Why landlords are still banking on a buy-to-let investment

With would-be first-time buyers choosing to rent, it's a good time to be a landlord, says Jenne Mannion

According to the Paragon Mortgages Buy-To-Let index, average rental income throughout the UK is now at record levels after jumping by 2.83 per cent in July to reach £10,835 a year. This marked the largest monthly increase since November 2004. Twelve months ago, average rental incomes stood at £9,598 having risen by 12.9 per cent over the year.

John Heron, managing director of Paragon Mortgages, a specialist buy-to-let lender, says UK landlords are benefiting from the overall nervousness about property prices, which is discouraging owner occupiers, particularly first time buyers, from buying their own homes. Therefore, demand for rental property increases, reducing vacancy levels and pushing up the rents paid.

Meanwhile, the value of rental properties has also continued to increase. An average rise of 3.2 per cent during July takes the average price to £162,409. The average house price has increased by 15.5 per cent over the year, though rises varied across the country and were steepest in the north.

Ironically, however, there is far less enthusiasm for rental property nowadays - when the outlook is bright - than there was 18 months ago when owner occupiers were also highly enthusiastic, reducing demand for rents and creating competition in buying properties.

According to the Council of Mortgage Lenders (CML), around £9.9bn worth of new buy-to-let mortgages was taken out in the first six months of 2005. This was marginally higher than the second half of 2004. Overall, however, this accounted for fewer mortgages as the number of new loans declined by 4 per cent in the first half of this year to 94,000.

Sue Anderson, head of external affairs at the CML, says most buy-to-let mortgages are taken out by landlords with portfolios of several properties. She says that while growth in this market is slowing, most landlords are staying put rather than offloading their properties.

"However, enthusiasm has slowed. Landlords are not acquiring at the fast rate they were in early 2004," Anderson says. "The number of people entering the buy-to-let market for the first time also seems to have slowed."

Despite this ebbing of popularity, there are several reasons why the buy-to-let market is now more attractive than it has been in recent years. Not least the cost of borrowing which is cheaper given the Bank of England's 25 basis point rate cut last month.

Lee Grandin, managing director of Landlord Mortgages, a specialist broker of buy-to-let mortgages, says the latest rate cut has prompted a rate war between buy-to-let mortgage providers. While such mortgages have traditionally been more expensive than owner-occupier mortgages, this is becoming less so the case. Grandin gives the example of one provider: BM Solutions, offering base rate (currently 4.5 per cent) plus 0.39 per cent for the life of the mortgage (based on a 15 per cent deposit).

Heron agrees. He says: "The recent cut in interest rates should encourage landlords to expand their portfolios as there are still good deals to be negotiated, while the owner-occupier market remains relatively slow."

The fact that the owner-occupier market is slow offers further benefits for new buy-to-let investors, or existing landlords looking to expand their portfolios.

Prices paid by residential property investors are still growing, but at a much slower rate than was seen during the heady days of mid-2004 when investors had to compete with owner-occupiers in a busy market with limited available stock, Heron says. He says only ever consider buying-to-let if you have a long-term time horizon and if this type of investment suits your investment objectives. But in general, he says, the backdrop for this type of investment is favourable.

There is a shortage of housing in the UK and the Centre for Economics and Business Research has assessed that the demand for rental properties should increase by 40 per cent over the next decade.

If you are considering becoming a landlord, then find property that can easily be rented, Heron says. "Managing a buy-to-let property is like any bus-iness. You must make sure that there is good demand from customers, which in this case is the tenant."

Location is also important. Regions such as Yorkshire and the North West continue to outperform other parts of the UK because of the strong house price gains where rental demand is particularly high.

Over the past 12 months, rents in Yorkshire have risen by 36.7 per cent and now stand at £10,495, according to the Paragon Buy-To-Let index. Meanwhile, landlord property values in the region have increased by 38.6 per cent since July 2004 to reach £143,684. Despite a large increase in property values, Yorkshire remains one of the highest yielding regions in the country, at 7.3 per cent.

Heron says the burgeoning student population in the area has contributed to the strong demand for rented accommodation in Yorkshire. "Additionally, many graduates remain in the county and look for shared accommodation in the major towns," he adds. "There has been a net influx of jobs in some parts of Yorkshire which has helped create a requirement for more rented homes."

The North West has also seen a strong buy-to-let market over the last year, notwithstanding a slight decline in rents this month. Rental incomes in the region have risen by almost 30 per cent to £8,731 annually, and property values by over 34 per cent since July 2004 to £125,502. Yields in the North West, at just under 7 per cent, remain above the national average of 6.7 per cent and on a par with the South West and East Anglia.

Meanwhile, buy-to-let property is likely to become more popular following changes to pension rules next April, which will allow residential property to be held within a pension fund. However, Heron believes most take up will be by existing landlords and he does not expect this change to swamp the market or have a negative effect.