Buy to let
For many years landlords have invested in residential property to be let for profit, but due to the rent controls imposed during the First World War, arranging a mortgage to fund such a purchase was difficult. Between 1915 and 1991, the percentage of housing stock accounted for by private rented properties decreased from around 90% to just 7%.
Since the Housing Act 1988 introduced assured shorthold tenancies, which are not subject to rent controls and provide less secure tenure than older tenancy types, mortgage lenders have been more willing to provide finance. The size of the buy-to-let market has been growing steadily in recent years, and as of Q3 2014 accounted for 14.4% of all mortgage lending.
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, she or he will have benefited from the use of the lending banks money indicating that she or 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.
Recent figures from the National Landlords Association (NLA) suggest that, as of September 2014, 27% of landlords who let out a single property and 19% of landlords who let out between two and four properties either break even or run at a loss.
On average, gross buy-to-let yields (the annual return on investment prior to the deduction of running costs) stood at 5.1% as of December 2014. This represented a decrease of 0.2 pp from average yields in December 2013.
Gross rental yields vary across the country with the highest yields delivered in Scotland at 6.1% and cities in the north of England, whilst yields in London stand at 4.1%.
Gross rental yields in the world's premier cities range between 1.6% (in Taipei) and 11.7% (in Moldova's Chisinau). Gross rental yields on residential property have trended down globally for several years, and have generally continued to fall since the housing crisis.
Buy-to-let mortgage is a mortgage arrangement in which an investor borrows money to purchase property in the private rented sector in order to let it out to tenants. Buy-to-let mortgages have been on offer in the UK since 1996.
Lenders calculate how much they are willing to lend using a different formula than for an owner-occupied property. They tend to look at the expected monthly rental income to determine the maximum loan available. Depending on the lender, borrowers might also be allowed to include their own personal income in the calculation of the maximum amount that they can borrow. First-time landlords might also be required to have a separate annual income of at least £25,000. For an owner-occupied property, the calculation is typically a multiple of the owner's annual income.
The most common type of buy-to-let mortgage is an interest only option. The interest rate on the mortgage can be fixed or variable. Fixed rates means that the payments would not fluctuate, and variable rates means that the payments may go up or down in line with the Bank of England base rate. The interest rates and fees that are offered on BTL mortgages are, on average, slightly higher than those for an owner-occupied mortgage. This is due to the perception amongst banks and other lending institutions that BTL mortgages represent a greater risk than residential owner-occupier mortgages.
In the late 1990s and during the early part of the 21st century, this type of investment became very popular and helped drive house prices dramatically upwards. 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, therefore tax is generally assessed at 20% or 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. Also, no National Insurance contributions are levied. If the landlord has used the BTL property as a main residence for a period then capital gains tax relief may also apply (so called "flipping"). These income tax incentives have made BTL investments more popular over the last few years.
Following the Second World War and prior to the Rent Act 1957, private tenancies in the UK were subject to strict rent controls. During the subsequent decontrol, between 1957 and 1965, the infamous landlord Peter Rachman is said to have started a trend of harassing existing tenants until they left and replacing them with new tenants who had diminished security of tenure and uncapped rents.
Parliament acted against so-called Rachmanism 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. As a consequence, the private rental sector declined, and without a growth in social housing to compensate, a housing shortage followed.
The 1988 Housing Act introduced ‘Right to Buy’ for council tenants and created the concept of the Assured Shorthold Tenancy. Landlords gained substantially more power to evict tenants under Sections 8 and 21 of the Act.
The early 1990s recession saw an increase in the number of repossessions. The percentage of mortgage holders in severe arrears peaked in 1993 at 1.5% – more than ten times the average throughout the 1980s – whilst the number of repossessions peaked at 75,500 in 1991, representing 0.77% of all mortgage holders. Subsequently, throughout the 1990s, the proportion of households that privately rented saw a modest upward climb, even whilst the size of the combined private and social rental sectors shrank. The biggest growth, however, came in the 2000s, during which the private rented came to account for 15% of all tenures (up from 9%) and approximately half of all rented tenures (up from around one third).
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. As of Q4 2012, some 1.45 million buy-to-let mortgages were outstanding, accounting for just 29% of the 4.92 million privately rented properties in the UK.
The Association of Residential Letting Agents conducts a quarterly survey of residential landlords to gauge their views on the market. 2014 Q4 survey, 66.7% of respondents said that they did not intend to sell any of their properties in the coming 12 months, and 24.9% said that they intend to acquire further properties during the same period. The average estimated life expectancy of a property investment among respondents was 20.3 years.
Buy to let mortgage products grew in popularity in the years following 2000, 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.
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.
As of 2014, the buy-to-let market had once again strengthened. Due to the increasing regulatory burden placed upon the residential mortgage market, many lenders began to shift their focus towards buy-to-let loans. The resultant competition between high-street lenders and the emergent specialist lenders caused buy to let rates to continue falling, even when residential mortgage rates were stable or rising.
Though buy-to-let business has historically been unregulated, pan-European legislation has forced a split in the market between lending to professional landlords who are investing for business purposes, and lending to ordinary consumers. In order to comply with the EU’s Mortgage Credit Directive, the UK government will forced to bring lending to so-called ‘accidental landlords’ – individuals who let out property that they own for circumstantial rather than professional reasons – under the remit of the Financial Conduct Authority (FCA). Some believe that the added regulatory burden could limit the availability of funds to non-professional borrowers.
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 the landlord and the tenant assurance of the tenancy for a short period (six months) and then allows the landlord to remove the tenant if he/she wishes to do so.
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Experienced investors and amateurs
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 in 2010 by the Department for Communities and Local Government (DCLG) found that although 95% of landlords own fewer than five properties, this accounts for just 61% of all privately rented dwellings. At the other end of the scale, the 3% of landlords who own more than five properties account for almost a quarter (22%) of privately rented dwellings.
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".
The government has also taken steps to reduce perceived tax evasion amongst BTL landlords over recent years, measures include:
- Compulsory third party deposit protection schemes which report to HMRC.
- Mandatory reporting of landlord details by estate agents to HMRC.
- Compulsory licensing of homes in multiple occupation (HMO), HMRC have access to data.
- Dedicated HMRC tax taskforces deployed to hunt down tax evading landlords.
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