Buy to let

The phrase buy-to-let can refer either to the investment strategy of buying a residential property to be let for profit; or to a particular category of mortgage used to purchase a property for letting.

For many years landlords have invested in residential property to be let for profit, but since the mid-nineties there has been rapid growth in the property market leading to a surge in demand for rental property which is being exploited by many mortgage providers keen to encourage new amateur landlords.

Benefits and risk

The benefits can range from a stable income to house prices going up with time, thus making it a valuable way to invest in money. The risks are that you may not be able to rent out the house for all 365 days of the year, while still having to pay a monthly mortgage payment.

Yields

Recent research by BDRC for Alliance & Leicester showed that 71% make a profit, but 29% break even or make a loss.

Buy-to-let mortgages

Buy-to-let mortgages have been on offer in the UK since the late nineties; they are specifically designed for investors to borrow money to purchase property in the private rented sector in order to let it out to tenants.

Lenders take different approaches. The amount of money investors can borrow is determined by the rental valuation of the property. Usually the annual rental income has to cover a certain percentage of the mortgage repayments, somewhere between 120% and 150%. This is to allow surplus rent to cover other costs such as property maintenance and void periods (periods when there are no tenants living in the property and therefore no rental income).

Other lenders will offer a three times' salary multiple and half the rental income.

Others base the amount that they will lend on your salary and the existing loan commitments that you have, but then apply the 'deduction rule'. This means that they will lend up to 3.5 times your income (or whatever salary multiple applies), minus a representative figure for annual mortgage payments worked out at a pre-set level of interest. Say you earn £40,000 and have an outstanding mortgage balance on your property of £120,000. Under the rule, the annual mortgage repayments may be calculated as £10,000. This would be deducted from your salary to leave £30,000, which is then multiplied by 3.5 to give £105,000 - the amount that you are able to borrow.

Typically the interest rates that are offered on BTL mortgages are fairly close to residential mortgage rates but will on average be higher and typically charge higher fees. This is due to the perception amongst banks and other lending institutions that BTL mortgages represent a greater risk than residential owner-occupier mortgages.

This type of investment has become very popular in the UK over the last five years or so, as house prices have dramatically increased. Another reason for their popularity is the tax advantages that are available to UK BTL investors. Rental income is considered in the same way as salary, and is therefore often taxed at 22% or even 40%. However, landlords can deduct costs from the taxable portion of their rental income, and these costs can include the interest portion of their BTL mortgage repayments as well as maintenance costs on the property. This tax set-up has made BTL investments more popular over the last few years.

Recent credit problems have had some investers maintaning the same percentage of equity in the property should prices fall and so rapidly find money to cover these downturns.

Effects on Society

In the UK, "buy to let" has been described by some as the epitome of what is wrong with British society. The basic idea behind buy to let is "How do I get someone else to work for me?", "How do I get money without having to work?" and "How may I leverage my privileged position to enable me to make further gains at the expense of my fellow citizens". This forms much of the basis of Real estate investment. Buy to let owners can effectively become grotesquely unemployed and yet still receive massive incomes. Not only do buy to let dealers make money from rent, but these rat-like creatures can and often do make massive profits on the sale of their housing stock. The result in the UK has been a wealth divide never seen since Victorian times. Buy to let, as a form of real estate investment, together with shrewd unethical banking tactics have driven up house prices in the UK to such an extent that first time buyers, who genuinely need a first home, let alone a fourth, can't afford to get a foot on housing ladder. It has become a massive problem in the UK which cannot be underestimated. It is only when the property-less classes rise up and feast on the intestines of the property-owning classes, that the world at large will be forced to acknowledge the extent of this miserable dichotomy. The lamentable children of the middle classes often find this problem effects them less as their parents, having paid of their mortgages, and having greater wealth than they know what to do with, are glad to 'give a leg up' onto the property ladder.

History

The 1988 Housing Act abolished security of tenure for tenants. Landlords gained the power to evict problem tenants more easily, and so the prospect of becoming a landlord is more attractive than previously. The housing crash between 1989 and 1994 saw an increase in the number of tenants, as people lost their homes and were repossessed.

