Don't let buy-to-let fade away
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Once upon a time buy-to-let was celebrated. The money pages of national newspapers hailed it as the perfect safety net just as a particularly nasty market seriously damaged the profitability of pension funds.
It was a win-win situation because investors jumping on the bandwagon drove up house prices, so in addition to an income stream from the rent investors could also look forward to a big pot of gold at the end of the rainbow when it came to selling up.
Moreover, rising property prices made it difficult for aspiring home owners to get a foot on the ladder, leaving them no choice but to become tenants.
But this was not regarded as a downside, even by building societies who owe their origins to artisans clubbing together to build homes in the bad old days of the Industrial Revolution when most people lived in rented housing chucked up by speculative builders.
So the societies wanted a slice of the action, and why not? The wisdom was that buy-to-let was counter-cyclical so that if there was a downturn in the housing market more individuals would defer the decision to buy and turn to renting.
This in turn, pundits reasoned, would encourage more landlords into the market attracted by lower entry costs and a tide of tenants either deferring the decision to buy or having their homes as a result of repossession.
In addition, the growth of buy-to-let was supposed to be for the greater good as the social rental sector declined, giving individuals - especially the young - more choice and increased job mobility at the start of their careers.
In short, the market was fuelled by an irrational exuberance to the extent that Bradford & Bingley gambled its future on becoming a specialist buy-to-let lender and West Bromwich Building Society even became a landlord with a portfolio of around 1,000 properties.
As assets go, property is fairly illiquid - it's a tough market for landlords and lenders to get out of when things go wrong. Indeed, the now-nationalised B&B recently posted first-half bad debt figures of £328m, with £270.8m being put down to fraud and professional negligence.
Societies have been suffering too, some terminally. So does buy-to-let represent a no-win situation for lenders whatever their position in the market? The answer is probably no - the biggest threat to the development of the private rental sector is likely to come from the regulator in a knee-jerk reaction to the B&B experience, and from the government in terms of ill-considered legislation.
True, B&B and some societies have suffered badly from exposure to buy-to-let but Coventry Building Society's first-half results show that not all societies are tarred with the same brush. In the six months to June it grew its balance sheet with net lending of £338m while others saw mortgage books shrink.
Moreover, its arrears figures look good, even in the buy-to-let sector where its portfolio - valued at £2.9bn - represents 22% of its mortgage book. But it has negligible exposure to the high risk city centre flat and loan portfolio markets and insisted from the start that all buy-to-let borrowers should have big deposits.
As a result it says its buy-to-let mortgages are performing "substantially better than industry norms". Indeed, as of June 30 just 0.68% of its buy-to-let cases were more than three months in arrears.
"From a lender's perspective buy-to-let is a superb product if properly underwritten, and there's the problem," says Bob Young, managing director of Capital Homes Loans. "Most buy-to-let business was poorly underwritten by lenders that had no understanding of the market.
"Fundamentals such as sustainable rental value were rarely sought. Indeed, the biggest lenders in the sector had criteria an idiot could drive a coach and horse through. And many idiots did - just look at the arrears."
In Young's view it will take years for the reputation of the sector to recover and even when the securitisation market comes back he believes investors will struggle to get anything with a buy-to-let tag by their credit committees.
Even so, he argues that the greatest threat to buy-to-let is interference from the government in the way of punitive taxation and restrictive legislation.
Young heads back down memory lane to prove his point.
"A buoyant private rental sector is not a new phenomenon," he observes. "Until the 1970s renting was as likely to be the experience of individuals as ownership. But that changed with the 1974 Rent Act.
"This was a knee-jerk reaction to poor standards in the private rental sector and the unintended consequence of this complicated and badly drafted legislation was a sharp contraction of the private rental sector. It took years to recover.
"With regard to taxation, the Bacon report in Ireland in 2000 led the government there to change the treatment of interest payments so that these were not tax-deductible - something I suspect our government would have done if it had thought of it first," he adds.
