You’re too late to get into buy-to-let. It had a good run, but the party’s over.

I graduated from university in the early 1990s. I got a job in The City, moved down to London, and shared a rented house with a few friends.

After a year of renting – and spurred on by a combination of parental pressure, MIRAS1, and (ludicrously) a mortgage interest subsidy from my employer – I bought a house.

Did I have a big inheritance? No. I saved up for the deposit in my first year of work.

Okay, that’s not actually quite true. I also had some profits from punting my student loan on the stock market, the proceeds of a systematic building society carpet-bagging operation, and a well-timed cash withdrawal on my credit card.

Combined this took me over the line into buying my own house.

And yes, I do mean a house – as opposed to a flat, let alone a bedsit.

My deposit plus salary secured a three-bedroom, freehold house with a garden and garage, in Zone 1, 30 minutes walk from my job in the City.

Even I cringe a bit as I write this. Sorry, millennials.

I paid £130,000 for this house and spent the autumn weekends decorating it to the incessant radio play of Whigfield’s Saturday Night.

Then, for a while, I just couldn’t get enough of the things.

My property portfolio balloons

I got my first ‘proper’ bonus (two figures!) soon after I bought that first property.

While my colleagues were spending their windfalls in Clerkenwell dives doing shots from lap-dancers’ bellybuttons, I was at home eating toast, reading about newly-launched buy-to-let mortgages, and perusing the property section of the Evening Standard.

And so, barely two years after buying my first house, I bought a second.

This one was an ex-local authority three-to-four bedroom property. I picked it up for £75,000. After a lick-of-paint I let it out for £600 a month.

That’s a starting gross yield of nearly 10%. 

Soon afterwards, newly married, I left London for a pointless dormitory town in the commuter belt. I moved into a house I bought with my wife, for which I paid – cough – less than I earned that year.

And of course I kept my original home in London to let out.

Because why would I not? 

Buy-to-let boom

In those open and liberal Blair years London was booming. As the de facto financial capital of the European Union, it sucked in talent and money from all over the world.

From American investment bankers and French derivatives traders to Polish plumbers and Italian waiters, everyone wanted to be in London.

Which meant London property prices were going through the roof:  

Shortly after leaving London, I bought three more properties in a single year. My wife still reminds me of the time I went out for a newspaper one Saturday morning and came back with a two-bedroom flat.

By this time I’d worked it out. I raised equity against my steadily appreciating London properties for a deposit on the local ones. This way I put no money down.

It was like I’d discovered a perpetual money machine!

Only… the machine started to sputter a bit. The problem was that while house prices kept going up, rents did not. Starting yields were decreasing.

This was largely a story of falling interest rates. Property was like a very long duration lightly-inflation-linked bond. Prices moved accordingly.

The landlord game was also getting more competitive because more people were doing it.

Buy-to-let had become… a thing.

Too late to get into buy-to-let for big bucks

You know the old adage that an optimist is someone without much experience?

Well, that was me.

I started out on my property ‘journey’ as YouTube pundits call it by guessing that my costs would be about 10% of the rent. That wasn’t far off, to begin with.

But as rents increased more slowly than my expenses, the economics got steadily worse.

Then there’s the ‘exceptional’ costs that nobody warns you about. Or, if they do, you don’t think they’ll happen to you.

What sort of expenses? This sort of thing:

Double-crossing agent

The agent for a London property reports the tenants aren’t paying the rent. Letters and threats of  legal action are (supposedly) sent to the tenants. Rent is received sporadically over the next couple of years. It turned out the tenants were paying the rent all along. The agent kept it himself. Agent declares bankruptcy, directors leave the country. Loss to me? About £18,000.

Shit happens

Tenant moves in, pays deposit and the first month’s rent. Never pays a penny more. Takes 14 months to get them out of my property through the courts. On taking possession I find their dog has eaten all of the internal woodwork. And when I say all, I mean all: doors, skirting, architrave, even the window sills. The back garden had been destroyed. It was like some combination of a First World War trench and 14 months worth of dog shit. I still wake up in a cold sweat, thinking about that day I spent in a HazMat suit digging out two-foot of shit to replace it with topsoil. Loss to me? About £15,000 (not including sleepless nights). 

