Buy to let

Buy-to-let is a British phrase referring to the purchase of a property specifically to let out. A buy to let mortgage is a mortgage specifically designed for this purpose.

For many years landlords have invested in residential property to be let for profit, but arranging a mortgage loan to buy such property had always been hard as tenants were hard to evict and rent levels were relatively low. Since the introduction of the Assured Shorthold Tenancy in the mid-nineties however the rights of tenants and landlords have been more evenly balanced and mortgage lenders have been more willing to provide finance. This led to a rapid expansion in the amount of mortgage finance available with schemes specifically designed for amateur and professional landlords that became known as buy to let mortgages. The recent credit crunch, however, has caused most UK lenders to cease offering these kinds of mortgage.

Benefits and risk

As for all property rental, the benefits for a buy-to-let landlord can include a stable income from rental receipts, as well as an accumulation of wealth if house prices go up over time. Rising house prices in the UK have made buy-to-let a popular way to invest. The main risk involves leveraged speculation where the landlord takes a loan to buy the property, with the expectation that the house can be sold later for a higher price, or that rental income will meet or exceed the cost of the loan. In the best outcome for the landlord, he will have benefitted from the use of the lending banks money indicating that he has allocated the capital more efficiently than professional investors could have done. If the landlord cannot meet the conditions of their mortgage repayments then the bank will seek to take possession of the property and sell it to gain the loaned money. The broad popularity of buy-to-let investments has made a large number of new landlords and is a component of a risk that forms a systemic threat to the banking system in the UK.

Yields

Recent research by BDRC for Alliance & Leicester showed that 71% make a profit, but 22% break even or make a loss.

On average, English buy-to-let yields (the difference between the rent the landlord receives and the costs of ownership) were just under 5.5% in Q3 2007. This has fallen from over 7% in Q2 2002.

Buy-to-let mortgages

Buy-to-let mortgages have been on offer in the UK since the late nineties; they are specifically designed for investors to borrow money to purchase property in the private rented sector in order to let it out to tenants.

Lenders give different ways. The amount of currency investors can borrow is decided by the rental valuation of the property. Usually the annual rental income has to cover a certain percentage of the mortgage repayments, somewhere between 120% and 150%. This is to allow surplus rent to cover other costs such as property maintenance and void periods (periods when there are no tenants living in the property and therefore no rental income).

Other lenders will offer a three times' salary multiple and half the rental income.

Others base the amount that they will lend on your salary and the existing loan commitments that you have, but then apply the 'deduction rule'. This means that they will lend up to 3.5 times your income (or whatever salary multiple applies), minus a representative figure for annual mortgage payments worked out at a pre-set level of interest. For example if the landlord earned £40,000 and have an outstanding mortgage balance on your property of £120,000. Under the rule, the annual mortgage repayments may be calculated as £10,000. This would be deducted from your salary to leave £30,000, which is then multiplied by 3.5 to give £105,000 - the amount that you are able to borrow.

Typically the interest rates that are offered on BTL mortgages are fairly close to residential mortgage rates but will on average be higher and typically charge higher fees. This is due to the perception amongst banks and other lending institutions that BTL mortgages represent a greater risk than residential owner-occupier mortgages.

This type of investment has become very popular in the UK over the last five years or so, as house prices have dramatically increased. Another reason for their popularity is the tax advantages that are available to UK BTL investors. Rental income is considered in the same way as salary, and is therefore often taxed at 22% or even 40%. However, landlords can deduct costs from the taxable portion of their rental income, and these costs can include the interest portion of their BTL mortgage repayments as well as maintenance costs on the property. This tax set-up has made BTL investments more popular over the last few years.

Recent credit problems have had some investors maintaining the same percentage of equity in the property should prices fall and so rapidly find money to cover these downturns.

History

The infamous landlord Peter Rachman started a trend of harassing existing tenants (who had security of tenure and rent controls) until they left, then packing in new tenants who had fewer restrictions and no cap on rent charged. Parliament finally acted in 1977 with the introduction of the Protection from Eviction Act, and more comprehensively through the Rent Act 1977, which although preventing unlawful eviction and creating security of tenure, meant that renting out property was often loss making for landlords. In consequence, the private rental sector declined yet growth in social housing did not increase to compensate. A housing shortage then ensued and to create a more open structure the 1988 Housing Act was enacted. It was a milestone piece of legislation which created the concept of the Assured Shorthold Tenancy whereby there was less security of tenure for tenants. Landlords gained the power to evict problem tenants more easily, and so the prospect of becoming a landlord was more attractive than previously. The housing crash between 1989 and 1994 saw an increase in the number of tenants, as people lost their homes and were repossessed which coincided with a significant growth of the new Buy-to-Let landlord.

Buy-to-let as a term was coined in 1995 as a marketing badge for a finance initiative launched by the Association of Residential Letting Agents (ARLA), although this type of lending had existed for many years.

