With dark clouds brewing over the residential property market, the appeal of buy-to-let as an investment proposition has diminished for many. Yet while some believe buy-to-let is currently best avoided, others suggest some rewarding opportunities are out there for switched-on investors.
Rises in mortgage rates in 2007 and other pressures on the consumer purse, along with overvalued house prices and the impact of the credit crunch have all taken their toll on residential property as an asset class. This has left many pundits predicting little or negative house price growth in 2008.
The flip side of this is that with consumers becoming more reluctant to buy amidst the current market turmoil, demand for rental properties has been bolstered, helping to breathe new life into rental yields.
Predictions for the residential market in 2008 vary considerably. While the likes of Hometrack and the Council of Mortgage Lenders predict house price growth of 1 per cent year-on-year, Capital Economics is predicting a 5 per cent fall. Meanwhile, Hometrack and Nationwide predict that the Bank of England base rate could end the year up at 5.25 per cent, while Capital Economics is looking to around 4.5 per cent. Mortgage approvals are also down, while repossessions are up. Bank of England figures show new approvals fell in December to 73,000, from 81,000 in November, while repossessions rose 21 per cent last year to their highest level since 1999.
As a result, whether now is a good time for clients with lump sums to invest to be putting their money into buy-to-let is a subject of some debate.
Specialist mortgage lender Paragon Mortgages released figures in January showing that rents were rising at the fastest rate on record, shooting up 19 per cent in 2007, and 8 per cent in the last quarter alone. Meanwhile, yields had broken through the 6 per cent barrier – where they had sat for over a year – to reach 6.2 per cent.
“It is already very apparent that we are in a period of very high, very strong rental demand,” says Paragon Mortgages managing director John Heron.
As well as being boosted by a lack of confidence in the housing sector and economy more generally, demand is also being driven by the scale of inward migration, the student population and the reduction in the social rented sector, he says. Heron believes yields will continue to improve “materially” over the course of the year.
“I think projections of house prices and all that kind of stuff make predictions fraught with danger, but we wouldn’t be surprised if we saw yields up around 7 per cent by the end of the year,” he says.
Lee Grandin, chief executive of Landlord Mortgages believes there are opportunities out there to buy under the market value as it was three to six months ago. “I certainly wouldn’t be looking to pay for a purchase at the market value of three or six months ago. The market has clearly softened and there should be opportunities in every county within the UK,” he says.
He suggests a property returning a yield of around 5.8 to 6 per cent is a good point at which to consider acquisition, pointing out that he has had reports of some new builds generating yields as low as 3 per cent.
However, he believes it is a misconception that property prices will continue to soften as yields go up, saying an adjustment will have to be made at some point to reflect the increasing value of rentals.
Ray Boulger, John Charcol senior technical manager is another industry expert far from giving up on the buy-to-let market at present.
He believes the current market conditions have the potential to throw up good investment opportunities for savvy investors taking a long term view.
Boulger says rents are being pushed up by some buy-to-let investors – mainly amateurs – selling up and thereby reducing supply, helping to swing the balance “quite significantly” into the landlords’ favour. “That situation I think will prevail for at least the first half of the year and probably the whole of the year,” Boulger says.
Furthermore, the “soft” market and fall in house prices mean that after a while, there will be distressed sellers, he says. “That’s an ideal situation for buy-to-let investors,” Boulger says. “Basically there are good opportunities in this sort of market to pick up property cheaply that they just would not get in a seller’s market.”
Boulger suggests investors should use the period to make “cheeky” offers, but avoid being tempted to “bid up” to the market.
While mortgage costs rose in 2007, Boulger, like many others, believes rates are likely to continue to come back down over the next few months.
Ed Stansfield, property economist at Capital Economics is currently less optimistic about buy-to-let as an investment, however. “I think the level of yields available to an investor at the moment, particularly once you take account of letting fees, voids, maintenance costs and all that kind of stuff, are pretty low,” he says.
“You need to have a pretty sizable deposit and therefore not be terribly reliant on mortgage finance to make ends meet on a month by month, week by week basis.”
Even despite the eye-catching growth in rents, Stansfield is not convinced. He believes that while some “buoyant” rental growth numbers have been reported, yields have fallen so far they have some way to come back. Stansfield suggests house prices could continue falling for the next couple of years.
“Which means you’ve got to be pretty comfortable with the view that you’re going to be able to ride that out and take a very, very long term view. It just seems to me that if you’re thinking about it, there’s going to be a better time in the next two or three years rather than right now,” he says. “Most investors are discretionary buyers, so why not wait until conditions are a little more favourable?”
Boulger concedes that there is an argument for holding off property purchase if you believe that the property market is going to fall significantly.
“Personally, I don’t think it is going to fall significantly. I think it will be soft for at least the first six months, but the time to pick up a bargain from a distressed seller is before it bottoms out. Once it bottoms out, they’re not going to be as distressed,” he says.
Mark Dampier, head of research at Hargreaves Lansdown is also unconvinced of the merits of buy-to-let currently. “I just don’t think this is the right time. My own view is you’ve got mortgage approvals flooring and that’s always an advanced warning of what’s going to happen to the housing market,” Dampier says.
“The banks are short on money to lend anyway and the whole residential and commercial property market works on borrowing. If borrowing starts to dry up then I don’t see that being good.”
That said, he does believe that over the next two or three years, eventually there will be attractive opportunities.
Other investment vehicles can offer exposure to the UK residential property market such as some Real Estate Investment Trusts which can offer a degree of exposure and unit trusts linked to house price indexes. Alpha Beta Fund Management for example has just launched a UK Residential Index Fund linked to the Halifax House Price Index. But many advisers are also reluctant to make use of such products as yet.
“Personally I wouldn’t touch anything to do with residential property, certainly for this year. I would take the opportunity to build up a lot of money for opportunities to come,” says Dampier. n
Case study – Where to buy to let
“Commercial property has had its correction, and seems to be settling down. Residential has got to go through that process”
Keith Churchouse, director, Churchouse Financial Planning
Guildford-based IFA firm Churchouse Financial Planning is currently advising clients to take a wait-and-see approach to buy-to-let as an investment proposition.
“I think we all acknowledge it seems to be a falling market at the moment and that the buyer has power,” says director Keith Churchouse.
“But at the end of the day if you’re putting down – as an example – say a 20 per cent deposit on a buy-to let, I think there is a chance you could lose half of that in a market correction.”
Churchouse predicts the UK is in for six months of market turbulence, followed by a levelling off in the third quarter. He believes in the buy-to-let concept for investment purposes and says there are no failings in the underlying marketplace. “There is nothing wrong with the fundamentals of buy-to-let, it’s just having a correction, as is everything else. So I’d just hold off for six months.”
He is also advising clients to hold off using any other investment vehicles such as Real Estate Investment Trusts, to gain exposure to the residential property market at this time.
“Commercial property has had its correction, or seems to have done and seems to be settling down. Residential has got to go through that process. So irrespective of what other vehicles you could use, I would still hold off.”