Size matters

That first rental I bought in London, which I’d always let to three sharers, is suddenly designated a ‘HMO’ by the local authority. (It’s not). So obviously I have to pay them £500 and spend several hours filling in pointless forms. Oh, and I can only let it to two people now – because of some arcane bedroom size restrictions. (Ironically it was the local authority that built this property…) Perpetual rental income reduced by a third. It’s hard to quantify the loss here – what discount rate to use? It’s a lot, anyway. 

Party walls

My personal favorite – not because of the cost, but because of the timing. A builder is completely refurbishing a London property for me. It’s a big job, including moving walls and bathrooms and so on. Randomly I get a bill, in the post, from the police, for something like £300. They’ve attended an ‘incident’ at the property. Turns out that unbeknownst to me the builder’s laborers had been sleeping on-site. They’d got drunk one night, had a fight, and the police were called. When did this bill arrive? I think you can guess – the day after I’d paid the builder his final payment. 

Once you factor this sort of thing in, along with the more regular stuff – the boilers, the double-glazing, the roof replacement, the damp that just WILL NOT go away – my 10% expense estimate was hopelessly naive.

Too late to get into buy-to-let – and too much hassle

I can now look back at more than 25 years of accounts from my modest buy-to-let empire. Starting with one property, with seven at the peak and with three remaining today.

Which means I can tell you, exactly, how much the non-interest costs were as a fraction of the rent:

31.4%!

Call it a third. Wow.

I do use agents to fully manage the properties, and they are expensive. But I will not be being phoned in the middle because of a blocked toilet. Not when I’m working 16 hours a day at an investment bank. (Okay, I don’t do that anymore, but I’m still not going to field those calls).

And this is why it is too late to get into buy-to-let. Along with falling rental yields, the trend in costs is only rising.

There have been lots rule changes over the years that have made things worse:

• Higher CGT rates
• Abolition of the Indexation allowance
• The pointless requirement to pay CGT outside of the tax-year cycle
• Annual Tax on Enveloped Dwellings (ATED)
• Extra stamp duty
• Elimination of the wear-and-tear allowance 
• Deposit protection schemes
• Tenant fee ban
• Section 24 (tax on rental turnover not profits)
• The PRA’s CP11/16 (which means you can’t borrow as easily)
• Arbitrary and retrospective ‘HMO’ rules
• All-sorts of safety and environmental regulations 
• So called ‘right-to-rent’ law that compels landlords to be a tool for the government’s cruel and damaging immigration policies

That was all off the top of my head – I didn’t even need to consult a list.

Now, don’t get me wrong. In isolation there’s nothing inherently wrong with most these rules (the exception being the last one) and the health and safety aspects are especially reasonable.

But the mood music is pretty clear. The government believes it can impose these costs on landlords because we are all loaded.

It’s not 1994 anymore

How loaded?

The average gross yield on my property portfolio is now – checks notes – 3.4%. Which implies that the long-run post-cost (excluding financing) yield is about 2.3%.

That is… not enough. Especially as there’s no tax shelter. 

My property portfolio has been an enormous accelerator of my wealth over the years. But the easy times are over. My success came about almost completely as a result of falling interest rates.

I simply got leveraged lucky. 

Some newcomers may try to make the maths work by getting into buy-to-let via a limited company or whatnot. I’d question whether it’s worth the hassle. In my view it’s too late to get into buy-to-let to make a killing. It’s not 1994 anymore.

Whigfield is more likely to have another global hit than you are to get rich investing in property at today’s starting yields. “Da ba da dan dee dee dee da nee na na na” indeed.

If you enjoyed this, follow Finumus on Twitter or read his other articles for Monevator.

1. Mortgage Interest Relief At Source, a defunct tax relief scheme to encourage home ownership in the UK. [↩]

This dissection of an ESG index is by The Scientist from Team Monevator. Check back every Monday for more new perspectives from the Team.

People like to throw the ‘ivory tower’ label at scientists like me. And it’s true, we can be guilty of making what we do inaccessible to everyone else.