The Council of Mortgage Lenders (CML) started collecting statistics on buy-to-let in 1997 and some observers have interpreted the growth in buy-to-let lending, as reported by the CML, as evidence of a boom. However the CML only measures the growth of the new specialist lenders in the market - such as Paragon Mortgages, Mortgage Express and BM Solutions, whilst omitting the core back book of loans to residential property investors by mainstream lenders.

The apparent growth in buy-to-let lending is attributable to the success of specialist lenders in taking market share by offering bespoke products and services and attractive pricing. In fact, as much as 40% of activity is remortgaging as established landlords switch from more expensive commercial mortgages.

Despite the growth of the buy-to-let market since its inception, the private rented sector remains predominantly undergeared, with only 19% of the 2.7m properties mortgaged. Not only does this put buy-to-let growth into context, it also shows the growth potential remaining in the sector.

The Association of Residential Letting Agents conducts a quarterly survey of residential landlords to gauge their views on the market. In the 2005 3rd Quarter survey (September 2005), respondents showed resounding commitment to their buy-to-let investments. Of the landlords surveyed, 90% said that they would hold on to their investments even if house prices fell, 62% said that the average life expectancy of their property investments is ten years or more and 58% said that they intend to acquire further buy-to-let investments in the near term. The overall average life of their property investments was 16 years.

Buy to let mortgage products grew in popularity in the years following the millennium, and by 2007 the market was filled with wholesale lenders. Some of the largest banks in the world began wholesale lending, including the Royal Bank of Scotland and HBOS. Capital was raised through the practice of repackaging mortgage securities and selling them to another lender at a higher price. These securities were ultimately worthless, and this contributed heavily to the downfall of a number of buy to let lenders in 2008 and 2009. Due to the low prices of buy to let loans being lent by these wholesale lenders, it became even cheaper to buy to let than to have a residential mortgage. The standard package tended to be allowing a mortgage of 85% of value, with rental cover at 125% (i.e Mortgage payments £5,000 pa would require rental receipts of £6,250).

The market peaked in 2008, before collapsing not long after. The market dropped dramatically, moving from $27.2 billion worth of lending in 2008, to just £8.5 billion in 2009 as lenders removed available products by the week, and with new products having a maximum loan to value of 70%. To add even more to the problem of gaining finance, valuers were becoming extremely cautious, with mortgage valuations often significantly less than the purchase price agreed. By the end of this period, the market had halved in value. The dramatic rises that the market saw in the first decade of the 21st century were wiped out within a matter of weeks. New government regulation has been announced in order to improve protection to consumers. This regulation will ensure that lending does not reach the low prices and unsustainable levels of 2007.

Assured shorthold tenancy

One of the key innovations required for widespread property investment was the reform of tenancy agreements and specifically the introduction of the assured shorthold tenancy (AST) agreement.

AST gives both the landlord and the tenant assurance of the tenancy and specifies the term the property is to be let and specifies notice period for both parties.

Experienced investors and amateurs

The buy-to-let world is divided into "old hands", and recent entrants, sometimes derided as amateur investors. The UK press often describes amateur investors as over-optimistic investors who are willing to buy property to let out, when there is little hope of making a profit.

The new landlord friendly legislation afforded by the 1988 Housing Act, coupled with the introduction of competitive mortgage products, brought new investors into the property market.

They have been attracted by rental incomes, rising capital values and a perception that the risk in housing is lower than for equity based investment. More recently, investors have seen buy-to-let as an alternative to their pensions, especially in light of the negative publicity pensions have received.

However, the sector is still dominated by professionals.

The Office of the Deputy Prime Minister's (ODPM) Private Landlords Survey, which appears in their English House Condition Survey, is the most comprehensive study of the private rental market. The survey is published every four years and the last three editions illustrate the changing structure of private rented sector ownership.

The ODPM survey does suggest that there has been significant growth in the number of small scale landlords owning up to four properties. However, further analysis of this data reveals that the private rented sector is still dominated by professional landlords with large portfolios of property.

Analysis undertaken by Capital Economics found that although 53% of landlords own less than five properties, this represents less than 3% of the dwelling stock. Further, at the other end of the scale, 13% of landlords own 74% of the stock.

Buy to Let and negative publicity

Buy to Let has experienced much poor press over the past few years, with many commentators believing that it has contributed to rampant house price inflation. Such is the popularity of Buy to Let that estimates have recently put one in three new properties in London being bought by investors. Oxford Economics stated in August 2007 that buy to let is "undoubtably contributing to the overvaluation of housing". 

See also

• Mortgage loans
• Remortgage
• Investing
• Irish Property Bubble
• British property bubble
• Greater fool theory

External links

• Council of Mortgage Lenders - The association that represents nearly all UK mortgage lenders.
• Association of Residential Letting Agents - The organisation that promotes buy-to-let properties on behalf of landlords.