The return of buy-to-let

Newspapers are telling us that house prices are on the way back up. Mark Lewis examines the case for and against getting back into bricks and mortar

Buy-to-let is back, if you believe the headlines. Property prices are rising again and a swelling band of tenants, unable to access mortgages of their own, need homes to rent. But close scrutiny of these optimistic claims and carefully selected statistics reveals a much more complex picture that could just as easily suggest the outlook is gloomy for buy-to-let. With the Bank of England base rate at 0.5 per cent and high street banks offering barely more on cash rates, high earners may well be considering investing in property. An average yield on rental property of between 4 and 8 per cent last autumn, depending on which data you look at, begins to look attractive compared to what the building society will give you, and if you factor in the potential for long term capital growth, the investment can seem tempting.

As a considerable number of distressed properties come on to the market estate agents argue there is an opportunity to acquire them at very keen prices. And just to complete the image of an ideal environment for buyto- let investment, figures show that the last six months have witnessed a dramatic change in the balance of supply and demand in the rented residential property sector. Many landlords are now saying that there are more tenants than properties available for them, a change reflected across the country.

More cautious investors will reflect that the buy-to-let sector has been devastated in the last two years. The number of buy-to-let mortgages granted has fallen off a cliff and the number of mortgage products available to investors has plummeted 93 per cent, from 3,662 to 239. Now most buy-to-let mortgages are now granted only to investors with a deposit of 25 per cent or more. And most important of all, investors have seen the capital value of their asset fall by 30 per cent or more in some parts of the country. Whether the recent increases in property prices mean the market has genuinely bottomed out remain key to investors’ concerns about entering the market.

Set against these kinds of figures any improvement would be welcome but should not been taken as evidence of a real and substantial recovery.

Moreover much of the improvement in rental yield and demand could be due to a seasonal bounce with students returning to university. The national average figures for rental yield mask considerable regional variations, creating a severely fragmented market for potential landlords.

Some players in the letting sector seem to take a decidedly tentative view of a buy-to-let recovery. Chris Norris, policy manager at the National Landlords Association says: “There is a real restriction on finance available to would-be landlords with the requirement of a minimum 25 per cent deposit and a further 4 per cent arrangement fee for many products.” He also points out: “There is a lot of uncertainty because of the proposed FSA regulation, especially the capital acquisition requirements.” Striking a cautious note about the whole buy-to-let sector he says: “It would be reasonable to say we are in limbo.” One prediction he is prepared to venture is that future lending will be much more circumspect. “I do not see a return to free lending practices and it will be the middle of this year before we have more certainty,” he says.

Looking at the national picture, Ian Potter, operations manager at the Association of Residential Letting Agents, says: “It is patchy, the market is all over the place.” On the subject of lending he too is conservative about a return to a more liberal regime. “In 1996 the first buy-to-let mortgage was introduced with no greater than 70 per cent loan to value ratio and an expectation of adequate rental yield to cover the costs of the mortgage. There may be a return perhaps to a more professional market with experienced landlords who know what is required of them,” says Potter.

Chris Norris, policy manager at the NLA, says: “There is an improved picture compared to last year, with the wiser investor holding fire, the most profitable time could be in the next 12 to 18 months for capital growth and established portfolio landlords are now in a good position to acquire property.”

Norris’s more positive interpretation is supported by Katie Hepworth, portfolio planning consultant at Assetz, who says: “Buy-to-let has been back for some time. There is a marked increase in investors booking seminars although initially it has been experienced landlords who have been re entering the market. It is better than last year simply because the cost of property is lower so the percentage of return is greater. There are a large number of distressed properties coming on to the market and we foresee an adequate supply of these for some time to come.” She predicts that city centre property is the type most likely to see growth in rental yield especially as the “focus of developers appears to be suburban development.”

Uncertainty about the FSA’s intentions to regulate the buy-to-let mortgage market is not a major concern for high earners looking to invest large chunks of cash. Stuart Law, chief executive of Assetz, comments: “Buy-tolet mortgage regulation could well stop speculators with no money entering the buy-to-let investment market and should also improve the transparency of individual transactions further. Far from impeding the recovery of the market, taking away the speculative, higher risk transactions will improve the risk profile of the sector from a lender’s perspective.”

Key to the success of buy-to-let investment is the ratio of tenants to properties and there do seem to be indications of a more positive outlook.

Oliver Gilmartin, senior economist at the Royal Institute of Chartered Surveyors says: “A slight increase in tenant demand, and a fall in new instructions to letting are starting to feed an increase in rental yield.”

Gilmartin cites two critical results from the most recent RICS survey. “The number of landlords expecting to sell their properties has picked up slightly from 0.2 per cent when the property market was on its knees in January 2009 to 3.2 per cent in November. This is a significant figure as a weak sector would probably lead to more landlords looking to offload their liabilities. But low interest rates have helped landlords and they may well be taking more money home as their mortgage costs have dropped.”

Most revealing is his comment on the implications for increased rental demand of a reduced supply of rental properties. “A key indicator is that new instructions for rental property are at their lowest since RICS began its surveys in 1998,” he says.

The strongest evidence that investors are returning to buy-to-let comes from the Council of Mortgage Lenders. The CML’s third quarter data showed that gross lending grew for the first time in two years, albeit from a much reduced base. At £2.1 billion, lending was 10 per cent higher than in the previous three months. The third quarter also saw a similar first increase in two years in the number of buy-to-let loans advanced, from 21,600 to 23,700.

More specific data comes from Paragon’s Financial Adviser Confidence Tracker (FACT) Index. The proportion of buy-to-let mortgages obtained for portfolio expansion has risen to its highest level since 2001.

John Heron, managing director of Paragon Mortgages says: “It is encouraging that landlords are now adding to their portfolios. We have not experienced the mass sell-off of buy-to-let property during the recession that some commentators were predicting, but buying activity has been subdued.”

“As house prices have stabilised, landlords now obviously believe that it is a good time to start expanding before house price inflation picks up again.”

This, of course, does not tell the whole story. Those investors in the strongest position to benefit from the downturn are cash buyers able to drive a hard bargain with nervy vendors. Figures from Allsop, the UK’s biggest property auctioneer, reveal that 86 per cent of its purchasers are currently private investors – an increase of 20 per cent on last year’s numbers. How sustainable this resurgence in cash funded investment remains to be seen as Gary Murphy, partner and auctioneer at Allsop comments: “For the foreseeable future banks will continue to use the opportunity presented by the current 0.5 per cent base rate to improve their balance sheets. Under these circumstances private investors could be restrained by limited cash resources. Once these have been invested, there is a risk that further activity will be affected.”

So the buy-to-let investment option does seem more viable than it has for the last two years. There are stable rental returns giving a greater percentage yield, a greater demand for rental properties and there is, for the moment, a plentiful supply of cheaper properties. Set against this are the considerable barriers to entering this market presented by stricter lending criteria and the spectre of further falls in capital value. The jury is still out on whether the market has bottomed out. But for cash buyers with a strong constitution and experience of managing properties, buy-to-let can appear no worse than other asset classes.