But for inaccessibility of language made into a true art form, nobody beats the financial industry.

Environmental, Social and Governance investing (or ESG for short, because acronyms always help…) is not a new fad. Nor is the concept very complex.

Yet I had no end of difficulty digging into the background of ESG indexes.

Introducing the ESG index

The core idea of ESG investing is to grow your wealth whilst trying to do some good.

Back in 1990 a group called KLD Research & Analytics started the first Socially Responsible Investment index (or SRI, because one acronym is never enough).

MSCI took over KLD’s index at a later date. MSCI now offers some 1,500 ESG indexes. There’s an ESG index for everything from human rights and climate change to the fallout from the COVID-19 pandemic.

The purpose of investing is to build wealth. And as it happens, since 1990 that first US-focused MSCI KLD 400 Social Index has bested the US market.

But the motivation behind ESG/SRI investment is not to outperform.

ESG investors choose to invest in such a way as to encourage business practices that have a positive impact on the world.

An ESG index dissected

I decided to look under the hood of an ESG index to see how it worked. I chose one closer to home: the FTSE4Good Developed Index.

The FTSE4Good index series is “designed to measure the performance of companies demonstrating strong ESG practices.”

The index I’ve chosen is an ESG take on the FTSE Global Developed World index.

Companies are screened for inclusion in this ESG index. The screen employs a convoluted algorithm containing about three layers. I say ‘about’ three layers, because the algorithm gets pretty complex, pretty quickly.

First, the relevance of the three ESG ‘pillars’ are considered with respect to a given company. These are: Environmental, Social, and Governance.

Then, within each pillar there are further ‘themes’.

Environmental:

• Supply Chain: Environmental
• Biodiversity
• Climate Change
• Pollutions and Resources
• Water Security

Social:

• Supply Chain: Social
• Labour Standards
• Human Rights and Community
• Health and Safety
• Customer Responsibility

Governance:

• Anti-Corruption
• Corporate Governance
• Risk Management
• Tax Transparency

Finally, within each theme are ‘indicators’.

Over 300 indicators are considered, with each theme containing 10-35 quality and data-driven indicators. For any given company, on average 125 indicators combine to calculate its ESG score.

Source: FTSE Group

Points mean prizes

Based on the indicators, a company gets a score out of five. Zero is totally rubbish, from an ESG perspective. Five is industry-leading best practice. Each theme and pillar is scored.

Theme and pillar scores are then weighted based on their relevance to a given company. Enter another scoring system – this time out of three. Zero is irrelevant and three is high.1

The relevance weighting reflects how responsible a company ought to be with respect to a certain theme. It’s determined by industry.

For example, you wouldn’t expect an insurance company to undertake many activities directly related to water security.

Super, smashing, great

Confusingly, the calculation of a company’s ESG score works backwards from how it is presented in the FTSE4Good documentation. It runs from indicator to a final ESG score.

But there is yet another step. A company’s ESG score is also weighted relative to the performance of other companies within its ‘supersector’.

What’s a supersector? Well, there is a supersector ‘taxonomy’, according to FTSE Russell’s Industry Classification Benchmark:

1. Technology
2. Telecommunications
3. Health Care
4. Banks
5. Financial Services
6. Insurance
7. Real Estate
8. Automobiles and Parts
9. Consumer Products and Services
10. Media
11. Retailers
12. Travel and Leisure
13. Food Beverage and Tobacco
14. Personal Care, Drug and Grocery Stores
15. Construction and Materials
16. Industrial Goods and Services
17. Basic Resources
18. Chemicals
19. Energy
20. Utilities

Their index, their rules, but scoring a company’s ESG rating relative to a supersector seems counterintuitive to me.

Why? Well let’s say everyone in the Energy supersector burns coal. Just because you burn less coal than others in your supersector, for me that doesn’t diminish the fact you burn coal. Or use slave labour. Or manufacture cluster bombs.

Worse, some of the indicators used to calculate the ESG scores are “tailored for different industrial sectors”. So sector-relative scoring is already at the heart of the ESG calculation. It is potentially accounted for twice.

