Risky business?

With so many pessimistic views swirling around the industry, it is not surprising that some people are also saying that buy to let ‘ traditionally (but wrongly) regarded as being at the risky end of the mortgage spectrum ‘ is currently a bad place to be for amateur landlords.

To decide the validity of this the first question to ask is whether buy to let can remain safe and secure for both landlords and lenders even if house prices begin to slide? And can we point to clear evidence that the trends and cycles of buy to let ‘ particularly for professional landlords ‘ are different from those of owner occupied housing?

The UK has a general shortage of reasonably priced housing, exacerbated by a low level of new build relative to other countries, while the number of people in private rented accommodation has grown steadily over the past decade or so. This is encouraged by demographic factors, such as the increase in divorce, the growth in single households, the expansion of the student population, and greater mobility of the workforce. At the same time, successive governments have run down the stock of social housing so that the private rented sector has been increasingly called upon to take up the slack.

Demand outstripping supply is a major contributory factor to the rapidly rising house prices seen over the past couple of years. House price inflation has also been fuelled by people’s ability to borrow large amounts based on growing incomes and sustained low interest rates; the Council of Mortgage Lenders (CML) reported in April this year that average variable rates on new loans were 4.09%. In short, prices have tended to rise to match buyers’ ability to afford them.

In this situation, first-time buyers with lower incomes and little or no deposit to put down have found it increasingly tough to take that first step onto the housing ladder. As well as those who are unable to afford to buy, another category of potential home buyers has chosen to hold back from owner occupation, either for social reasons (to remain ‘footloose’ for longer), or in order to wait for prices to fall, or for lack of confidence.

Increased yields

By way of illustration, the age at which first-time buyers purchase their first home has risen progressively since the mid 1990s, from around 27 years of age to almost 31 (according to the Nationwide). It was unsurprising therefore that in March the CML announced that mortgages to first-time buyers had fallen below 30% for the first time.

All this means that there are far more twenty-somethings who either stay at home with their parents until they reach their thirties, or resort to rented accommodation. With steadily increasing demand for rented property, buy to let becomes a better business proposition regardless of whether the landlord is classed as professional or amateur.

Landlords generally are seeing an attractive business opportunity, and are taking advantage of a slower housing market and softening prices to grow their portfolios of investment properties and generate additional rental income.

There seems to be a clear correlation between faltering first-time buyer activity in the market and demand for rented housing. Therefore could we go so far as to suggest that buy to let is counter-cyclical to the sector?

It may be difficult to claim that buy to let is totally immune to the vagaries of the housing market and the landlord who has a property that is falling in value may have fewer options open to them than in a rising environment. In simple terms, they may not have the option to sell and take a profit. On the other hand, closing this ‘cut and run’ option does not necessarily mean that the landlord’s position is fundamentally weaker.

It is undoubtedly true that there are examples of investment properties ‘ London riverside penthouses and other upmarket properties ‘ whose values have fallen markedly. This type of accommodation has a less than ready market of prospective tenants, as there are now fewer foreign bankers and businessmen looking for a London pied à terre. But we must remember that such properties represent a tiny percentage of properties compared with the huge market for more modest lodgings.

If a small number of residential property owners are in difficulties ‘ and few lenders report finding problems among their landlords ‘ we must not take this as being representative of the market as a whole. The error made by struggling landlords was that their motivation was one of property speculation rather than a genuine residential lettings business.

This highlights the difference between what we tend to call the ‘professional’ landlord and the ‘amateur’: the former treats buy to let as a business proposition with a long term revenue generative potential, while the latter is more often than not looking primarily for short term capital appreciation, without any real understanding of the rental market.

The distinction between the two types of landlord may be seen in the size of the portfolio ‘ with the professional typically owning ten, twenty, fifty or even a hundred or more properties ‘ but as much as anything it is a matter of attitude and approach rather than numbers.

So what are the key issues for the serious landlord ‘ whether they own one, two or a hundred properties?

To run a successful buy-to-let business a landlord must understand the market place. For many investor clients, it is very unusual for landlords to spread their portfolios across more than one area, and normally they buy in their local; area. This means that they understand local demand ‘ who are the renters? Are they students, nurses, professional sharers, or young families living on social security? What type of accommodation do they require, what are their preferred areas, what type of furnishing do they expect, do the right public transport links exist? What about schools and nurseries?

Demand for rented accommodation tends to be concentrated at the lower end of the market and among Paragon’s landlords properties are usually of below average value, with terraced homes and flats the most popular.

Any landlord worth their salt does not look for a property to meet their own tastes and criteria, but rather the needs (and budget) of their tenants. There is no point in buying the luxuriously appointed penthouse in a smart area where there is little or no tenant demand ‘ that is the wrong property in the wrong location, a mistake frequently made by the ‘amateur’ landlord. The tenant is the horse and the property is the cart, and you must never put the cart before the horse

Checks and balances

Having a suitably equipped property in the right location in an area of good tenant demand is just the first stage for the landlord. A ‘professional’ will ensure that they perform credit checks and character references on their prospective tenants to ensure that they both pay for, and look after, the property.

In addition, the buy-to-let landlord needs to have the ability to maintain and repair their properties. Well maintained properties breed better tenants and better tenants are better payers who have more respect for the home where they live. The professional landlord with a portfolio of properties can benefit from the economies of scale by having a panel of regular specialist tradesmen (plumbers, electricians, carpenters, gardeners) or maybe even full-time maintenance staff. For the small-scale landlord who owns just one or two properties maintenance work may prove relatively more burdensome and expensive.

This leads to another key point. Landlords cannot live in isolation and they need a network of professional and other support. They may require tax, accountancy and legal advisers, to help manage their financial affairs, to help ensure that the rights and obligations of tenants are made quite clear, and assist when things go wrong. For the larger landlord, owning the properties through a company may be appropriate and more tax efficient. In short, making buy to let work is a hands-on, proactive pastime and not a matter of sitting back and cashing in.

In summary, the landlord who treats buy to let as a long term business will be motivated first and foremost by the need to generate a steady cash flow from lettings and will regard capital appreciation as a by-product rather than the be-all-and-end-all. They will treat a softer market, with more supply and easing prices ‘ the current situation ‘ as an opportunity to buy properties at attractive prices, in order to respond to tenant demand. They will not panic and sell if the value of an individual property dips, because they are there for the long term and the underlying asset value is not his primary concern.

The small landlord ‘ who operates buy to let as a sideline rather than treating it as a business ‘ is likely to be more driven by speculative gain and is more likely to make mistakes. Of course, a single house can be a successful buy-to-let proposition ‘ and we all have to start somewhere. From a lender’s perspective, they will help novice landlords, but will satisfy themselves that they are able to service the mortgage even without rental income, until such time as they are able to prove to themselves and to the lender that they have the right skills and expertise to make buy to let work as a business.

key points