B2L boomers

28 November 2011 | By Robert Thickett, Samuel Dale

The surge of new entrants into buy-to-let is reminiscent of a gold rush into a sector predicted to grow. With a mortgage market on its knees, it represents the one great hope as housing undergoes profound demographic changes.

Net immigration, greater numbers of students and higher deposits for first-time buyers are some of the factors pushing more people towards renting.

Various lenders are pledging to significantly ramp up their lending but how much of an impact will it have? Can buy-to-let be the market’s saviour?

To analyse the market, Mortgage Strategy hosted a round table discussion, in association with The Mortgage Works, with the brightest and best from the sector.

Q. WHAT PERCENTAGE OF THE MARKET WILL BUY-TO-LET TAKE UP IN 2012?
Ben Thompson: Lenders say the market will be flat next year with gross lending of around £135bn. We predict there should be a minimum of £17bn of buy-to-let loans, which is 12.6% of the total market. It is similar, in percentage terms, to buy-to-let levels at the 2007 peak.

Paul Howard: By the end of this year buy-to-let will make up around 12% of the market, which is similar to 2007. Given the ongoing demand for rental properties I can see that share increasing further, perhaps going as high as 15%.

Richard Sexton: In September and October, 10% of all our valuations were buy-to-let and that’s been growing all year, so I would expect it to be between 12% and 15% next year.

Chris Bramham: There will be significant regional variations. I believe inner London could see buy-to-let as high as 18% because the demand for rental property is enormous. We are seeing at least 13 applicants for each rental property. Landlords are the key at the moment and it is their instructions that we need because there is a massive shortage of property.

Ronnie Green: The average age of a first-time buyer is now 37 and rising, and the more it rises the more demand there will be for rental property. It will soon become one of the few investment vehicles people feel secure enough to put their money into. We may even see a return to government-sponsored business expansion schemes to encourage investment. In the 1980s the government set up a scheme where people got tax relief for putting money into companies that bought properties purely for rental purposes. Investors were banned from trading in them and had to rent them out for five years.

David Whittaker: Business expansion schemes were the biggest con perpetrated against investors in the history of taxation. Prices were inflated and by the time you took the tax relief out, the property prices came out about right. The schemes took about 10 to 15 years to rewind after the last recession and it would be the wrong way for the property market to go as it would create an artificial bubble.

Green: But it kick-started the rental market and made rental business more sophisticated - and some schemes were successful.

Q. WHY IS BUY-TO-LET PROVING SO POPULAR?
Howard: Today’s market has two positive features - record rents and a reduction in void periods. It makes this an attractive time to be a landlord right now.

Ying Tan: The time to rent a property is now down to two weeks, from our experience, as you have five to six people chasing one tenancy agreement.

Whittaker: Yields of 6% on buy-to-let property aren’t sustainable in the long term as the traditional returns have been between 4.25% and 5.5%. Right now the whole market is running north of 6% so at some point there will be a softening, probably in the next 18 to 24 months, just at the time when the base rate inevitably goes up.

Thompson: There is an artificial tip from the owner-occupier market being squeezed. The affordability problems facing first-time buyers are not about to change.

Q. ARE RENTS RISING TO UNSUSTAINABLY HIGH LEVELS?
Green: I don’t think so because I bought my first rental property in the mid-1990s and the price has tripled, but my rental income has only increased by 50%. While the demand is there, the price will go up - it’s simple economics.

Sexton: Our statistics show that arrears have fallen in recent months so I would suggest there is still some mileage in it yet.

Tracie Pearce: If we compare it to the housing market in 1997, then house prices tripled in value while rents have increased by only 50%. There’s definitely some room for movement.

Q. COULD SOME FORM OF CAP OR RENT CONTROL BE INTRODUCED TO ENSURE RENTS DON’T CLIMB TOO HIGH?
Sexton: Rental caps seem to work in Europe but this government is instinctively anti-interventionist. Although there is a degree of intervention with the cap on housing benefit, particularly in London, rents remain the highest in the country. It’s hard to tell someone who wants to rent their property in the year of the Olympics that they have to cap it. Whoever asks might get a javelin inserted somewhere they wouldn’t want.

Howard: Can you imagine trying to put rental caps in place and police it across the country? It would be impossible. It’s about supply and demand and the market will sort itself out. We will see the purchase market start to grow and at that point yields will start to ease off. The market will self-correct.

Bramham: It is cheaper to buy than rent but most people can’t do it because of the deposit requirements to buy and credit profiling. It’s the reason why we have 37 year olds in good jobs who can’t get on the housing ladder.

Tan: But buyers need deposits of between £15,000 and £40,000 when buying an average property costing around £160,000, whereas to rent the deposit is between £800 and £1,500.

Green: Another benefit of renting is the flexibility it provides, as more people want the ability to move easily. The word mortgage actually comes from the phrase ’until death’ but if you’re renting then you can leave after a year. Renting is a way of life in Europe and the US and we are heading more towards that model.

