The damaging effects of the credit crunch on the buy-to-let market were finally brought clearly into focus yesterday, as the sector's third-largest lender, Paragon, revealed it had been forced to draw up provisional plans for an emergency rights issue.
Its story is a very similar one to the tale of Northern Rock. Like the Newcastle-based bank, Paragon's business model relies on being able to raise money in the credit markets. Hence, as it has become harder to get its hands on capital through the traditional routes in recent months, it has been cornered into considering other options. Unlike Northern Rock, however, Paragon does not have a savings book – and will not be granted the luxury of a Government bail-out – leaving it more exposed as the credit crunch has dragged on.
Yesterday's news of a potential right's issue confirmed investors' worst fears, promptly wiping 39 per cent off the share price and leaving the stock worth around a quarter of the value it held when the credit crisis began in August.
Elsewhere, Bradford & Bingley, the buy-to-let sector's largest lender, sold off more than £4bn worth of loan books to sure up its own balance sheet – a less dramatic but equally significant move. Both events displayed just how hard the credit crunch has been on smaller lenders in recent months. And while their respective fundraisings should eventually leave B&B and Paragon with enough money to finance their existing debt obligations, it will continue to be very difficult to write any significant volumes of new business with confidence, as long as there is no end in sight to the current crisis.
But do the financial woes of Britain's largest buy-to-let lenders mean that the party is finally over for private landlords?
Certainly it is becoming much harder for individuals to get their hands on new loans. With the sector's third-largest player, Paragon, and fourth-largest, Northern Rock, having taken a big step back from the market, there is far less capacity available in the buy-to-let arena. The lenders that are left are tightening their criteria.
Ray Boulger, the senior technical manager at the independent mortgage broker John Charcol, says that while borrowers with a good deposit and good credit record should still find it relatively easy to get a mortgage, the quality of the property has started to become increasingly important. He points to newly built flats, where a perceived over-supply has left some mortgage providers reluctant to lend on such properties.
"Alliance & Leicester, for example, has reduced its maximum loan to value on new-build flats to 70 per cent," he says. "Lenders are no longer confident that the valuations on these properties are accurate."
Earlier this month, the Royal Institution of Chartered Surveyors (RICS) issued a report claiming barriers to entry – such as rising interest rates and stricter lending criteria – had left the buy-to-let market "so inaccessible to the average investor, that only the wealthy can afford to become landlords".
And for any new investors there is no longer much to get excited about anyway. After years of house price rises, which helped buy-to-let investors achieve many consecutive years of double-digit returns, yields have now fallen to pitiful levels in some areas of the country over the past 12 months.
Although Paragon's base of professional landlords claims to be achieving rental yields of 5.6 per cent in London (which now boasts the lowest average yields in the country), the real average is believed to be well below 5 per cent in the capital. Across the country, Paragon's landlords put the average yield at around 6 per cent – only marginally above the Bank of England base rate. But again, the real average is thought to be much lower.
Although yields looked unappealing well before the credit crunch kicked in, the boom in house prices continued to make buy-to-let an attractive proposition. But with all the latest house price data showing a slowdown in growth, the investment proposition no longer looks as appealing.
As analysts at Credit Suisse put it, in a recent research note: "In the absence of significant house price inflation, the maths just does not work."
With borrowing costs also on the rise, many new landlords are likely to be paying more in mortgage payments than they are receiving in rent each month – even on an interest-only basis. While it is still possible to get competitive headline interest rates on buy-to-let mortgages, many lenders are now tacking fees running into tens of thousands of pounds on the top. These are generally lumped onto the rest of the loan, immediately plunging the borrower into negative equity.
However, Simon Rubinsohn, the chief economist at RICS, says rising rents will eventually come to the rescue. "It's not surprising that lenders who need to obtain finance to support a mortgage book are going to have problems," he says. "But that shouldn't be seen as a negative for the whole buy-to-let market. Over the recent months, there have been such good capital gains that investors have very quickly been able to look at a paper profit, if not to actually realise one. For those already in the market, they may find that the capital uplift will not be as dramatic – there may even be some falls – but alongside that, the balance between rent and the cost of borrowing will improve a bit."
Unsurprisingly, Nick Keen, the finance director of Paragon, is equally bullish about future prospects for the sector. "It's more difficult for people to get on the housing ladder now," he says. "So at the margin, there are more people who in ordinary situations would have bought, but who now are having to continue renting."
He also points to the growing number of immigrants as a positive force in driving demand for rental property, and hence helping to increase yields.
"There is a higher borrowing cost, and that may slow down activity," he continues. "But if you look at someone who took out a mortgage two or three years ago, then while they may have to pay 1.5 per cent more on their mortgage now, their rents have grown 15 per cent over that time."
Boulger adds that while borrowing costs are still relatively high in the buy-to-let market, interest rates are expected to come down in the near future.
"We're going to get at least two bank rate cuts, so for those on interest-only loans, that's a cut of more than 8 per cent in their mortgage payments," he says. "Meanwhile, rents are likely to continue rising."
Even if rents do continue to rise, the credit crunch could yet come back to bite buy-to-let investors again. If conditions remain tight, lay-offs will come thick and fast in the financial services industry. And most economists agree that once unemployment rises, the stability of the overall housing market can be called into question. It will be several more months until the outlook is clear.
Mortgage lenders face testing time
The Building Societies Association reported a pick-up in mortgage lending during October, with total advances reaching £4.65bn, their highest level since March. Net lending, which strips out redemptions and repayments, was £1.12bn, a level last seen in June. But both figures were well down on the figures for October last year, when total advances were £4.94bn and net lending was £1.66bn.
There was also a steep fall in mortgage approvals, with just £3.66bn of new loans approved by building societies, the lowest since February this year and down on October 2006's £4.28bn.
The Council of Mortgage Lenders, which reports on lending by all groups, showed a similar pattern. It said total mortgage lending reached £32.36bn in October, nearly 6 per cent more than in September and October last year . But it said that while the increase was higher than the typical 3 per cent rise seen between September and October, this reflected applications and approvals made before the market was hit by wholesale funding problems. The CML said it expected mortgage advances to be "somewhat lower" during the rest of the year.
Michael Coogan, director general of the CML, said: "The next few months will be a testing time as ongoing pressures in financial markets feed through into the wider economy. Funding constraints will continue to restrict lending activity and make loans more expensive. The Bank of England's recent quarterly Inflation Report reinforced the likelihood of a reduction in rates early next year, and that should provide some relief for borrowers sooner rather than later."
Sean O'GradyReuse content