Selling a property is extremely difficult in the current climate. Sellers have been very slow to catch up with the falling price expectations of buyers. As such, the 'correction' that we are seeing in house prices across the country has actually been sluggish; there has been a reduction in sales in lieu of a reduction in price. Mortgage approvals are down, and the market seems on the verge of seizing up but while the residential property market's future is set, the future of buy-to-let remains unclear.
The extraordinary growth in popularity of buy-to-let investments is attributable in great part to the blinkered attitude of many buy to let mortgage lenders. The property bubble was deemed impenetrable and that assurance was passed on to investors, many of whom were new to the property rental industry. Some lenders proclaimed that the cycle of boom and bust, in both financial markets and property, had been abolished. Given the current climate, the spuriousness of this claim need not be explained.
For many commentators, the decimation of property values has sounded the death knell for buy-to-let. However, looking at it from a slightly different angle, the property slump may actually provide a springboard from which a buy to let renaissance may be launched.
There are two ways of looking at this: in the first instance, the market is awash with cheap property, and it is getting cheaper all the time. Fewer and fewer people are getting mortgages, meaning that the demand for rentals is on the up - indeed, rental demand has risen 50% in the past six months. As such, if you have sufficient capital to purchase a property, or if you are a safe enough bet to get a mortgage approval, you stand to make a good return on rental income.
The second advantage is that property prices will inevitably rise once the slump has reached its nadir - remember that the recent boom came after the bust of the '90s. It can be presumed that, when this rise happens, there will be a s fall in rental demand and a slight reduction in the amount that landlords can expect their tenants to pay. However, this would be more than offset by the capital appreciation on your property. As such, there is the potential for significant returns if you can hold on long enough to ride out the rest of the slump.
The attractive nature of the buy-to-let industry is evidenced by the interest shown in troubled buy-to-let mortgage lenders in recent months by investors. A number of American and Middle Eastern investors were reportedly engaged in negotiations to rescue Bradford and Bingley over the summer. B&B were the largest buy-to-let mortgage provider in the country and their collapse was seen by many as the last straw for this type of property investment. While no offer was forthcoming from any of these groups, the fact that the negotiations happened at all (and that they got so far) is sufficient illustration that serious investors still see a life for buy-to-let.
One of the positive outcomes of the property crash has been that amateur investors will hopefully think more seriously about the cons as well as the pros of buy-to-let. The days of 100% loan to value (LTV) mortgages are over, and this is for the best. Prudence and caution will be the industry watch-words, and any investor considering entering the market in the near future would do well to remember them. If you are considering buy to let, there are a number of factors that you should address from the outset:
- In order to make buy to let in any way viable, you will need to keep your mortgage repayments down. This means finding a low interest rate mortgage (the lowest we could find today - 26 November 08 - was around 6%). However, the best rates are generally only available on LTVs of around 75%; in other words, you would need a 25% deposit.
Many landlords take on interest-only mortgages as doing so cuts monthly repayments by around two thirds. You would not pay off any of the mortgage debt but it can be particularly advantageous as competition in the rental market grows because you then have the freedom to drop your rents while retaining a sufficient margin. By way of a guide, your rental income should never be less than 125% of your mortgage repayments - but if you are paying an interest only mortgage it can be more flexible.
- Predictions vary wildly, but it seems that the housing market has not yet reached its lowest point. The most recent predictions range from 0% growth in the coming year to a contraction of up to 35% by the end of 2009. The big buy-to-let gains are to be made through capital appreciation, rather than rental income. As such, you should be buying when prices are as low as they are going to get and while it is clearly impossible to accurately predict when this will be, it seems wise to hold off purchasing, at least for a few months.
- It is clearly unlikely that you are going to see any capital appreciation within at least the next year. However, you can increase the potential for gains by investing any surplus rental income you generate. This makes particular sense if you can find a savings account with a higher rate of interest than you are paying on your mortgage. This might well be difficult, particularly as the interest rate cuts have affected savings accounts to a far greater degree than they have affected mortgages. However, you might consider taking an interest only mortgage and putting your surplus rental income into, for example, a fixed rate bond at around 7%. This ensures that your money will be working for you while you wait for the upward phase of the property cycle.
- You must be absolutely confident that you could shoulder the financial burden of an increase in interest rates. There has been much talk of mortgage rates falling as a result of the Bank's base rate reduction. However, unless you have a base rate tracker deal (and this is highly unlikely if you are applying today) this reduction may not be passed on at all.
- The cost of mortgage lending is related not to the Bank's rate, but to the cost to the mortgage provider of borrowing money. The most accurate indicator of this cost is the Libor, or the London Interbank Offered Rate. This describes the price of banks lending to each other. The Libor has historically floated at around 0.12% above base. Today, however, despite an overnight fall, Libor stands at 3.94%, nearly a whole percentage point above the Bank's rate.
Buy-to-let, therefore, is certainly not a risk-free investment - but then in reality, no such thing exists. Those who have continued to prosper in buy-to-let have done so because they have been able to predict the peaks and troughs of the market or have safeguarded against them. The serious money is now to be made by those who have the courage to buy low and sell high. As such, buy to let could yet turn out to be a remarkably sound investment - but only for those who can afford to hold on to their property if the inevitable price rises take longer than expected.