Pearce: It is difficult to impose a cap when you’re not familiar with the area being served, the quality of the security, the type of property and a whole host of other factors.

Q. WHAT IMPACT ARE CUTS TO HOUSING BENEFIT HAVING ON THE MARKET?
Bramham: It’s keeping demand up, there’s no doubt about that. There are multiple problems with local housing benefit and landlords have to look at it when getting into that market. For starters, arrears are a problem and landlords aren’t chasing them properly, particularly as the government has decided to pay tenants directly. We have problems as tenants receive a £1,200 cheque every month and end up buying a widescreen television rather than worrying about the rent. Alternatively, we’re renewing about 70% of all tenancies so from a landlord’s perspective it reduces void periods.

Howard: Are rents going up beyond expectations?

Bramham: In some cases but not hugely. A landlord will always try to get more rent because he has the commodity everyone wants so people aren’t moving around. I’m talking from a north London and Essex perspective so I can’t speak for the whole country, but there’s a massive number of tenants on housing benefit.

Adrian Scott: There has been growth in landlord numbers and they have matured and become more commercial in their decisionmaking. It’s not just about chasing every pound and they’re accepting that a good tenant is a good thing, so they are not as concerned about the extra £20.

Bramham: About three years ago there were lots of estate agents entering the market and offering ridiculously cheap deals for property management. They are getting found out now as landlords realise they get what they pay for as they don’t chase rents, inspect the property or look at contracts. They should only be dealing with agents that are members of the Association of Residential Lettings Agents. Landlords aren’t stupid and realise there are a lot of scurrilous agents that won’t provide a good service.

Q. WHAT DO YOU THINK OF THE FINANCIAL SERVICES AUTHORITY’S DESIRE TO REGULATE BUY-TO-LET?
Pearce: There is certainly strong support for regulation of the buytolet market. But the Mortgage Market Review is not easily transferred across to commercial business transactions that investors and landlords are taking on their portfolios. Any response needs to be proportionate.

Howard: Buy-to-let regulation would not be helpful to the market and I wonder what would actually be regulated.

Scott: Obtaining finance is just one part in a long process of property investment. There is an argument that the regulatory focus should be on other areas of the transaction, such as property clubs. Also, the reason for regulation is to protect markets and consumers but buy-to-let mortgages are business transactions. I hope it isn’t regulated but I expect it to be, so the industry needs to be prepared.

The question for regulators is who is an amateur landlord and who is a professional? The consensus is that this is usually determined by the number of properties owned but what if a landlord had 15 properties before the crash but sold them at the right time?

It makes him a serious investor but now he has no properties so he is treated as an amateur. Conversely, if someone won the lottery and bought 10 properties, it wouldn’t make them a professional landlord, so there are lots of grey areas.

Pearce: This is where we ask the intermediaries to give advice on investment areas and mortgage finance because they are skilled and able to help them make the right decision.

Q. WOULD MORE REGULATION PUT OFF NEW ENTRANTS IN BUY-TO-LET?
Thompson: From conversations I’ve had with lenders, there is a fear that regulation could reduce the size of the market, which isn’t a good thing. From a lender perspective a smaller market with more players means more competition, so it won’t look as attractive as it would have done. But regulation is a long time away yet, it’s not certain and there are lots of people coming in next year.

Green: The key challenge is to recognise what the market will look like in the end because if you replicate the regulatory situation on residential mortgages, that’s not a huge amount of change. It all comes down to what the rules are and what the cost will be. As an industry, it would be good to have some clarity because it has been hanging around for a long time and everyone has it at the back of their minds, particularly lenders when making decisions. The benefit we will get next year is some clarity on the matter.

Howard: Regulation could inhibit product innovation because these are commercial transactions. If that’s regulated in the same way as the residential market then it inhibits some of the products, such as lending to limited companies. Would that be regulated? I can see some issues there.

Sexton: Lenders are best placed to regulate themselves but one of the issues is that the sector has become a watering hole for fraud. Lenders need to set their defences against this because at the moment it is a magnet for hidden purchases. We’ve seen it flip around because people used to buy a property and let it out but now there are people pretending to buy a buy-to-let property to live in.

Tan: It has self-regulated in the past couple of years and there are much stronger controls in place to guard against those sort of things. It is a lot less than two or three years ago.

Q. DOES ANYONE FEEL THAT LTVS WILL GO ANY HIGHER?
Sexton: If Ben is right about competition that has to drive up LTVs. Thompson: Lenders have been pretty clear that they are going higher but not to crazy levels. We have learnt a lot as a lending community in the last four years.

Tan: You will see a lot more people operating at 60% or 70% LTV but I’m not sure there will be too many at 85% LTV.

Whittaker: Rental levels are important too because if you combine the LTV with the capital value and the prudent level in the area then that can move the rental value on. Everyone forgets that the gross rate needs a 30% reduction to get to the net rate so a 6% yield is actually 4%.

