Buy to let

The phrase buy-to-let can refer either to the investment strategy of buying a residential property to be let for profit; or to a particular category of mortgage used to purchase a property for letting.

For many years landlords have invested in residential property to be let for profit, but since the mid-nineties there has been rapid growth in the property market leading to a surge in demand for rental property which is being exploited by many mortgage providers keen to encourage new amateur landlords. Fact|date=February 2008

Benefits and risk

As for all property rental, the benefits for a buy-to-let landlord can include a stable income from rental receipts, as well as an accumulation of wealth if house prices go up over time. Rising house prices in the UK [House prices have generally risen in the UK in recent years, almost doubling in the two years since February 2002 http://www.rightmove.co.uk/pdf/p/hpi/HousePriceIndex18thFebruary2008.pdf] have made buy-to-let a popular way to invest. The main risk is that the property might not be occupied for all 365 days of the year, while the owner still has to pay a monthly mortgage payment. Also, buy-to-let landlords would suffer along with all property owners should prices fall.

Yields

Recent [http://www.alliance-leicester-group.co.uk/html/media/non-indexed/release.asp?txtTable=pressreleases&txtCode=PR1701071 research] by BDRC for Alliance & Leicester showed that 71% make a profit, but 22% break even or make a loss.

On average, English buy-to-let yields (the difference between the rent the landlord receives and the costs of ownership) were just under [http://www.buytoletmortgages.co.uk 5.5%] in Q3 2007. This has fallen from over 7% in Q2 2002.

Buy-to-let mortgages

Buy-to-let mortgages have been on offer in the UK since the late nineties; they are specifically designed for investors to borrow money to purchase property in the private rented sector in order to let it out to tenants.

Lenders give different ways. The amount of currency investors can borrow is decided by the rental valuation of the property. Usually the annual rental income has to cover a certain percentage of the mortgage repayments, somewhere between 120% and 150%. This is to allow surplus rent to cover other costs such as property maintenance and void periods (periods when there are no tenants living in the property and therefore no rental income).

Other lenders will offer a three times' salary multiple and half the rental income.

Others base the amount that they will lend on your salary and the existing loan commitments that you have, but then apply the 'deduction rule'. This means that they will lend up to 3.5 times your income (or whatever salary multiple applies), minus a representative figure for annual mortgage payments worked out at a pre-set level of interest. Say you earn £40,000 and have an outstanding mortgage balance on your property of £120,000. Under the rule, the annual mortgage repayments may be calculated as £10,000. This would be deducted from your salary to leave £30,000, which is then multiplied by 3.5 to give £105,000 - the amount that you are able to borrow.

Typically the interest rates that are offered on BTL mortgages are fairly close to residential mortgage rates but will on average be higher and typically charge higher fees. This is due to the perception amongst banks and other lending institutions that BTL mortgages represent a greater risk than residential owner-occupier mortgages.

This type of investment has become very popular in the UK over the last five years or so, as house prices have dramatically increased. Another reason for their popularity is the tax advantages that are available to UK BTL investors. Rental income is considered in the same way as salary, and is therefore often taxed at 22% or even 40%. However, landlords can deduct costs from the taxable portion of their rental income, and these costs can include the interest portion of their BTL mortgage repayments as well as maintenance costs on the property. This tax set-up has made BTL investments more popular over the last few years.

Recent credit problems have had some investers maintaning the same percentage of equity in the property should prices fall and so rapidly find money to cover these downturns.

Effects on Society

In the UK, "buy to let" has attracted some negative publicity. It has been described by some as the epitome of what is wrong with British society. The basic ideas behind buy to let (according to this analysis) are "How do I get someone else to work for me?", "How do I get money without having to work?" and "How may I leverage my privileged position to enable me to make further gains at the expense of my fellow citizens?". This forms much of the basis of real estate investment. Buy to let owners (it is argued) can effectively do little work and yet still receive substantial incomes, not only making money from rent, but potentially realising large capital gains on the sale of their housing stock. The suggested result in the UK is that of a wealth divide never seen since Victorian times. Buy to let, as a form of real estate investment, together with complicit lending practices and legislation, has arguably been one factor behind the huge rise in house prices in the UK since the late 1990s. First time buyers frequently struggle to get a foot on the housing ladder.

Others argue that these criticisms of BTL landlords as fat-cats is unfair. While property owners of all kinds undoubtedly benefit from periods of house price inflation, one analysis of BTL suggests that its main effect has actually been that of "crowding out" the more traditional landlords who own their properties outright. So, while concerns about buy-to-let form a valid part of debate over the UK's wealth divide, the main, tangible change brought about by the changes in the market is the emergence of a wider property ownership base. More properties are owned by smaller investors than before, as they chip away at the dominance of more traditional landlords, such as property companies or landed gentry.

One suggestion is that the main reason for rising house prices is one of straightforward supply and demand: the number of households has been rising faster than the number of homes. In these circumstances, there are increasingly too few homes to go around, and the price is forced up. [http://digitalnation.fileburst.com/arla/arla_btl_history.pdf] This trend has been the case in Britain since 1992. A counterargument to this, however, is that rents have not increased in line with house prices, which is what one might expect if a genuine shortage of dwelling units were the sole or main reason for the increase in purchase prices.

