The outlook of the buy-to-let market has been rocky over the past few years. One minute the future is looking rosy and everyone should be considering it ‘ and the next minute the experts are predicting doom and gloom. So is the buy-to-let market at its peak ‘ or is it simply tumbling to the ground?
Looking back over the past few years the market has shown consistent growth and is now worth about £15bn. From an initial group of eight providers, 65 institutions currently offer more than 250 different products. This increase in competition has meant good news for investors and their advisers, as lenders have offered an increasing range of competitively-priced mortgage products.
Looking forward, it is not wise to make sweeping generalisations about the future strength or weakness of the market because the prosperity of the buy-to-let market can vary ‘ and even within ‘ regions.
While in some areas buy to let may be losing its appeal or suffering from over-supply, other areas continue to offer an attractive, viable option for investors. So when assessing the health of the buy-to-let market, one way ‘ and perhaps the best way ‘ is to examine it on a regional level.
The regional differences in the buy-to-let market that currently exist manifest themselves in two ways: in the capital appreciation of the property and the actual monthly rental return. Increases in property prices may not be reflected in an increase in rental values. For example, anecdotal evidence has suggested that London Docklands has benefited from capital growth but due to an over-supply of rented property, rental values have since fallen.
The following statistics highlight how much property prices and rental values in regions can vary. These figures apply to the whole area and within these regions there will be differences.
In the past two years, house prices in both Bristol and Bath have risen by 11% and rents are up 5%. In Manchester, house prices are up 12%, while rents have remained static. In Birmingham, house prices are up 10%, but rents have fallen by 15%.
The differences in these figures show how important it is for investors to consider location and how the buy-to-let market is booming in some areas and slowing in others. A local housing market can also be affected by smaller changes, for example, the influx of new staff to an area when a large company relocates and the effect of large scale redundancies. These factors are unlikely to be considered when taking a view on the whole market.
So how can a broker best advise on the buy-to-let market? A broker’s role is not just about assessing which buy-to-let mortgage is most appropriate for a client, but also considering whether buy to let is a suitable investment option for them at all.
To do this advisers need to ensure their clients have a good understanding of the prevailing local conditions for this type of investment and benefit from expert advice by using a letting agent. As with any investment, clients need to be fully aware of the risks as well as the rewards offered by a buy-to-let investment before they commit themselves.
One of the first tasks for the intermediary is to manage the investor’s expectations. The next stage is to encourage clients to treat buy to let as they would any other investment and research it properly. This involves not only identifying the right type of property to suit their investment needs, but also taking a realistic look at potential costs, risks and funding options.
After location, choosing the right property at the right price is key to making buy to let a successful investment. Two-bedroom flats and smaller houses located near shops and schools with good transport links are often popular with people looking to rent.
If obtaining a regular monthly income is important then properties that would attract students should be considered. These tend to be located in less attractive areas and are therefore cheaper to buy. However, such properties are not likely to appreciate in value as quickly as a more expensive flat in a better area, for example.
Letting agents can provide a wealth of advice on the current state of the local market, particularly the types of property which are in demand and the rents that can be attained.
One mistake many investors make is choosing a property they would want to live in themselves. Urban properties, for example, such as flats over restaurants, pubs and shops, are growing in popularity with young people looking to rent who wish to live near local amenities, yet such properties might not be where the landlord would want to live.
Clients looking to buy to let also need to be made aware of their future tax, legal and safety responsibilities, for example, rental income will usually be taxable. However, maintenance, insurance, cleaning and professional fees can be offset against this liability.
Interest paid on a mortgage is also eligible for tax relief. However, any profit created by the sale of the property in the future will be subject to the Capital Gains Tax rules in place at that time. The Council of Mortgage Lenders (CML) and the Inland Revenue have published guidance on these issues which investors should be encouraged to read.
When investors have made a property choice, based primarily on location, property type and affordability, the final consideration is finance. There are three main options: buying the property outright for cash, borrowing against the value of an existing property, or taking out a buy-to-let mortgage. The latter is the option most people choose.
Potential landlords will need a deposit of at least 15% and generally be aged over 21. The amount available to borrow will be dictated by the income the property will generate, not the investor’s own earnings.
To cover mortgage repayments, unavoidable running costs and to allow for times when the property is likely to be unoccupied, most lenders will insist the rental income covers mortgage repayments by between 120%-130%.
A bright outlook
So what does the future hold for the buy-to-let market? On the whole, the outlook for the market remains bright due to both supply and demand pressures. More young people are prepared to rent and postpone buying a property. A strong economic climate will continue to attract overseas investors as well.
On the supply side, the market will continue to attract new investors while existing landlords will build on their experience in the market and add to their property portfolios.
The overall buy-to-let market also has a built-in stabiliser that prevents wild fluctuations occurring. During downturns capital appreciation slows but rental yields increase because there is a greater demand for rented properties. When house prices rise more quickly, rental yields fall, but landlords benefit from the increase in value of the property.
However, there will be regional differences. There have been indications that London might become a hot potato for new landlords, due to an over-supply of property. But London is a large place with many variations between boroughs. It is more likely that only certain parts of London could be faced with over-supply problems. Outside of London there will also be regional differences. Some commentators are suggesting university towns may experience an over-supply of rented properties, but this should be countered by the growing numbers of students.
The conclusion is that the buy-to-let market is set to continue to grow, albeit at a slower rate than in the past. Buy to let is not necessarily for everyone and clients should be aware of the potential pitfalls, the work involved and their legal responsibilities of being a landlord.
However, for people who are prepared to do their research and accept the risks involved, it should as part of a diversified investment strategy to generate a regular, modest income as well as the chance to enjoy capital growth.
Jeff Knight is residential mortgage marketing man-ager of Sun Bank
Rental income relies on demand, meaning landlords must not assume a rise in property values goes hand in hand with increased rental income.
The Inland Revenue produces a guide detailing the tax situation for landlords.
Some experts fear London and student cities could suffer from an over-supply of rental properties.