Much has been written recently about the buy-to-let market and this is hardly surprising. Rising property prices, a steady demand from the rental market and a depressed stock market are all factors that have contributed to buy to let becoming one of the strongest growth sectors in the mortgage market in the past few years.
According to the Council of Mortgage Lenders (CML), there is a staggering £14.7bn worth of mortgages on buy-to-let properties. Advisers across the country have received thousands of enquiries from would-be landlords. So what kind of clients could be suited to the market?
There is no typical buy-to-let purchaser. They form a cross-section of society and buy property to suit a variety of purposes. Those that bought for capital growth over the past five years are likely to be feeling very pleased with their investment.
According to the latest figures from the Centre for Economics and Business Research (CEBR), house prices have risen by 53% in the past five years ‘ and are continuing to do so. Your clients could be saving for a variety of reasons, for example, setting up a nest egg to pay for their children’s university education, or to supplement their pension.
Clients that travel abroad but do not want to lose out on the property market are increasingly deciding to buy to let or let out their existing property. Many feel they may struggle to get onto the property ladder if they delay buying until returning home, which may not be for several years. In both cases, advisers are well placed to advise those clients to buy a property before going abroad ‘ it is easier both financially and legally.
More parents are buying a property for their student offspring to live in when they go to university. The availability of cost-effective buy-to-let mortgages has meant that buying rather than renting can make financial sense. This is a key consideration at a time when parents are contributing more towards their offspring’s higher education. Not only have grants been abolished in favour of student loans, but parents earning more than £20,500 also now have to pay for tuition fees.
Many parents are looking for ways to reduce this financial burden. For some, the option of buying a student property looks attractive. Parents reason that buying a house will not only give their child somewhere decent to live, but flatmates can contribute towards the cost of the mortgage, allowing the extra rental return to subsidise the cost of their education.
Although it may seem surprising, there are a small number of first-time buyers who opt to buy to let. In many cases, they earn a good salary in the South East of England but simply cannot afford to buy. However, these enterprising would-be landlords are making their money work for them by buying property elsewhere. Many opt to buy close to their parents or family who will have good local knowledge.
Doing the maths
Customers are often nervous that buy-to-let mortgages will be hard to take out. This is not the case. Those buying for the first time usually have a choice. This could mean taking out a mortgage based on their salary and existing loan commitments. Many lenders then apply the 7% rule, which means lenders will advance 3.5 times a borrower’s income, minus their existing yearly mortgage payments worked out as if the interest rate is 7%. Most loans are available at about 75% loan to value and about 3.5 times income.
For example, if a customer earns £35,000 a year and assuming they have a home with an existing mortgage worth £100,000, under the 7% rule their yearly mortgage payments will be calculated as £7,000. The £7,000 will then be deducted from the £35,000 salary, leaving £28,000, which when multiplied by 3.5 would enable the client to borrow £98,000.
The alternative is a self-financing mortgage where the rental income yield from the property exceeds the mortgage repayment by a pre-set ratio, typically 30%.
Although there are nearly 80 lenders offering buy-to-let mortgages, most advisers find the best place to start is with specialist lenders. They offer various rate options, have experience of the market and are used to coping with the routine complexities of buying to let. For example, most high street lenders use credit scoring which can lead to high rejection rates among potential buy-to-let customers.
Other specialist lenders individually assess each customer, which means they can take lots of different factors into account.
The buy-to-let boom has also led to another interesting development ‘ the career landlord. Several lenders offer investment portfolio mortgages, where borrowers can usually buy between two and 10 properties. But the conditions and interest rates vary widely.
Apart from the interest rates, other key factors include the extent to which the lender takes into account rental income, how much deposit is required and how the loan is underwritten. Many lenders charge a higher borrowing fee, but specialist lenders are moving away from this practice.
In almost all cases, investment portfolio mortgages are based on the rental income, rather than the customer’s earnings. Usually the customer will need to find at least 15% of the value of the property and the rent must cover the mortgage by a pre-set ratio of 125%-130%.
But advisers are also well placed to advise clients of the many pitfalls for the first-time buy-to-let landlord. Some people think they have an instinctive feel for the market because they have made money from their existing home. They see the rewards ‘ but not the risks. As a result, they do not research the market properly and buy a property based on personal tastes, with location and tenants as an afterthought. Others do not work out the real cost and return on investment.
Despite predictions that a flood of new properties on the market would depress yields, the rental market is holding up well and so far has not seemed vulnerable to any short-term economic downturn. According to recent research by the Association of Residential Letting Agents (ARLA), average rental yields in the UK are 7.2%.
A buoyant future
So, is there a long-term market for buy-to-let property? The signs are encouraging. The Government has stated its desire for a healthy and expanding private rental sector. It knows that as it slowly reduces the number of public housing options, the only rental option is the private market.
There is now no longer any stigma associated with renting. The workforce is becoming more mobile as people change jobs more frequently and move further afield to do so.
Furthermore, the high cost of housing means many young people are struggling to get onto the housing market ‘ explaining why the average age of a first-time buyer has risen to the late 20s. This change also partly accounts for Government figures for 2001 which indicate that in the next 10 years, 33% of people will be living alone. All these factors indicate that the rental market is likely to have a healthy future.
Buying to let has some obvious attractions. Providing an investor buys a suitable property, over the medium to long term, they can usually expect a steady rental return that will cover the mortgage and associated expenses. They also stand to gain if property prices continue to rise.
It is important that clients are encouraged to research the market and talk to reputable letting agents to assess the demand and achievable rental returns in the local area. First-time landlords need to ensure income is about 30% above the mortgage repayment to cover all additional costs including void periods.
Landlords need to understand their tax liability. Rental income is liable for income tax and borrowers could be charged capital gains tax on the sale of any property that is not their main private residence. There are other legal and safety responsibilities. Although furnishing and letting a property are tax-deductible expenses, there are legal requirements to consider, such as ensuring all soft furnishings (sofas and beds) are flame retardant, for example.
Provided buy-to-let clients enter the market for the medium to long term (more than 10 years), they are unlikely to lose out.
Interest rates are stabilising, there are forecasts of moderate property inflation, and the workforce is becoming increasingly flexible. These are all cases for continued optimism in the buy- to-let sector. As long as advisers can recognise which of their clients may be suited to buy- to-let investment, they should be able to continue to increase their business in this advice-driven market.
Bill Dudgeon is managing director of The Mortgage Business
First-time buyers living in expensive areas can get a foot on the property ladder by buying in more affordable areas and letting the property out.
Buy to let can be attractive for expatriates who do not want to miss out on the booming UK property market.
More borrowers are buying student properties to house their children while subsidising their education.