To paraphrase the words of Mark Twain, reports of the death of the buy-to-let market have been grossly exaggerated.
Admittedly there has been a well documented cooling of both prices and activity levels, particularly in London, but the Council of Mortgage Lenders (CML) recently produced evidence suggesting that property which was typically being bought by first-time buyers is now being snapped up by both first-time and repeat buy-to-let investors.
What is more, even though housing trends indicate the number of property purchases in certain parts of the UK have moved downwards, the remortgaging frenzy which has characterised the mortgage market in 2003 includes healthy quotas of buy-to-let investors who have been refinancing loans which are now two or more years old.
A lot of the durability in this market can be attributed to the buying patterns of landlords over the last 12 months, during which mortgage finance has never been cheaper. Lender surveys have found that rental yields were being sustained at around 8% last year, and lenders are now offering products priced from as low as 4% on interest only terms, and so affordability ratios are only compromised in certain property sectors (such as high value apartments in flagship London locations). With equities at their lowest ebb since the mid-1970’s, investment capital has steadily migrated out of the stock market into more tangible asset classes such as property. And in terms of value for money, property prices in many parts of London for example have fallen to a level where even though rental incomes are very modest in places the potential for capital growth is greater than was the case say 18 months ago
Based on these figures, and borrowers unabated appetite for investing in property, it is little wonder that the provision of buy-to-let products is deepening. New lenders have entered the market and those already established in it are presently seeking to protect or secure their positions. The reason for this is not purely about satisfying borrowers’ needs; the motive is as much about the pursuit of profit ‘ margins on many prime residential lending products are threadbare and in some cases even loss making. The buy-to-let market (which is often bracketed with self-certification and adverse lending under the term non-conforming) offers healthier margins ‘ albeit those which themselves are now being pressurised by added competition.
There was a time when buy-to-let products were the preserve of a narrow band of product innovators such as Bank of Scotland, Capital Home Loans and Mortgage Trust. However, since the mid-1990’s more and more lenders have courted this business. Companies such as GMAC RFC, Mortgage Express, Bristol & West, Woolwich, Britannic Money and particularly BM Solutions now compete vigorously with the industry’s pioneers for a share of a £10bn plus market.
And in the last 12 months this group has been swelled by smaller and more localised lenders, so it is not just a tale of well-capitalised mainstream players who have scale and distribution at their disposal. Derbyshire, Coventry, West Bromwich, Newbury and Scarborough are just a handful of building societies who are honing their capabilities in the buy-to-let sector. And for those lenders who may not elect to develop their own buy-to-let expertise on the grounds of either risk or cost, there are still the alternatives of buying this elsewhere. Purchases can be of either a market specialist or simply a tranche of securitised buy-to-let debt. Do not be surprised to read of buy-to-let related acquisitions over the next 12 months ‘ particularly as such deals can be strategically defensive as well as offensive. After all it was only in the last few weeks that Paragon revealed that it was in take-over talks with Britannic Money.
Despite all of this, one change of approach which lenders have initiated relatively recently is that relating to their rental cover to interest payment calculations. Rental returns (not to be confused with yields) have fallen in London and some other large cities to such an extent that a rise in interest rates coinciding with an unexpected void period for a landlord could lead to a shortfall in repayment coverage.
Adjustments to this key formula can work both ways depending on whether a lender is seeking to develop or protect its loan book. For example, Bank of Ireland recently reduced its rental calculation from 7.75% to 6.5%.
If a client opts for a medium term fixed rate (such as five years plus) then often that pay rate can be used. Only a few lenders such as Mortgage Express will base the rental cover on a typically lower discounted rate though they do apply a 130% interest cover formula rather than 125% as used by most lenders.
While Bank base rates have only fallen by 0.25% since January, funding for fixed rates has become much cheaper so short and medium term rates have fallen markedly, so much so that five-year rates are approximately 1% lower now than a year ago. For the lenders who base the rental coverage on their standard variable rate this means that the small drop in base rate has meant a smaller drop in their standard variable rates which does not reflect the greater reduction in fixed discounted and tracker product pricing. The real significance of this is that it is affecting what product a borrower will need to select just to secure the funds they need particularly at an 85% LTV level.
What is also significant is that rental coverage formulae have not fallen as fast as the rental returns on property itself. A few years ago it would have been unheard of for the rental income on a property to be insufficient to cover the mortgage amount applied for if the loan fitted into the lenders LTV range. In some areas (London once again) it is now not uncommon to fail to achieve a rental high enough to justify 85% borrowing. Alarmingly, on selected new build sites along the Thames even a 75% LTV loan can be tricky to secure.
In this climate lenders are becoming more circumspect about who actually executes the rental assessment. Previously many would allow this to be authenticated by an ARLA letter alone. But currently most lenders would require this to be done by the valuer who of course has his own professional indemnity position to safeguard as well as his relationship with both lender and broker alike.
Some quite profound changes in lending practice are therefore in motion. And what is equally apparent are changes in the public’s attitude to renting over the past 12 months.
For any broker, staying close to buy-to-let buyer patterns at an agency level is important. Over the past 12 months Hamptons has reported a substantial surge in demand by single people and young couples for rental property. These ‘in betweeners’ are the most nervous about buying property right now but have intentions in this direction in six to 12 months time when both occupational and global conditions are hoped to be more stable.
This lapse in owner occupier demand has depressed house prices by up to 10% in pockets of Southern England and 20% in some parts of London. And this has served as an invitation to investment portfolio buyers to revisit the market now and buy up tracts of property at sizeable discounts particularly from large developers seeking more liquidity.
Outside a 60 mile radius of London the buy-to-let landscape is of course different. Values and rental incomes are holding up and in places such as the North West, the North East and Wales they have still further to go.
Lenders and brokers have specific roles to play in prolonging the life of the buy-to-let market. Lenders should consider three specific strategies. First, to continue the recent shift towards prudent lending criteria (whether the buy-to-let market is regulated or not) no one needs a market where investors are being encouraged and hurt by reckless underwriting terms. Second, to continue to be innovative in product design ‘ Paragon’s property development- to-investment schemes and other lenders’ forward buying facilities are recent example of this. And finally, to show greater favour to those borrowers who have a long standing non-property related income which renders them more resilient in a volatile buy-to-let market. These applicants deserve a less subjective underwriting approach.
Brokers can play their part by working more closely with lenders on the above matters including product design ‘ there rarely has been enough two-way consultation here. They should also challenge their clients to be realistic when advising brokers of their properties’ valuations and rental incomes at a time when lenders and valuers are understandably scrutinising applications more carefully than they were 12 months ago.
Lenders have recently changed their attitudes to rental cover with regard to interest payment calculations.
Buyer concern over the stability of the market has led to an increase in rental demand.
Greater pressure needs to be put on clients to be truthful about expected rental income to help ensure the stability of the market.