Many people have suggested the buy-to-let (BTL) bubble is ready to burst. Over the past few years, ‘doom merchants’ have often prophesied that the ‘end is nigh’. The figures, however, tend to confound the sceptics and we have seen consistent growth in this market over very many years. Of course those in the ‘glass half empty’ camp will be right one day and will no doubt say: ‘I told you so’ in that self congratulatory way that sometimes exists when the expounded theory happens in practice. We don’t know for certain when that day will come, the magnitude of any downturn, and what actions people will take if and when it occurs.
Back to reality
The reality is that buy-to-let (BTL) has grown significantly since the late 1990s. For 1999, the Council of Mortgage Lenders (CML) reported gross advances of £3.1bn, while for 2005 it reported £24.5bn. The first half of 2006 has seen record lending with gross advances reported as being up to a staggering £17.5bn. If this continues we may well see figures of £35bn for the full year, which would be a 10-fold increase in less than half a generation. This has been real growth too, with BTL increasing from 2.7 per cent of all new advances in 1999 to 8.5 per cent of all advances in 2005.
It seems to me that this market is to some extent ‘self-perpetuating’ and is therefore likely to continue to grow. Demand for homes greatly exceeds supply causing property prices to stay on an upward path. House prices put purchasing out of the reach of many first-time buyers because their incomes are often insufficient to meet lending requirements. On the other hand, those with capital can invest in rental property, and are often willing to diversify from the ‘safer havens’ of deposit accounts because the interest rates are considered fairly low. The properties can be let with sufficient cover to pay the mortgage and running costs, often leaving a residual profit. Those would-be buyers become the tenants. The tenants probably pay out more on rent than they would on a mortgage. The tenants find it difficult to save for a deposit and become virtually trapped in a cycle of renting. A little simplistic perhaps, but not that far from reality and a situation that seems will continue unless some of the fundamentals change.
Owning property is embedded in the British psyche, so the lure of potential profit from homeownership is quite appealing. So too is the prospect of making a capital return on the total asset while someone else pays the interest on the money borrowed to buy it.
There has probably always been a demand to own property to rent but, up until the changes to the way building societies were allowed to source funds and account for their lending, the BTL market was very much the preserve of the high-street banks and was perceived as quite difficult for all but the professional landlord to enter.
At Bristol & West Mortgages we started selling BTL mortgages in 1997, with a clear, simple proposition. Key to the success was the accessibility to the wider audience, allowing ‘the man on the street’ the opportunity to take a slice of this pie. We were the first major society (we have since changed status) to enter this market and were able to lend using a rental cover of 130 per cent at 9 per cent interest.
Changing times
How things have changed. There are now over 80 providers fighting for business, which has proved beneficial for the customer. The increased competition has driven prices down, with products now being priced much nearer to mainstream lending than was the case in the late 1990s, and has, in part, resulted in a lightening of the criteria used to assess potential loans.
For our part, we have adapted our criteria over time as we have gained in our knowledge of account behaviour and now use a 115 per cent rental cover based on either the actual payable rate for fixed rate products of more than three years, or of 5.70 per cent for all others. Although there will be new entrants to the market, I feel this will slow as they either need to go out on a limb with lending criteria or price products at very low rates to take business from the established providers.
Recently, we have seen the growth of ‘big fee’ products that provides the lender with the returns they need while, in many cases, allowing the customer the opportunity to use the lower pay rate for the rental calculations. An example of this would be the 5.35 per cent (correct at time of writing) three-year fixed rate product in our current range, where the customer can add the 1.5 per cent arrangement fee, while assessing the maximum borrowing at 115 per cent of the pay rate. The fee can be added in addition to the maximum loan. Current property values have made this an attractive way to maximise the borrowing while ensuring the proposition is self-financing.
Benefiting from captial
growth
Many borrowers choose to raise the maximum amount possible they can, either at the outset or through further advances. Apart from the advantage of the potential for extra tax relief, for customers with substantial cash sums this allows them to use this money to fund deposits on several properties and benefit from the capital growth on a bigger asset base.
If we look at two examples, shown below, using £200,000 available capital, we can see how this may work to advantage, although it would be sensible for customers to take advice from a competent professional intermediary before pursuing this course. In the first example, we are going to assume the client simply purchases a property for £200,000, and in the second example we are going to assume that the client uses the £200,000 as deposits on six properties. For ease of calculation, we are assuming the properties are sold after 10 years and that there is an average of 5 per cent per annum increase in property prices.
Example 1
Purchase price £200,000
Sale price at 5% p/a compound growth £325,000
Capital profit £125,000
Rent @ £1000 p/m £120,000
Total gross profit before tax £245,000
Example 2
Purchase price 6X £200,000 £1,200,000
Sale price 6X £325,000 £1,950,000
Capital profit £ 750,000
Rent @ £1000 p/m per property £1,200,000
Mortgage servicing costs on 85% loan at 6% average £ 612,000
Rental profit (rent minus mortgage costs) before tax £ 588,000
Total gross profit before tax £1,338,000
Clearly this is a very simplified example and totally ignores income tax, capital gains tax, purchasing costs, and repairs. But it does illustrate the point that ‘gearing’ works and that borrowing to buy can make sense and should be considered. The old adage ‘there is no loan cheaper than no loan’ may be true but a slavish addiction to that principal may cost a lot of lost potential.
Degree of risk
Property, like any other asset-backed investment, has a degree of risk and prices can fall as well as rise. There is also the added dimension of managing the property, rental voids, and the potential for bad tenants. These can not be ignored and should be considered before embarking on this path. That said, there are over 700,000 mortgaged BTL properties in the UK and presumably a good chunk more that are mortgage-free, so there are a lot of landlords out there who are prepared to accept the balance of risk.
There is also the facility to use expertise via letting agencies, the ability to obtain credit reference to minimise some of the tenant risks and a wide range of practical information from bodies such as the National Landlords Association (NLA) that may help mitigate some of the downsides. Lenders, too, play their part by applying prudent lending restrictions protecting customers from potential overborrowing.
An option for retirement
Much of the capital owned in the UK is held by the older generation. For those who are in the pre-retirement group, there are fears that pensions will not deliver the necessary income in the future or a feeling that pensions are less secure than they should be. Many have considered BTL as a viable way of planning for the future and as an alternative to the traditional pension plans.
For those in retirement, particularly those who rely on the interest from savings to supplement their other incomes, there is the worry about what inflation will do to their standard of living and whether they will need to dig into capital reserves to make ends meet. This sector of the community are often risk-averse, and in many cases, avoid the more traditional investment bond or unitised investments. Investment into rented property has more appeal because it is familiar and provides a realistic opportunity for both capital growth and an increasing rental income. At Bristol & West Mortgages, we do not have a maximum age limit for BTL customers and do not restrict older customers from borrowing or insist that the loan is repaid at any maximum age, so they too can benefit from ‘gearing up’ should they so desire.
BTL is deep-rooted in our financial culture. It is not risk-free, and it is not always going to be an easy ride. The economy will change and demand will at some point wane or accelerate. BTL is a good medium to long-term investment and should provide people with a realistic opportunity of above-inflation capital growth and a steadily rising income. I don’t believe the bubble will burst any more than I believe we will see the sustained double-digit price inflation of three to four years ago, and feel that this makes it a better place to be than the more volatile environment of the early 2000s.
