Not a day seems to go by without someone in the press making a comment regarding the state of the UK mortgage market, whether it be about credit crunch, non-conforming mortgages here or in the United States, or the decline in the UK housing market.
While all these opinions are certainly welcome, it can lead to confusion over any potential impact the current state of the market will have on the buy-to-let (BTL) sector and those involved in it. To help try and give some clarity to the situation, I have been reviewing the press over the last few weeks trying to draw conclusions myself.
Before sharing some of the comments made I believe it is, firstly, worth re-emphasising some of the key investment strategies that all experienced BTL investors use when building portfolios.
Gearing and leverage
The first is gearing and leverage. The key reason why investors can build substantial portfolios quickly is the ability to use other people’s money to do so.
There is a clear benefit to using only 10-15 per cent of your own money to purchase the property; principally, the more deposit the investor puts in, the less per cent return on their investment over the medium to long term. As an example, a £10,000 deposit could purchase a property worth £100,000. Why put £20,000 into the same property, as this, in effect, halves the potential growth on the investment.
Providing that you have a tenant who is effectively paying the mortgage through the rent they pay then the investor is on his or her way to building a substantial asset base.
Clearly, as lenders look to tighten lending criteria and potentially reduce loan-to-values (LTV), this could have an effect on the amount of new BTL purchases. Remember, however, that BTL lending today is chalk and cheese to that of five years ago, with far greater flexibility.
Confusing off-plan with BTL
Note here that I mention a tenant paying rent. The common mistake the press make is confusing BTL and buying off-plan. The majority of BTL investors I know will now have nothing to do with off-plan in their portfolios, preferring second-hand properties with known valuations in areas of high tenant demand
Purchasing off-plan is a different investment strategy altogether. In the past, investors would attempt to flip properties (sell on the contract) prior to completion to make a quick profit. The current issue with the off-plan market is the oversupply of new build apartments with no tenants wishing to rent them. The mature BTL market is nothing to do with quick profit but holding on to an asset for the medium to long term.
That being said, if the discount is big enough, some may be tempted. But only on the basis of knowing the ratio of owner occupation in any development and taking into account the potential for longer voids in the early days in their investment calculations.
One of the best pieces of advice I found when looking at recent articles on BTL came from David Austin, managing director of Property For Life. Less experienced property investors should follow the example of professional landlords and diversify early on to spread risk and secure more lucrative returns.
He believes that, with the correct advice, investors with less experience and fewer properties should be aiming to diversify and balance their portfolios to ensure that they attain better risk-adjusted returns.
He said novice investors predominantly purchased purpose-built flats and favoured one type of tenant. He added: “In contrast, seasoned investors diversify on area, property type and tenant type. Experienced landlords invest in areas where rental yields are greater with fewer void periods. Areas undergoing regeneration are particularly popular with these investors.”
Austin said novice investors who preferred to purchase in one area should aim to invest in different types of property which appeal to different tenant types. He commented: “By buying a student flat and a family house in the same town, property investors have the advantage of understanding the area while successfully spreading the risk and benefiting from economies of scale.”
Yield
Yield is another important area to look at in the BTL market. Providing the yield is greater than the BTL mortgage then an investor can sit on the property until wishing to realise the investment.
Many professional property investors will not look at a deal unless it is producing at least 6 per cent yield. So with the predictions of interest rates being at their peak, then I believe that the market will continue to grow as the sums still add up.
This can be confirmed by the recent index published by Paragon Mortgages, showing that rental yields were holding firm at 6 per cent, with rents rising by 2.4 per cent over the last 12 months. Paragon said that BTL is benefiting from growing tenant demand as potential house buyers are less able or willing to take on a mortgage.
This was further confirmed by recent figures published by the Royal Institution of Chartered Surveyors showing that tenant demand for rented property is at record levels.
Voids
The basic BTL model of getting your tenant to pay the rent to allow the investor to pay the mortgage can come off the rails if you either have not got a tenant or they do not pay what they owe.
Clearly, the latest report from the Council of Mortgage Lenders stating that BTL arrears in excess of three months stand at only 0.63 per cent in comparison to 1.06 per cent for the overall mortgage market is a clear indicator that the majority of landlords and property investors must be managing their BTL portfolios well.
Demise of BTL
While so far I have written about the positive press coverage and recent indices that have been published, there will always be column inches spent on the demise of the sector as a whole. This month was no different, as there were several rather negative outpourings from various bodies, the press, and, of course, television reporters.
The Institute of Directors (IOD) made the press with its proposal for sweeping reforms to the BTL tax structure, which some warn could deter landlords from entering the market altogether. The report, entitled ‘Encouraging Savings: A Better Tax Regime’, recommends that the ability of BTL investors to deduct interest from rents should be withdrawn. The IOD essentially wishes to bring BTL investment in line with those who invest in other asset classes.
Richard Terrington of Platform, commented: “The IOD’s proposals would have a destabilising effect on the property market, removing one of the incentives for landlords to invest and making renting more expensive”.
While I am all for equal playing fields, if the rented sector supply fell then could the IOD advise me where tenants are likely to live? Perhaps they could rent out rooms in one wing of the IOD’s houses.
The best piece of television journalism I saw in the last month was a BBC reporter on breakfast television telling a professional investor that he was doomed and that houses prices were falling. This was to a man who had built up a portfolio of £8 million in the last five years and had total borrowing of circa £4 million. His response: “Why do I want to sell any?”
Moneyfacts also reported that the BTL sector is suffering from the effects of the current credit market upheaval with mortgage lenders in the sector having either tightened criteria, withdrawn products or increased fees. This was supported by an intermediary stating that demand seems slow. Undoubtedly lenders are moving criteria with many taking the opportunity of realigning charges to improve margin.
Though if all the reports are to be believed, then now is a fantastic time for intermediaries to get involved with experienced BTL investors. Though they are not going to walk through your door, they need to be found. In previous ‘BTL master class’ articles I have highlighted a plethora of ways to do this. So if your business is falling back at this time, dig out the back copies or look on the Mortgage Introducer website.
Silver lining
To finish, and to hopefully dispel the BTL doom mongers, Mark Blackwell, head of corporate accounts at Cheltenham & Gloucester, recently commented: “For the careful property investor, it is far from doom and gloom. In a case of ‘every cloud has a silver lining’, the current unsettled climate is helping fuel tenant demand.”
He went on to state that according to the recent Association of Residental Letting Agents (ARLA) report, tenant demand now outstrips supply in all areas of the rental market. As a result, landlords are taking the opportunity to push up prices, with more than half of ARLA members saying that they have increased rents in the last quarter.
Thank you Mark for the reminder – it’s time I did the same.
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