Boom or bust for buy-to-let?

Buy-to-let offers the opportunity of income as well as capital growth and its popularity as an investment shows no sign of waning despite interest rate rises and slowing property prices. Figures from the Council of Mortgage Lenders (CML) show that 330,000 buy-to-let mortgages were taken out last year – a rise of almost 50 per cent on the previous year.

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Rising rates and slowing house prices

Many landlords will have taken out low fixed rates a couple of years ago and will be looking to remortgage now. How do you think the rises in interest rates will affect them?

AO’D: “The rise in interest rates will affect everyone. Rental yields are falling, but I don’t see any major decline in the buy-to-let market. There are still some strong points underpinning the marketplace. Provided people are in it for the long term and not for short quick wins, the recent round of interest rate rises shouldn’t materially affect the market.”

Presumably the professional landlords will be OK, but the amateurs may get stung?

PD: “I’m not so sure whether the professional landlord will be OK. We’ve seen the professional landlords taking equity out of their paper-based portfolios, and if interest rates continue to rise there will be a dampening of house price inflation which will naturally mitigate what equity they’ve got available to expand their portfolio.”

Paul believes that landlords who have taken fixed rates will be in a better position to weather the storm, but there may be restrictions on how far they can continue to expand their portfolios.

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FC: “We’ve just carried out a survey of over 5,000 of our landlords, and 88 per cent are saying that they are going to maintain their existing portfolio or intend to expand it in the future, which is actually up on our figures from last year, so we’re quite convinced it’s still positive.”

Stuart reckons that the buy-to-let successes are those that are in it for the long term, rather than regarding it as a get-rich-quick scheme.

SM: “From the West Bromwich Building Society perspective we think the market will continue to grow. But people will need to be realistic as rent may not always be enough to cover rental voids, so they may need to fall back on a bit of income and plan a little more effectively.”

AO’D: “In a recent survey we got exactly the same results. More people are planning to add to their portfolios, and a single-figure percentage are planning to exit buy-to-let.”

PD: “The effect of rising interest rates will see without a doubt more people going into arrears and consequent repossessions, but in terms of social demographics they are quite sophisticated and are probably better able to weather the storm than first-time buyers.”

What sort of mortgages do landlords take out?

AO’D: “At C&G it has recently been a two-year market – either two-year fixed rates or trackers with no ERC (early repayment charge). We’ve tried to steer the market to longer-term fixes with some good recent offers but as it is hard to predict rates more than two years ahead it has been difficult to change habits.”

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PD: “Our experience has been different from yours. We introduced a five-year fixed rate and were very surprised at the take-up. The five-year take-up was twice that of the three-year.”

Stuart says that West Bromwich Building Society does a lot of tracker deals with no ERCs and these are proving popular, particularly with bigger landlords who don’t want the hassle of remortgaing every few years.

SM: “Some of the fees associated with the two-year deals are quite punitive and people are looking quite closely at the fee structure. If someone is remortgaging every couple of years, fees start to eat into their capital.” He believes that lenders are beginning to take a longer-term view.

Fiona believes that there is still a huge appetite for two-year fixed rates and argues that paying the higher fee secures a lower rate for the landlord which protects them against short-term interest rate rises.

Buy-to-let lending is becoming increasingly competitive and the products more innovative. Typically buy-to-let lenders require rent to be 125 per cent of the mortgage loan, but growing numbers of lenders are reducing the rental requirement to 100 per cent. What are the consequences of doing this?

Paul believes that some lenders could be heading for trouble by reducing rental calculation down to 100 per cent for novice landlords. He is also concerned that others are increasing the LTV (loan to value), meaning that the landlord puts less capital into the property.

PD: “One thing that the buy-to-let market has not experienced is a severe recession. There will be some dire consequences if the market does go into recession as there are increasing numbers of novice landlords obtaining finance aimed specifically at experienced end of the market.”

What checks do lenders carry out before agreeing to a buy-to-let loan?

AO’D: “Each lender will have different rental income calculations, and there’ll be normal credit scoring. Lenders will also impose different numbers of properties and maximum values that can be held by individuals.”

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Alistair believes that landlords get around this by having a number of portfolios with different lenders. This is a way of avoiding commercial rates: “A landlord with 100 properties can have 10 properties with ten different lenders and get residential buy-to-let rates rather than commercial rates.”

