Over the past few years buy-to-let has been a boom area for investors. Buyers in some parts of the country have benefited from rising house prices and rents, and low interest rates have made the cost of borrowing to fund a purchase cheaper than ever.
According to property firm Savills, landlords have made nearly £180bn in capital gains since 2009 alone. And separate research has suggested that returns from rents and pricegrowth over the past year have hit 8% in some parts of the country.
Given these returns it’s perhaps not surprising that the sector has been growing. While in 2000, buy-to-let accounted for 4% of mortgage lending, by the second quarter of 2015 this had risen to 16%. Lenders are battling to win business, with Accord becoming the latest to offer a rate below 2% on a two-year fixed-rate deal, while rents and prices are still heading upwards in many areas.
Experienced buy-to-let landlords are optimistic, according to lender Paragon Mortgages. It found that 89% of those it surveyed expected stable or growing demand from tenants over the next year. Indeed, despite owning on average 12.8 properties each, 18.4% of these landlords intend to purchase more property before the end of the year.
But are investors who leap in now too late?
Tax changes
One cloud on the horizon for buy-to-let investors is the change to tax relief announced in July’s budget. Under the plans announced by the chancellor, George Osborne, tax relief on mortgage interest is to be capped at 20%, phased in gradually over a four-year period from 2017.
Landlords will also be unable to claim 10% of the rent charged for wear and tear in furnished properties– previously they could claim even if they hadn’t made any improvements. The new scheme is meant to ensure that landlords only deduct expenses they actually incur in relation to their property.
The Residential Landlords Association believes the restriction on mortgage interest relief will have a large impact on landlords with multiple properties. It cites the example of a landlord owning seven properties who collects £60,000 a year in rental income, pays £5,000 in expenses and £40,000 in mortgage costs, and who has a £25,000 income from other sources. Under the changes they would see their income fall by 22%, from £34,120 to £26,597.
Andrew Montlake, a director at mortgage broker Coreco, is less concerned. “These changes will undoubtedly make some prospective landlords think twice about entering buy-to-let, but the response we have had from landlords suggest that while it will cut down on their profits, it is not enough to fundamentally change their views and start selling off all their properties.
“It will just be a case of taking these changes into account when making a business decision on each property to see if the basic maths of a new purchase still works.”
The Bank of England has also expressed some concern about the sector. In September it said that the rapid growth in popularity of buy-to-let could amplify sudden price moves, ultimately affecting market stability. For example, a large fall in property prices would hit buy-to-let landlords with interest-only deals, possibly resulting in a dash for the exit and further price drops. Alternatively, an increase in buy-to-let activity would increase house prices further, putting pressure on other property buyers to mortgage to the hilt.
Potentially, the Bank could act through its Financial Policy Committee to dampen the market, requiring lenders to tighten up on loan-to-value or mortgage-to-income ratios for investors.
Property prices
Prof Steve Keen, head of economics at Kingston University, believes the UK is heading for falling house prices, unless households go on a borrowing spree.
His view is based on an analysis of the data on outstanding mortgage debt and nominal gross domestic product (GDP). “When demand for mortgage debt is accelerating, house prices rise; when it is decelerating, house prices fall,” he says. “So zero acceleration tends to correspond to constant prices (compared to a year ago) and negative acceleration to falling prices. That’s where Britain appears headed right now.”
He adds: “Most recently, mortgage debt has declined against GDP, and if this continues it is quite possible house prices will fall – we could even have a house price crash across the country. Alternatively, if instead UK households start to leverage up further we could have a further boom in prices.”
Ed Stansfield, chief property economist at Capital Economics, has forecast a 5% rise in property prices for 2015, followed by a further 2% increase in 2016 and again in 2017. He says: “The market is now very expensive and needs to slow down if we are not to have a problem when interest rates rise. In any case, it looks as though future price rises will be constrained by slow growth in incomes and rising interest rates.”
Stansfield believes that because of the slowdown in capital growth, the returns for buy-to-let investors in the future won’t be as strong as before.
The UK isn’t a homogeneous housing market and Keen does differentiate between London and the rest of the country. “London will always be a separate beast because of the international component,” he says. “Then you need to add in the dynamics of other countries: are Russian/Chinese/Saudi buyers having their own problems, and how is this likely to affect their buying of London properties?”
However, even in London price rises appear to be slowing. Estate agent Knight Frank has revealed that in prime central London annual price increases of residential properties reduced from 5% at the end of last year to 1.3% in September. It has also cut its 2016 forecast price rise from 4.5% to 2%, with this increase contingent on a strong economic recovery.
Rental yield
Although London has led the way for capital growth, the best rental yields – rents as a proportion of the property’s cost – are to be found elsewhere. This is because house prices in London are so high, at an average of £522,000 in August, according to the latest figures from the Office for National Statistics. This compares with only £151,000 in Northern Ireland.
A list of the top three areas for rental yields by LendInvest puts Glasgow top, with 6.13%, followed by Uxbridge and Motherwell. In Glasgow and Motherwell, landlords are able to buy properties relatively cheaply, at average prices of £134,733 and £119,304 respectively, while average rents are £8,255 and £6,870 a year. Prices are higher in Uxbridge, at an average of £363,152, but landlords benefit from high rents averaging £21,568 a year.
On the subject of capital growth and rental yield, Johnny Morris, research director at estate agent Countrywide, says: “Over the long term, rents tend to grow in line with incomes, with shorter-term market forces pushing prices up or down. As the outlook for wage growth is picking up and supply of homes remains constricted, it’s likely we’ll see further growth in rental prices in coming years.
“We expect rents in 2015 will end about 4% up on the previous year, with similar growth in 2016.”
Jacqui Daly, investment director at Savills, is more cautious: “I expect over the next couple of years they will go up on average around 2%-2.5% a year. In under-supplied urban areas such as London and regional cities such as Manchester it should be upwards of 3%.”
Interest rates
At the start of the summer, the Bank of England governor, Mark Carney, suggested a rate rise might be considered as early as the turn of the year. However, this threat seems to have receded after inflation slipped into negative territory in September. According to Capital Economics: “While financial markets have probably gone too far in pushing back expectations for the first rate hike until the first quarter of 2017, a rise before the second quarter of 2016 still seems unlikely in our view.”
That is certainly good news for buy-to-let investors in the short term, as is growing competition among lenders that has pushed interest rates to new lows. However, wise investors will factor a rate rise into their calculations when deciding whether to make a purchase.