It took three years before the consequences of that legislation were understood and it nearly brought the private rental sector in Ireland to a halt. The law was later changed and interest payments now qualify for tax relief.
"Hopefully, against this backdrop our government will neither impose requirements that make owning a buy-to-let property unattractive nor try to raise tax," says Young. "Unfortunately, property has always been a political football and governments rarely remember the mistakes other administrations have made."
An irony of the present situation is that on the supply side the buy-to-let mortgage market is contracting while the government, with its 2008 Review of Private Rented Sector Housing - otherwise known as the Rugg review - is looking for ways to grow the tenure so it will be seen as a less marginal option that the report says "sits behind the preferred tenures of owner-occupation and social renting".
Let's consider how the appetite to lend has changed in the buy-to-let market where the landscape has radically changed as result of the crunch.
Bob Pannell, head of research at the Council of Mortgage Lenders, commented on this in the council's News & Views newsletter in August"Of the six largest buy-to-let lenders in mid-2007 two are now state-owned, two have merged and are heavily state-influenced, one has received support from the Irish government and one is not lending while there is no new funding," he writes. "Seven consecutive quarters of decline have left buy-to-let gross lending at very low levels. There were 21,600 new buy-to-let loans advanced in Q2 2009, 69% lower than the Q2 2008 and 75% lower than in the same period in 2007."
According to CML figures, buy-to-let gross advances by value totalled £1.9bn in Q2 which equates to 5.6% of total gross mortgage lending. But buy-to-let gross lending for the equivalent period last year was £8.9bn - 11.9% of total gross mortgage lending. So the impact of the crunch is as marked on the buy-to-let market as it is on owner-occupation.
That's unhelpful given changing demographics and the fact that last year there were only 105,000 housing starts in England compared with the government's fanciful target of 240,000 every year.
In terms of supply, the evidence as provided by Julie Rugg and David Rhodes of the University of York in the Rugg review suggests buy-to-let has not brought new housing to the rental market.
"Despite the popular imagery, few data firmly link buy-to-let mortgages with new-build property," the authors write.
"It is possible that where the private rental sector is generating new property stock tends to be in sub-markets where high density build is appropriate - for example, in the student sector.
"With regard to affordability it could be argued that the sector has been successful in meeting the needs of intermediate households whose income means they are unable to afford owner-occupation but who are not in a priority group for social housing," they add.
That said, the review emphasises that the sector caters for the whole social spectrum, "serving as a first port of call for new households, a bolt-hole when circumstances change, a stopping-off point as people change jobs and move house and a for some, a long-term home".
In that context, 21% of private renters have lived at their present address for five or more years although generally speaking churn is the name of the game, with 40% these households living at their current address for less than 12 months.
And even within this, the private rental sector is complicated, catering for high income renters in the corporate lettings sector at the top end right down to vulnerable households in slum rentals at the bottom.
In other words, maintaining the health of the private rental sector and by implication the buy-to-let market is essential both socially and economically.
Interestingly, from a buy-to-let lender's perspective the Rugg review does not concur with the view that there is a need for a better taxation vehicle to leverage large-scale investment into the private rental sector.
"The residential market has very few landlords operating at a scale whereby big institutional investment would be appropriate," states the review. "Policies should therefore concentrate on helping good landlords of all sizes to expand their portfolios.
"It is important that this should include smaller landlords since larger ones generally grow through portfolio acquisition. Our suggestions include changes to Stamp Duty and Capital Gains Tax to encourage portfolio development."
Finally, the review argues that small scale landlordism does not necessarily create financial instability and that many cottage industry landlords are in a pretty good financial situation. Indeed, the majority have low LTVs and are characterised by a great deal of uncosted 'sweat equity', meaning they don't factor into their rents the time they spend managing their properties.
Given these findings and the importance of the buy-to-let sector that has bankrolled small investors let's hope the Rugg review is being read at the Financial Services Authority and the Department for Communities and Local Government. But then again, although they are both government agencies they have differing objectives.
Source:
Lending Strategy