Stuart thinks that some lenders are carrying out fewer checks. Lenders used to insist that a surveyor viewed the property and assessed the rental potential, but he believes that a number of lenders don’t ask for any income proof whatsoever. Borrowers are also able to use a lender from the Association of Rental Letting Agents (ARLA) as proof of rental potential.

SM: “There is a perception that with an ARLA letter it will be a bit easier to get the rental figure higher. A valuer will take a more balanced view.”

FC: “ A couple of lenders (e.g. RBS) have dropped down to a 100 per cent LTV, but they are looking at the applicant’s income instead. I think they’ve got a minimum of £30,000 annual income. They are looking at a level of protection for the consumer from that point of view.”

AO’D: “We will accept an ARLA letter, but we do have a minimum income of £25,000.”

How do they prove that income? Presumably much of their income comes from rent?

AO’D: “No, this is excluding rental income. That’s just our safety net that there is other income there as well so they’re not solely relying on rental income.

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“Another point is that most lenders will only lend up to 85 per cent LTV – although there are one or two creeping up towards the 90 per cent LTV mark. And most lenders will consider a lower LTV for newbuild flats – at C&G this is 65 per cent. Whatever the LTV, BTL investors are investing a significant personal stake.”

The effects of buy-to-let

The rise in buy-to-let has often been blamed for causing problems for first-time buyers as the landlord and first-time buyer often goes for the same sort of property. Do you think this is true?

SM: “If you have several people wanting to buy a property it’s going to push the prices up so I think there is a degree of truth in that. If there’s more people competing at that level in the market it’s harder for owner-occupiers to make a purchase. It’s a matter of supply and demand.”

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FC: “But the landlord is approaching it from a very different mindset. The first-time buyer wants a home, the landlord wants an inves
tment, so the chances are the landlord is going to go in at a lower offer than the first-time buyer with a very different agenda. So in that respect I don’t think it’s having as much impact as people perhaps think.”

SM: “When experienced people are buying with bridging finance there’s the speed of transaction. They can complete in 48 hours. It’s very difficult for the first-time buyer to compete on speed. If the landlord has made a lower offer a seller might be happy to sacrifice price for speed of transaction.”

AO’D: “There are some new developments where many of the starter units are quite obviously bought by landlords with a view to multiple-occupancy lets, and that can price those properties out of the reach of first-time buyers. It is just generally difficult for the first-time buyer to get on the housing ladder, but I wouldn’t blame that on the buy-to-let market.”

Stuart makes the point that let-to-buy is also restricting supply.

SM: “There are a number of people who keep hold of their first property and rent it out rather than sell it. Those properties would naturally have gone back on the market as first-time-buyer homes.”

Fiona believes that another reason why the number of first-time buyers is in decline is down to the choices they make.

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FC: “You might start your career out and know that you’re not going to stay in one place. You’re going to move around, so you might make the choice to rent in the short term while you establish a base.”

AO’D: “I would agree. First-time buyers are choosing to enter the market later in life. Probably a decade later, and that’s just contributing to a lack of first-time buyers and the slack is being taken up by the buy-to-let landlords.”

PD: “Developers will build whatever they can sell. We’ve seen in the city areas a predominance of one and two-bed apartments, which have been the natural fodder of the buy-to-let investor. They’ve snapped them up. We’ve seen the emergence of property investor clubs buying 10 or 20 off-plan at a substantial discount, and this is where the market is maligned by saying that the buy-to-let investor has taken the bread and butter from the first-time buyer.”

What good effects has buy-to-let had on the property market?

PD: “Buy-to-let has bought benefits to certain housing communities by improving standards and assisting in urban regeneration. It might actually have bought first-time buyers into an area that previously they may have excluded. So I don’t think it should be viewed entirely negatively.”

The lenders were in agreement that one of the main benefits of buy-to-let was the increase in the standards of rental property.

AO’D: “It used to be that when you wanted to rent a property – 10 or 15 years ago – you went and signed on at the local council and hoped you’d get a council house.”

SM: “Back then rental properties were typically of lower quality, with much of the housing stock in poor condition, but in the main we’ve moved away from the ‘rising damp’ scenario.”

PD: “People are more discerning and demand a higher property spec. And because there are more buy-to-let landlords about, there is a greater competition for the tenants, and tenants will go where the rent versus the choice and the standard of property is best for them.”

