Lettings market may no longer add up
Too many new homes and rising rates threaten the buy-to-let investor, says James Daley
Saturday 03 November 2007
House prices have finally started to come off the boil over the last few months. According to figures from Hometrack (who compile information about the housing market) released this week, average residential property prices fell for the first time in more than two years in October. Even the more bullish property-price surveys have been reporting a marked slowdown in growth since the end of the summer.
For the average homeowner, this need not be too much of a concern. With interest rates, inflation and unemployment all still at relatively low levels, the chances of the UK sustaining a major housing crash any time soon are still remote – so it is probably best to sit tight and wait for the storm to pass.
However, for those who have been, or are thinking of, dabbling in the buy-to-let sector – buying up residential property for investment purposes – the economics are rapidly becoming less attractive.
In its financial stability report, published at the end of last week, the Bank of England warned that buy-to-let investors are now starting to look rather vulnerable, pointing to the fact that residential rents have been weak over the last few months, while borrowing costs have been on the rise.
According to Paragon, the specialist buy-to-let lender, the average rental yield (the annual rent as a percentage of the property's value) across the UK is now at around 6 per cent. However, in many areas of the country, especially the south-east and London, yields are much lower – often well below 5 per cent, according to some analysts.
With the Bank of England base rate now at 5.75 per cent, and mortgage rates generally higher still, borrowing costs and expenses are now often much greater than the rent that landlords are receiving.
Although it's still possible to get buy-to-let mortgages with interest rates of just over 5 per cent – such as Chelsea Building Society's two-year tracker at 5.24 per cent – the chances are that you'll also be hit with a hefty fee. In the case of the Chelsea deal, the fee is an eye-watering 2.5 per cent of the property value, which could come to more than £10,000. Adding high arrangement fees onto your mortgage may have made sense when house prices were rising at more than 10 per cent a year, but with stalling property prices and low rental yields, the economics are very different.
Analysts at Credit Suisse said last month: "In the absence of significant house price inflation, the maths does not work."
The Bank of England highlighted the particular problem of newly built properties, where prices have typically been even softer than the rest of the market over the past few months.
David Hollingworth, of London & Country mortgages, the fee-free broker, explains that, when a large number of buy-to-let landlords buy flats in the same newly built block, it tends to have a detrimental effect both on rents and prices. As a result, lenders have become increasingly reluctant to grant mortgages on these types of properties.
"Several lenders have started pulling away from new-build," says Hollingworth. "A lot of the talk of the buy-to-let timebomb at the moment has been due to the oversupply of new flats." GMAC, for example, will no longer lend buy-to-let landlords any more than 75 per cent of a property's value if it is newly-built. Alliance & Leicester has capped its buy-to-let mortgages on new builds at just 70 per cent. Portman Building Society stopped lending on newly built properties altogether several months ago.
Hollingworth points out, however, that plenty of established buy-to-let investors, who bought into the market many years ago, will still be quids in. "There are a lot of landlords out there who have pretty stable tenants in place, and who got into buy-to-let a long time ago," he says. "They've got plenty of equity in their properties, their mortgages are fairly modest and are easily covered by the rent."
However, Ray Boulger of Charcol, mortgage broker, argues that for amateur landlords – who only own one or two properties, and who are sitting on slightly larger mortgages – there may be a case for taking profits, especially if you're not committed to the sector for the long-term.
He adds that if you are thinking of selling a property, it's important to examine the tax implications. Last month, the Chancellor announced that he was planning to abolish taper relief (which reduces tax the longer you hold an investment) on Capital Gains Tax (CGT) next year, while reducing the headline rate from 40 to 18 per cent.
Currently, if you've owned a property for more than 10 years by the time you sell it, you will be entitled to full taper relief – reducing the effective tax rate on your capital gain to 24 per cent. And if you've owned it for much more than 10 years, you should also be entitled to indexation relief, which will reduce your tax liability even further.
From next April, however, all gains will be charged at 18 per cent, regardless of how long you have owned them. So if you've held the property a long time, it may make sense to sell out before the changes to take advantage of the taper and indexation relief you are entitled to. If you've only owned your property for a few years, you will be better off waiting until the change in the CGT rules.
It's also not yet clear whether lettings relief will be retained. This exempts you from tax on £40,000 of any gain if the property that you are selling was ever your principal residence. If the Government suggests that it is to scrap lettings relief, many landlords are likely to want to sell up before it is abolished.
If you're thinking of getting into buy-to-let for the first time at the moment, Boulger advises that you tread carefully. "Do your homework, get to know your market, check where there's good rental demand, and then watch the market," he says. "There are inevitably going to be some distressed sales over the next year – perhaps as people who have had their properties on the market for a while are forced to mark them down because they need to move. So looking out for these sort of bargains is the way to go."
The likes of Paragon claim that rents are now starting to rise, as fewer first-timers can afford to buy, and the immigrant population continues to expand. If this is the case, yields will eventually become attractive enough to attract new landlords back into the market, and then prices will follow. The next year or so, however, looks like it will offer slim pickings for the buy-to-let landlord.
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