Sexton: There is an appetite from lenders to have more objective data on rent levels. It is an issue when compared with capital value, which has objective evidence. Most lenders have to go to a rental agent, where the independence can be questioned. We are working with lenders to source more objective data.

Howard: If you look back to when buy-to-let was introduced, LTVs were 75%, so the current levels of 75% to 80% LTV are about right.

Whittaker: We’re back at the equilibrium we were at in 2003, when the core market offered 75% LTV with one or two specialists of fering 80% LTV. While some headline rates are, say, 85% LTV, by the time borrowers have been put through a bracing stress test it is about 81% LTV.

Pearce: Landlords’ expectations have been reset too. The average LTV across the market is around 48% to 50% so there’s plenty of capacity for landlords to leverage their portfolios at a level that they think is appropriate to buy further properties without exceeding the LTV.

Bramham: While many people think the buy-to-let market is operating at 75% or 80% LTV, it is actually more often sub-50% LTV. The danger with pushing up LTVs is that there will be more amateur landlords who can’t handle rental voids and arrears will start to creep up again.

Q. ARE NEW ENTRANTS CREATING AN UNSUSTAINABLE BOOM?
Bramham: Right now LTVs are at a manageable level but the worry is that a number of lenders are talking about entering the sector next year. Platform is talking about doing three or four times more lending than this year, as is Barclays. Is it a sustainable model for lenders?

Howard: There are a lot of drivers pushing up buy-to-let business, from the inability of first-time buyers to get on the ladder to net immi gration and higher student numbers. I think more lenders will see buy-to-let business grow overall. It will act as a catalyst.

Sexton: Will lenders get to a certain level of lending and not want to expose themselves further in a similar way to new-build?

Howard: I would struggle to see who those lenders would be so I think there won’t be many that pull out. The margins on prime business are shrinking with more competition and that will inevitably lead lenders to more margin opportunities such as buy-to-let.

Thompson: New competition reduces over-exposure as well.

Pearce: What we need are lenders with knowledge and experience of the sector and the capacity to be a real competitor.

Tan: We have lots of lenders knocking on our door claiming they are doubling or tripling their lending next year. The reality is that new lenders have to get their service and systems in place to warrant that kind of business. It isn’t just a headline rate because if you have a bad experience with one or two deals you won’t want to use them again. I’m finding it already with some new entrants that have attractive rates but not the service and many brokers are sticking with the lenders they know work.

Scott: Not many of these lenders are competing with the scale of BM Solutions or The Mortgage Works. There are 23 lenders now in total and they probably don’t amount to 10% of the market so they’re not having much of an impact. The entry of Barclays and Santander could make a big difference but right now it’s not affecting it.

Whittaker: TMW and BM Solutions have around 70% or 75% share of the market so if they decide to do 10% more lending, that is significant. If some other lenders quadrupled their lending it would be less than 1% of TMW’s uplift. Only TMW and BM Solutions can affect the market because new players, with their issues of scalability and getting up to speed, wouldn’t become movers and shapers in 2012.

Q. DOES RELYING ON ONLY TWO MAJOR PLAYERS MAKE THE SECTOR VULNERABLE?
Whittaker: The two main players are here to stay. It is better for the overall market if some of the weight is lifted off their shoulders. It will take time for others to catch up as their service standards and systems aren’t as well-oiled and tested and it can’t be changed overnight.

Thompson: It’s partly the reason we are forecasting £17bn buy-to-let lending next year as we think 2013 will be the year when new entrants have a real impact.

Bramham: The rental market is estimated to make up 20% of all housing stock in 2013, which is great for professional landlords.

Q. AND FINALLY, WHAT ARE THE PITFALLS OF HAVING MORE AMATEUR LANDLORDS IN THE MARKET?
Sexton: There are a lot of lenders sat on get-rich-quick amateurs from before the crunch.

Bramham: This could happen again if we see an influx of buy-to-let products. I’m not saying that’s bad but the pitfall is that arrears will go up. Instead of having to find 25% deposit, there will be amateurs who think since they only need 10% or 15% so they can make lots of money. You cannot make money from one property.

Tan: This is where we go back to property clubs. Three years ago many of the landlords came from these get-rich-quick schemes by putting money into buy-to-let. It was one of the biggest factors in the downfall of the markets, particularly in the new-build sector with cash-back schemes and low deposits. As professionals we have to ensure these aspects do not return to the market as it continues to grow again.

Bramham: Amateur landlords will also struggle with tenants who trash properties because you can take all the references possible but you cannot legislate for that. If you’re looking to earn money then you will have to completely refurbish the property and have two or three-month void periods.

Tan: That could happen every two or three years and it could cost up to £15,000. Landlords must be educated and advised of the risks. We have lots of clients in it for the long haul and also some first-time landlords from years ago who have survived. There are some who see this as an opportunity to take on more properties but it is a risk. For the first-time investor there needs to be lots of hand-holding and advice so they know the risks.

 

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