One area where fingers of blame have regularly been pointed at some buy-to-let landlords is in the cases where a property is allowed to remain empty for a sustained period of time (a form of land speculation also known as "buy to leave"). This exacerbates the shortage of supply for housing, and has the potential to push both rents and house prices up further. Leaving a property unoccupied is arguably unlikely to be the long-term strategy for most property owners, since they are forgoing rental income, but the very notion that the strategy might be viable nonetheless in the current economic climate has caused concern.

Another suggested effect of BTL is that buy to let landlords tend to buy property that the first time buyer would otherwise have tended to buy therefore forcing up the price in this market and forcing the FTB to rent a property of a landlord rather than being able to buy the property instead which has been shown. This would make BTL a type of monopolistic strategy.

General disillusionment with the property market has resulted in the boundaries becoming blurred between the perceived dangers of buy-to-let, the existence of a property bubble and the global credit crunch that has made it harder to obtain mortgages at attractive rates for some customers.

History

The 1988 Housing Act abolished security of tenure for tenants. Landlords gained the power to evict problem tenants more easily, and so the prospect of becoming a landlord is more attractive than previously. The housing crash between 1989 and 1994 saw an increase in the number of tenants, as people lost their homes and were repossessed.

Buy-to-let as a term was coined in 1995 as a marketing badge for a finance initiative launched by the Association of Residential Letting Agents (ARLA), although this type of lending had existed for many years.

The Council of Mortgage Lenders (CML) started collecting statistics on buy-to-let in 1997 and some observers have interpreted the growth in buy-to-let lending, as reported by the CML, as evidence of a boom. However the CML only measures the growth of the new specialist lenders in the market - such as Paragon Mortgages, Mortgage Express and BM Solutions, whilst omitting the core back book of loans to residential property investors by mainstream lenders.

The apparent growth in buy-to-let lending is attributable to the success of specialist lenders in taking market share by offering bespoke products and services and attractive pricing. In fact, as much as 40% of activity is remortgaging as established landlords switch from more expensive commercial mortgages.

Despite the growth of the buy-to-let market since its inception, the private rented sector remains predominantly undergeared, with only 19% of the 2.7m properties mortgaged. Not only does this put buy-to-let growth into context, it also shows the growth potential remaining in the sector.

The Association of Residential Letting Agents conducts a quarterly survey of residential landlords to gauge their views on the market. In the 2005 3rd Quarter survey (September 2005), respondents showed resounding commitment to their buy-to-let investments. Of the landlords surveyed, 90% said that they would hold on to their investments even if house prices fell, 62% said that the average life expectancy of their property investments is ten years or more and 58% said that they intend to acquire further buy-to-let investments in the near term. The overall average life of their property investments was 16 years.

Assured shorthold tenancy

One of the key innovations required for widespread property investment was the reform of tenancy agreements and specifically the introduction of the assured shorthold tenancy (AST) agreement.

AST gives both the landlord and the tenant assurance of the tenancy and specifies the term the property is to be let and specifies notice period for both parties.

Experienced investors and amateurs

The buy-to-let world is divided into "old hands", and recent entrants, sometimes derided as amateur investors. The UK press often describes amateur investors as over-optimistic investors who are willing to buy property to let out, when there is little hope of making a profit.

The new landlord friendly legislation afforded by the 1988 Housing Act, coupled with the introduction of competitive mortgage products, brought new investors into the property market.

They have been attracted by rental incomes, rising capital values and a perception that the risk in housing is lower than for equity based investment. More recently, investors have seen buy-to-let as an alternative to their pensions, especially in light of the [http://www.fairinvestment.co.uk/pensions-news-Pru-finds-retirement-age-rising-to-meet-pensions-'crisis'-18187539.html negative publicity pensions] have received.

However, the sector is still dominated by professionals.

The Office of the Deputy Prime Minister's (ODPM) Private Landlords Survey, which appears in their English House Condition Survey, is the most comprehensive study of the private rental market. The survey is published every four years and the last three editions illustrate the changing structure of private rented sector ownership.

The ODPM survey does suggest that there has been significant growth in the number of small scale landlords owning up to four properties. However, further analysis of this data reveals that the private rented sector is still dominated by professional landlords with large portfolios of property.

Analysis undertaken by Capital Economics found that although 53% of landlords own less than five properties, this represents less than 3% of the dwelling stock. Further, at the other end of the scale, 13% of landlords own 74% of the stock.

Buy to Leave and negative publicity

Buy to Let has experienced much poor press over the past few years, with many commentators believing that it has contributed to rampant house price inflation. Such is the popularity of Buy to Let that estimates have recently put 1 in 3 new properties in London being bought by investors. Oxford Economics stated in August 2007 that buy to let is "undoubtably contributing to the overvaluation of housing". [cite web
url = http://business.guardian.co.uk/houseprices/story/0,,2142389,00.html
title = Average English house price will top £300,000 in five years, says study
publisher = The Guardian
accessdate = 2007-08-06]

References

See also

* Mortgages
* Remortgage
* Investing
* Irish Property Bubble
* British property bubble
* Greater fool theory

External links

* [http://www.cml.org.uk/ Council of Mortgage Lenders] - The association that represents nearly all UK mortgage lenders.
* [http://www.arla.co.uk/ Association of Residential Letting Agents] - The organisation that promotes buy-to-let properties on behalf of landlords.