The British love of housing is legendary; the stuff of dinner parties and potential general election defeats. Over the past 20 years a new breed of investor has emerged: the buy-to-letter. Generally they have done well in a period of falling interest rates. Not only have they achieved a good yield but a fair measure of capital appreciation too.
Much has been written on the UK housing market over the past week. I wonder for how much longer the impressive returns on buy-to-let investments can continue. More concerning are the poor comparisons I see between buy-to-let and cash deposits.
The dramatic fall in interest rates over the past few years has left many people scrabbling around for better investment returns. Buy-to-let increased by 19 per cent in volume and 31 per cent in value last year, according to the Council for Mortgage Lenders.
This coincides with deposit rates falling to around 1.5 per cent. News media in particular give headline yields on buy-to-let of 5 per cent to 6 per cent. In an extremely superficial comparison the yield of course is far superior to cash deposit. Yet interestingly in a time when the rest of the financial services industry is rightly being asked to be more transparent on fees, the unregulated buy-to-let industry, along with many television programmes devoted to property, has little to say on costs or fees.
I am not anti buy-to-let, but it is a little more complicated than buying the house next door. The professional or more savvy buy-to-let investors tend to seek out properties under the stamp duty threshold in unpopular areas with yields of 8 per cent plus. My worry is a new brand of investor is emerging who believes buy-to-let is a safer alternative home for their capital than the bank or building society. In this case, is a yield of 5 per cent to 6 per cent enough and is this the yield you actually receive?
I would argue it isn't and I also think buy-to-let investors have to accept they are unlikely to receive any yield for the first year at least. The costs of buying the property must be considered, particularly if the purchase price is above the stamp duty threshold. Add solicitor costs, service fees if it is a leasehold property, and management costs and most of the first year's yield will probably disappear.
Other costs must also be considered. The property might need furnishing and landlord's insurance would also be prudent. There are also maintenance and repairs to consider. At the very least these can be time consuming and a hassle. The alternative is to pay a company to manage the property on your behalf, thus incurring further costs. Buy-to-let properties are also prone to periods of vacancy when there will be no rent coming in. These other costs could easily cut the headline 5 per cent to 6 per cent yield in half. Finally, it must be remembered that secondary property can be illiquid – it could be difficult to sell quickly if you require your capital back.
Many buy-to-let investors are also failing to consider the impact of rising interest rates, in my view. At some stage interest rates will have to rise again. The summer of 2015 is being predicted as the most likely time; convenient for the coalition government given that it would be after an election. Should cash deposit rates rise to say 4 per cent or 5 per cent, buy-to-let investments will start to look less attractive in comparison. Some might point to capital appreciation as being able to compensate, but once you delve below the headlines it becomes clear that outside London there has been virtually no recovery in property prices.
I am a natural cynic of politicians who are famous for their policies designed to please the electorate in the run-up to a general election. The funding programmes the government has designed are more useful to help that feelgood factor. There will be a price to pay, in my view, but this won't come until after the election. Unless you are a professional buy-to-let investor be careful. Buying the flat or house next door is not true buy-to-let. Do your sums carefully and I think you will find you want a yield well north of 5.5 per cent to make it really worthwhile.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit hl.co.uk/independent