Buy-to-let boom muffled as costs creep above rents

Lenders are allowing landlords to take more risks, but this should be a warning, says David Prosser

Some warning signs are too obvious to ignore. Remember Imogen Thomas, the former Miss Wales, from the last series of Big Brother? Thomas has subsequently ploughed her earnings from modelling sessions into a portfolio of buy-to-let investment properties in South Wales.

Has Thomas - hardly recognised as the sharpest Big Brother housemate -moved into buy-to-let just as the smart money is moving out? After three interest rate rises in the space of six months, some analysts warn that in large parts of the country, buy-to-let - which has boomed during the past 10 years - no longer adds up.

"Rents are going up, but not as quickly as property prices," warns Richard Donnell, research director of property analyst Hometrack. "As a result, the yield that property generates is falling just as the cost of acquiring it is rising, through higher interest rates."

Mortgage lenders are concerned that the stream of investors applying for their buy-to-let loans may be about to dry up. Several have this week relaxed the criteria they apply when considering applications for buy-to-let mortgages.

Typically, lenders expect borrowers to be able to show that the rent they can expect to earn on the property to be mortgaged will cover the loan repayment, with a margin of comfort. But these rules are preventing increasing numbers of borrowers from securing loans.

Accordingly, Cheltenham & Gloucester has reduced the rental cover it requires from 125 per cent of the mortgage repayment to 100 per cent. The Mortgage Works, a specialist lender, has cut its figure from 120 to 100 per cent. The rental cover required is also down to 100 per cent - from 115 per cent - on certain Bristol & West loans.

But the fact that lenders are prepared to allow buy-to-let investors take more of a risk when adding to their portfolios, or even buying for the first time, doesn't mean you should do so.

"Lenders are still making money, but landlords are now running close to the wire," warns Paul Hearnden, a director of independent mortgage broker My Mortgage Direct, who even says a collapse in the market is not inconceivable. "You only need a few people with very little margin to start dropping their rental rates to ensure they'll always have a tenant for prices to be driven down across the market."

It's not just new investments in property that are beginning to look more risky. Landlords who bought properties in 2003 and 2004 were able to take out two- and three-year fixed-rate mortgages priced at close to 4 per cent. Now these deals are coming up for renegotiation, the best rates on offer are above 5 per cent. The profit margin of rental income over mortgage repayment is bound to be much thinner - or even non-existent.

But buy-to-let property professionals are adamant that 2007 will not be the year the sector hits the skids. "Most people have worked this out so that the odd quarter point rise in interest rates will not push them into the red," says Malcolm Harrison, of the Association of Residential Letting Agents.

Harrison adds that if interest rate rises do cause a slowdown in the housing market, buy-to-let investors should benefit. A drop in the number of people buying a home in which to live would produce a corresponding increase in the number of people looking to rent, he says.

Similarly, John Heron, managing director of Paragon Mortgages, a buy-to-let specialist, says stock market investors who have deserted his company - Paragon shares are down almost 10 per cent since the start of the year - are making a mistake. "Our research suggests landlords will be able to take the increased cost of borrowing in their stride," Heron says. He points out that the typical landlord has borrowings worth less than 40 per cent of the total value of their property portfolio.

But Andrew Mortlake, a director of mortgage adviser Cobalt Capital, says investors must be realistic. "The reality is that rising interest rates must be an issue," he warns. "We're not expecting hard-core investors to quit the market this year, but there will be a decline in the numbers of amateur buyers."

Hometrack's Donnell advises landlords to be smarter - to buy where there is a large 18-to-30 year-old population working in the private sector, and not in the most obvious of places: where they live; student towns; new-build developments. There could be more risks in such ventures, he adds, but more reward, too.

The best buy-to-let mortgages

* Melanie Bien, an associate director at independent mortgage broker Savills Private Finance, says there has never been a more important time for buy-to-let investors to secure the best-value mortgage possible.

* "As rent increases haven't kept pace with interest rate rises, investors may find their profit margins are being squeezed if they are on variable rate mortgages," Bien says. "One way round this is to fix at least part of your portfolio - many of our experienced investors do this so that they have some security while keeping the remainder of their portfolio on a variable rate, so they can benefit from any interest rate reductions."

* Bien likes a deal from Mortgage Express, a two-year fix costing 5.09 per cent for buy-to-let investors, which is available on loans of up to 85 per cent of the value of the property. Though there is a 2 per cent fee, it can be offset against tax.

* "If you feel you don't need the security of a fix - or want to keep part of your portfolio on a variable rate - you will get a cheaper deal," Bien adds. "BM Solutions has a two-year tracker at 0.51 per cent under bank base rate for two years, giving a pay rate of 4.74 per cent."