No score draw

After all this accounting alchemy, a company has a score out of five.

The company needs to score 3.3 or higher to get in a FTSE4Good index, in a Developed market. (2.9 or higher in an emerging market).

But wait, no, actually there is one more consideration!

Some kinds of companies are actively excluded. This includes those that manufacture or produce tobacco, chemical and biological weapons, cluster munitions, nuclear weapons, conventional military weapons, firearms, coal, or are investment trusts.

Personally, I find this the most concerning. It suggests the long, complicated ESG calculation we described above doesn’t already work to exclude companies that partake in these naughty list activities.

So what was the point of it all?

Indeed, what is the point of ESG?

Again, the point of ESG is not to outperform the market.

Just as well. As recently reported in the Financial Times [search result]:

“There is no ESG alpha,” said Felix Goltz, research director at Scientific Beta and co-author of the as yet unpublished paper, Honey, I Shrunk the ESG Alpha.

“The claims of positive alpha in popular industry publications are not valid because the analysis underlying these claims is flawed,” with analytical errors “enabling the documenting of outperformance where in reality there is none”, he added.

Financial Times, 3 May 2021

Deciding to invest by considering ESG scoring should instead be a decision to allocate capital towards companies that do ‘good’.

For me, ESG indexes are not a perfect means to that end. Perhaps more convoluted than effective. But they’re better than nothing.

What’s the alternative? You could instead investigate every single company you invest in. But then you’re an active stock picker. That does not go well for most people.

Passively investing via index funds is the best way to go for nearly everyone.

And if you want to include ESG considerations in your passive investment strategy, then choosing funds that follow ESG indexes is a simple way to do this.

Two cheers for ESG index funds

Choosing to invest in ESG funds is a bit like shopping for Fair Trade coffee, carbon offsetting your gas bill, or buying an electric car. You’re making a choice with your spending power to try to make some small difference.

Investing in the status quo means you will only ever get the status quo. We have to start somewhere.

It may be hard to understand the rationale behind any given ESG index, but alternative ways to invest in an ESG-friendly way don’t work most of us.

By buying ESG funds, you at least indicate to the market that there is a demand for ESG products. Hopefully they’ll get better and clearer in time.

In time you will be able to see all The Scientist’s articles in their dedicated archive.

1. FTSE calls relevance ‘exposure’. [↩]

What caught my eye this week.

First off, apologies if you got a rogue email from us yesterday pointing to a popular US investing website – and nothing else!

This was a screw-up, and the person responsible has been roundly ballsed-out – which was the longest talking to I’ve given myself in a bathroom mirror since I worked up the courage to ask out Joanna Jones when I was 13.

It was also a reminder that I really must sort out our creaking email system.

If you subscribe to Monevator by email (and how could you not, it’s free?)  then please watch for an opt-in reconfirmation in the next few weeks. That will ensure you keep getting posted our articles.

(The real ones, I mean. Not the SNAFUs!)

Watching the watchmen

Second, a quick pointer that the FCA is after comments on its discussion paper concerning the rules around high-risk investments and regulated investment firms.

I appreciate that Monevator is the spiritual home of ‘two cheap diversified tracker funds in a tax-wrapper and you’re done’ investing. Many of the products being looked at – such as P2P investing, crypto, and crowdfunding – are frowned upon by true passivistas.

But personally I enjoy the opportunity to lose money experiment with all sorts of weird and wacky things – with my eyes open to the risks – and I know I’m not alone.

Of course there should be proper regulation, disclosure, and oversight. But active and esoteric investing shouldn’t just be for the rich.

Maybe you feel differently? Fair enough. The point is the FCA is asking for your thoughts by 1 July. If you want to have your say, you best get opining.

Otherwise there are truly tons of links below, just in time for the end of summer floods… Enjoy!

