Most buy-to-let investors who have been in this market for at least five years have done extremely well. The Association of Residential Letting Agents (ARLA) reports that the average total return on a purchase using 75 per cent debt over the last five years was almost 24 per cent per annum. That said, the halcyon days of spiralling prices, plentiful tenants and consistently strong returns, for the time being at least, are over.
New investors face a more mature and complex market where pitfalls and traps await the naive and unwary – and there are lots of those. More than 20 per cent of respondents to a recent ARLA survey had been residential landlords for only a year or less. With more than half those surveyed having less than five years experience the need for expert advice has never been greater.
Growth
Data from the Council of Mortgage Lenders (CML) shows that new buy-to-let lending grew from £3.1 billion in 1999 to £21.8 billion in 2004. 2005 ushered in a new, more subdued phase but many commentators expect a slightly more buoyant performance during 2006.
Nearly two-thirds of the landlords questioned in the recent ARLA survey said they expect to enlarge the size of their property portfolios during 2006. This is the second consecutive quarter to show an upward trend. What’s more, nearly nine out of ten (89 per cent) landlords said they would not sell their investment properties should house prices fall in the future. On average they expect to hold their properties for over 15 years.
Clearly then the majority of existing landlords are not speculators but are investing for the long-term. That is not to say the market is free of speculators, particularly those who have been lured into property by the siren voices of certain investment clubs. Thus, it is all the more important that prospective investors get pragmatic, informed support from their financial advisers.
The right advice
Typically, landlords fall into four broad categories. At the top end are those professional investors whose property portfolios are their main source of income. According to a CML survey, landlords with over 250 properties account for almost half of all rental stock. These players are normally very clear about their objectives and have strategies in place to achieve their goals. These investors tend to gear their portfolios aggressively and often want lenders to work with them on a portfolio basis. This can be more important to them than the price of their finance. The Mortgage Works, for example, allows both aggregated loan-to-value and rental income calculations at portfolio level.
The next segment includes part-time landlords for whom the portfolio is an additional source of income – roughly a fifth of all landlords fall into this category. These investors are normally savvy and specialise in particular markets. While many are still seeking to build their portfolio, they do not consider property investment to be their full-time occupation, even when it generates 50 per cent of their total income.
The two remaining groups constitute some 68 per cent of all landlords. The income generated from buy-to-let is not the prime source of income for either group and most people are in salaried employment.
One group is a mix of investors who typically own one or two properties. In many instances, these players are investing for long-term capital growth and see property investment as a way to boost their retirement provision. The last group typically own only one property, are new to property investment and often have little idea what they are doing or the risks they are running.
It is these two latter market segments who are most concerned with and vulnerable to falling house prices and slackening rental demand. When experts talk about ‘the froth coming off the buy-to-let market’ it is in particular the speculative investor to which they are usually referring. ARLA recommends that a five-year period is the minimum period over which it is viable to make a buy-to-let investment, taking into account purchase and set-up costs.
New entrants
Advisers will often find new entrants do not have a grasp of the basic principles of successful investment including the considerations, the risks and the potential rewards of gearing with debt. Tax in general and inheritance tax in particular need to be considered and many investors pay little attention to this important dimension.
Many new entrants are attracted to apartments as their entry point. Few realise, however, that in quarter four 2005, while the average capital value of rented houses fell by 1.5 per cent, the value of rented flats fell by up to 9 per cent.
Concentrations of new-build supply for rent coming onto the market can also cause local difficulties and experienced intermediaries can again ensure new landlords have understood the dynamics of the local environment and whether there is disproportionate activity in the areas being considered. Many lenders will now limit their exposure to new developments and there may be increased risks of voids due to oversupply.
Past performance demonstrates that geographical location has had a limited impact on long-term returns. For example, the South West produced the lowest total annualised return over five years on a geared investment at 21.27 per cent, while the best was in Scotland, Wales and NI at 24.25 per cent. The relative performance of regional markets is hard to predict. What’s important is the location of investment property which will greatly affect tenant demand. It’s no coincidence that some of the most successful investors specialise in very particular areas.
There’s no doubt the current market hides some nasty risks for the novice buy-to-let investor. But, for the astute investor and the capable adviser there remains a wealth of real opportunities.
Matthew Wyles is group development director at Portman Building Society