Paul points out that buy-to-let contributes over £30 billion to the UK economy, which is more than four times the UK motor industy.

With the buy-to-let boom, are we now in danger of an oversupply of rental property?

AO’D: “Leeds is one area where we would identify an oversupply – although there are one or two other areas too.”

FC: “ Absolutely. They’ve built so many apartment blocks [in Leeds] and are still building more and they’re just not selling. We’ve had feedback that people have had them on the market for 18 months to two years, or are now selling them for less than they actually paid for them. A lot of that has been buying off-plan hoping for capital growth.”

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Fiona says this is evidence that people have gone into it for the wrong reasons, for short-term, quick wins rather than investing for the long term.

The lenders agree that Bournemouth, Birmingham, Nottingham and Cardiff also have the problem of having too many properties of a certain type – ie purpose-built flats.

PD: “The biggest growth in any sector has been in the two-bed apartment – it counts for about 50 per cent of the newbuild market.”

AO’D: “It’s interesting that councils are beginning to turn against the development of new flats. Whether they can enforce anything is a moot point. It may be that demand or supply is dampened by councils.”

I’ve heard that a number of lenders are increasing the amount they ask for as deposit on newbuilds, and some are not willing to lend at all. Have you come across this?

FC: “I attended a CML meeting recently and there were quite a few lenders there who were considering putting a cap on the amount of lending they were going to do on newbuilds.”

Alistair agrees that there’s a lot of nervousness about lending on newbuilds.

AO’D: “I spoke to a valuer the other day who said if you lend more than 45 per cent on a newbuild in Leeds at the moment then you’re probably in trouble – he was probably only half joking.”

Tax matters

The Chartered Institute of Housing has called for tax changes to discourage people from buying property as an investment as it believes it is contributing to the housing problems of first-time buyers.

Do you think buy-to-let should be taxed in a different way to limit the number of landlords and free up the property for first-time buyers?

SM: “Landlords can potentially pay capital gains tax alongside stamp duty and income tax. I think they’re probably taxed enough.”

FC: “We need to be mindful that landlords don’t become the next scapegoat in terms of taxation. Because a huge number of people are using it to support their pension provision, we feel it would be very unwise to do it any differently.”

PD: “The government want people to focus on a degree of self-sufficiency in their older age, and if people are putting their own funds into buy-to-let and believe it is a secure nest-egg, what’s the alternative if you then tax them out of that arena?”

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AO’D: “Landlords are responsible for improving the housing stock and standards within the buy-to-let market – so any further taxation would have a detrimental effect.”

PD: “You’ve already got 40 per cent capital gains tax to pay on the equity you’ve derived over a period of time; if you increase that threshold, there is going to come a point where people will say, no it’s not for me.”

Paul believes that its stamp duty thresholds that need to change to enable more buyers to afford property.

“It seems wholly inequitable to me that we have this one threshold where if you fall one side of it you pay no stamp duty and if you fall the other side you pay the full amount. It should be graduated.”

The outlook for buy-to-let

Do you think the outlook remains positive for buy-to-let despite the fact that there appears to be a cooling in the housing market?

PD: “Yes, there is a cooling, and where a cooling stops and a recession starts I’m not sure.”

FC: “Gross lending overall, including buy-to-let, is up for the first half of the year against the same period in 2006, so the market is still going strong, and I think as long as people do it for the right reasons and for the long term, buy-to-let will continue to be a good investment.”

PD: “Fewer people are going into the market as a means of acquisition of rent – ie to get monthly income. Most are looking at it for the longer term, for the equity build-up.”

FC: “There is some evidence to suggest that people are more willing to supplement buy-to-let out of their personal income because they have that ambition to be in it for the long term to supplement their pension. I think that’s also helping to keep the market where it is.”

PD: “My concern is that now the market-place is a lot tighter and you have novices coming in they will not make it work in quite the same way as if they’d tried it five years ago. But, it’s a big tanker and it will take quite a long time to turn.”

AO’D: “There’s nothing we can see to derail it. What could derail it is massive interest rate rises or some major world event.”

Stuart emphasises the importance of carrying out research and doing homework before investing in buy-to-let.

SM: “It really is about doing homework, picking the right properties in the right sort of locations and trying to market the property to the right sort of tenants.”