From Monevator

How an offset mortgage can help you achieve financial freedom – Monevator

Defensive asset allocation and model portfolios – Monevator

From the archive-ator: Enter The Accumulator’s confession booth – Monevator

News

Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!1

UK inflation hits 2.1%, ahead of BOE target – Reuters

About 2.3m Britons hold cryptocurrencies, despite warnings – Guardian

JP Morgan swallows Nutmeg ahead of UK launch of digital bank – Sky News

Cashless society nears, with only one in six payments in cash – Guardian

UK food and drink exports to the EU have plummeted – ThisIsMoney

FCA urges thousands to seek compensation over pension transfers [Search result] – FT

‘Big Short’ investor Michael Burry warns of biggest bubble in history – Business Insider

Hong Kong’s Apple Daily newsroom raided by 500 officers over national security law… – Reuters

…and the paper subsequently sells five times as many copies – BBC

The distributions of equity returns are not that different whether inflation was rising (blue) or falling (red) [PDF] – JP Morgan

Products and services

Equifax has revamped its credit score scale: does it matter? – Which

Lifetime ISA deposits hit £1bn for the first time – ThisIsMoney

Offer: Open a SIPP at Interactive Investor and you pay no SIPP admin fee for six months, saving you £60 – Interactive Investor

Savers pull £24.5 billion from NS&I after rates are slashed – ThisIsMoney

Fidelity now has nearly $18bn in its game-changing zero-fee index funds – Investment News

Sign-up to Freetrade via my link and we can both get a free share worth between £3 and £200 – Freetrade

Seraphim investment trust to give UK investors access to space – ThisIsMoney

How the Maker crypto token reinvents the financial system – Net Interest

Homes for celebrating the summer solstice, in pictures – Guardian

Comment and opinion

Three solutions for index fund voting dominance – Morningstar

Portfolio acid test – Humble Dollar

Want to stick to your budget? Open six bank accounts – Guardian

A mindful way to pay your bills – Rock Wealth

Avoiding early retirement invisibility madness – Leisure Freak

Predicting inflation is hard – A Wealth of Common Sense

Factory reset – Indeedably

Mid caps are not hidden champions versus small or large – Factor Research

The evidence against private equity and venture capital – Advisor Perspectives

Naughty corner: Active antics

When does the stock market go up? – The Blindfolded Chimpanzee

Two stock pickers look back at their Covid trading journals [Podcast] – Telescope Investing

Mega marketplaces – Drinking from the Firehose

Ideas – Enso Finance

The Schiehallion Fund: early and patient – IT Investor

The post-Covid economy mini-special

Office, hybrid, or home? – Guardian

Winners and losers of the Work From Home revolution – The Atlantic

Kill the five-day workweek – The Atlantic via MSN

A ‘Great Resignation’ wave is coming for companies – Axios

Half of US pandemic unemployment money may have been stolen [Really?!] – Axios

Covid corner

English Covid R number remains unchanged at 1.2-1.4 – Reuters

What will delaying the 21 June full unlock achieve? – BBC

All over-18s in England can now book a vaccine appointment – The Sun

Brazil’s main Covid strategy is a cocktail of unproven drugs – NPR

In hunt for pandemic’s origin, new studies point away from lab leak – Guardian

Kindle book bargains

The Joy of Work: 30 Ways To Fall In Love With Your job Again by Bruce Daisley – £0.99 on Kindle

Legacy by James Kerr – £0.99 on Kindle

Think and Grow Rich by Napoleon Hill – £0.99 on Kindle

Liars Poker by Michael Lewis – £0.99 on Kindle

Environmental factors

How low can birth rates go before it’s a problem? – Five Thirty Eight

Standard or ESG benchmark? – Klement on Investing

Off our beat

Man swallowed then spat out by a whale – Cape Cod Times

Harder than it looks, not as fun as it seems – Morgan Housel

Some scientists believe the universe is conscious – Popular Mechanics

Three couples in their 60s who share a house in their retirement – Guardian

And finally…

“Indeed, the very idea of ‘normality’ is now little more than a fiction, and in no sense a guide to the future in a world continuously reshaped by radical uncertainty.”
– Gordon Brown, Seven Ways To Change The World

Like these links? Subscribe to get them every Friday! Like these links? Note this article includes affiliate links, such as from Amazon, Interactive Investor, and Freetrade. We may be  compensated if you pursue these offers – that will not affect the price you pay.

1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [↩]