Buy-to-let as a term was coined in 1995 as a marketing badge for a finance initiative launched by the Association of Residential Letting Agents (ARLA), although this type of lending had existed for many years.

The Council of Mortgage Lenders (CML) started collecting statistics on buy-to-let in 1997 and some observers have interpreted the growth in buy-to-let lending, as reported by the CML, as evidence of a boom. However the CML only measures the growth of the new specialist lenders in the market - such as Paragon Mortgages, Mortgage Express and BM Solutions, whilst omitting the core back book of loans to residential property investors by mainstream lenders.

The apparent growth in buy-to-let lending is attributable to the success of specialist lenders in taking market share by offering bespoke products and services and attractive pricing. In fact, as much as 40% of activity is remortgaging as established landlords switch from more expensive commercial mortgages.

Despite the growth of the buy-to-let market since its inception, the private rented sector remains predominantly undergeared, with only 19% of the 2.7m properties mortgaged. Not only does this put buy-to-let growth into context, it also shows the growth potential remaining in the sector.

The Association of Residential Letting Agents conducts a quarterly survey of residential landlords to gauge their views on the market. In the 2005 3rd Quarter survey (September 2005), respondents showed resounding commitment to their buy-to-let investments. Of the landlords surveyed, 90% said that they would hold on to their investments even if house prices fell, 62% said that the average life expectancy of their property investments is ten years or more and 58% said that they intend to acquire further buy-to-let investments in the near term. The overall average life of their property investments was 16 years.

Assured shorthold tenancy

One of the key innovations required for widespread property investment was the reform of tenancy agreements and specifically the introduction of the assured shorthold tenancy (AST) agreement.

AST gives both the landlord and the tenant assurance of the tenancy and specifies the term the property is to be let and specifies notice period for both parties.

Experienced investors and amateurs

The buy-to-let world is divided into "old hands", and recent entrants, sometimes derided as amateur investors. The UK press often describes amateur investors as over-optimistic investors who are willing to buy property to let out, when there is little hope of making a profit. The reality is often very different from this.

The new landlord friendly legislation afforded by the 1988 Housing Act, coupled with the introduction of competitive mortgage products, brought new investors into the property market.

They have been attracted by rental incomes, rising capital values and a perception that the risk in housing is lower than for equity based investment. More recently, investors have seen buy-to-let as an alternative to their pensions, especially in light of the negative publicity pensions have received.

However, the sector is still dominated by professionals.

The Office of the Deputy Prime Minister's (ODPM) Private Landlords Survey, which appears in their English House Condition Survey, is the most comprehensive study of the private rental market. The survey is published every four years and the last three editions illustrate the changing structure of private rented sector ownership.

The ODPM survey does suggest that there has been significant growth in the number of small scale landlords owning up to four properties. However, further analysis of this data reveals that the private rented sector is still dominated by professional landlords with large portfolios of property.

Analysis undertaken by Capital Economics found that although 53% of landlords own less than five properties, this represents less than 3% of the dwelling stock. Further, at the other end of the scale, 13% of landlords own 74% of the stock.

Buy to Leave and negative publicity

Buy to Let has experienced much poor press over the past few years, with many commentators believing that it has contributed to rampant house price inflation. Such is the popularity of Buy to Let that estimates have recently put 1 in 3 new properties in London being bought by investors. Oxford Economics stated in August 2007 that buy to let is "undoubtably contributing to the overvaluation of housing".

A phenomenon called 'Buy to Leave' has also attracted criticism. This is the process where properties are bought on an investment basis and left empty as inflation has increased capital growth. In April 2007, Yvette Cooper, Minister for Housing, expressed concerns that Buy to Leave was making housing unaffordable for first time buyers. However, recent studies have suggested that only 3.1% of investors 'Buy to Leave' as most investors need rental income to make the investment viable.

See also

• Mortgages
• Remortgage
• Investing
• Irish Property Bubble
• British property bubble
• Survivor Investing

External links

• Council of Mortgage Lenders - The association that represents nearly all UK mortgage lenders.
• Association of Residential Letting Agents - The organisation that promotes buy-to-let properties on behalf of landlords.
• UK Buy To Let Mortgage Guide