit the above criteria. A good example of this are Northwood, a national chain of estate agents who offer a guaranteed rent service for landlords.
I am a big fan of not leaving money on the table, just because a property doesn’t meet your core strategy (which should always be long-term buy and hold as a wealth preservation and accumulation tool).
So, if you fit the above and if you happen to meet a landlord whose circumstances and property naturally lend themselves to a R2R agreement, then adding the property to your existing management portfolio of your own properties is a small increment in overhead for a correspondingly larger increase in cash flow.
What criteria should you set? This is down to your own metrics, but I would personally look for:
- A repayment period of no longer than 6 months for any upfront expense I agree to do on the property in order to get it ready to let. This could be in meeting regulations for an HMO or in reaching the appropriate refurbishment standards and specification for running a Serviced Accommodation unit. You could opt for a longer payback period in return for a longer lease period with the landlord.
- A net profit of at least £500pcm, in order to provide a suitable return in exchange for the extra management overhead in running an HMO or Serviced Accommodation unit and the extra risk in providing the landlord with the contractually obliged rental income each month.
- Also try and negotiate a purchase option agreement with the landlord for the property. For example, at the end of the lease period, you could agree that you have the option to buy the property for a given price. This means you could then execute your right to buy and add the property as an asset to your portfolio, should it have proven to be a good rental and the option purchase price is attractive under the market conditions at the time.
I do not believe Rent-to-Rent is a strategy for beginners to property. It is not easy to:
- Find landlords that are interested in handing over a very expensive asset to someone with no experience, or money.
- Find properties that are suitable and compliant.
- Run a HMO or Serviced Accommodation unit.
Importantly, it is not a property investment strategy.
But it is a potentially lucrative cash flow addition for existing landlords whom:
- Have experience of being a landlord with their own property portfolio.
- Have the knowledge and experience of managing their own properties.
So consider it as a potential tool to add to your investors toolbox rather than a strategy you should exclusively follow.