Sink or swim

15 February 2010 | By Christine Toner

There is an argument that the era of the amateur landlord is coming to an end. When credit was easy and television programmes offering viewers the key to making millions as property investors popped up left right and centre, many would-be landlords tried their hand at the buy-to-let market.

But then came the credit crunch and landlords not experienced enough to handle the pressure got their fingers burnt.

Property programmes still air of course, but now they are seen as what they were originally intended to be - entertainment rather than ’how to’ TV.

The authorities seem keen to make the sector much more professional too. The Financial Services Authority’s Mortgage Market Review, published in October 2009, revealed plans to regulate the buy-to-let sector. And last week it was announced that the government is to develop a TripAdvisor-style feedback website which will allow tenants to post their views on rental accommodation and landlords.

So some now see the buy-to-let market as strictly for those willing to invest time and experience in it. But others argue that this is the ideal time for investors to enter the sector.

Figures show that confidence is on the up. And according to LSL Property Services, after 14 months of landlords making negative annual returns in October last year that changed. By December investors were enjoying returns of 7.6%.

So who’s right? Has impending regulation and the liquidity freeze damaged the market beyond repair? Is this the right time to take the plunge in the buy-to-let sector as the property market seems to be on the up again or are the uninitiated better off waiting a while?

John Heron, managing director of buy-to-let mortgage provider Paragon Mortgages, says it’s the motive behind the investment that determines whether it is a good time for investors to jump in.

“Certain conditions such as low savings rates, a stable housing market and strong tenant demand make buy-to-let an attractive investment,” he says. “But whether an individual should enter the market depends on the type of investment they intend to make and their motive. If they are investing - or more accurately speculating - on rising house prices to make a quick profit, buy-to-let is not for them.
“But if they enter the market with a long-term view and base their purchase decision on proven levels of sustainable tenant demand it can be a positive investment.”

It was the idea that house prices would always rise and huge returns were a given that prompted the surge in buy-to-let. Buying a property, renting it out while prices soared and then selling it on for a massive profit was painted as the fast-track to fortune.

But it’s not just those who were in it for the short term who got their fingers burnt. Even more cautious investors who had no intention of selling quickly saw their mortgage payments rise as their deals came to an end and lenders tightened criteria.

It would be a pretty optimistic person who said the mortgage market was back on its feet. A 0.1% growth in the economy is nothing to write home about and the Bank of England’s Monetary Policy Committee decision last week to halt quantitative easing could yet have serious ramifications. But there are signs that the market is expanding.

According to Mortgage Brain nearly 1,000 new mortgage products were launched in January - the biggest monthly increase for more than a year. The total number of live mortgage products rose 26% in the month, going from 3,534 on January 4 to 4,457 on February 1.

On top of this house prices appear to be on the up, with the Centre for Economics and Business Research predicting that the average house price will be around 20% higher than today’s levels by the end of 2013. Signals such as these support the case of those who argue that this is the time to invest, before prices get too high.

“Making good investment choices is about deciding when the market has reached its lowest point,” says Chris Norris, policy manager at the National Landlords Association.

“Lots of investors have been sitting on their hands waiting for prices to hit the bottom. Although nobody can be confident that prices won’t fall again, early indications are that the market is recovering. So investors with sufficient capital could do worse than buy now.”

Norris says house prices are conducive to improved yields, while the prospects for capital appreciation are better than they have been for a number of years. But he adds that finance is hard to come by at reasonable cost so the opportunity is only realistic for investors with good liquidity.

David Brown, managing director of LSL Property Services, also believes the buy-to-let market is beginning to look lucrative again.

“After a tough few years property investment has bounced back to profitability,” he says. “The downturn hit investors hard. As house prices plummeted the typical landlord lost £15,000 in 2008 alone. In the aftermath of the credit crunch we saw thousands of short-term and amateur investors leave the market. As returns ran into the red and mortgage finance dried up many potential investors stayed away from the private rental sector.”

Brown says two important factors have led to the turnaround since last November - rising house prices and rents outstripping their levels a year ago after falling for four months.

“We have reached a good point to invest in property,” he says. “House prices are affordable and arrears are performing well. Provided investors can get mortgage finance property investment is a lucrative proposition again.”

But as the old adage goes, once bitten twice shy. While conditions for investment may be improving it will be some time before the challenges of the past two years are forgotten. Would-be investors will recall the headlines of the past 24 months - ’The party’s over for buy-to-let investors’ declared The Times, and ’Investors suffer as buy-to-let loan rates rise’ reported the Telegraph.

So has the crisis deterred future investors?

“Yes, to an extent,” says Brown. “The credit crunch highlighted the fact that buy-to-let investment is a long-term commitment rather than a speculative punt to make a fast buck. Potential landlords need to go into it with their eyes open.

“They should base their decision on long-term considerations such as rental income and tenant demand rather than simply assuming property values will continue to rise. Those looking for a get-rich-quick scheme rather than a long-term business investment are less interested than they once were.”

Indeed, the challenges thrown up by the credit crunch prove buy-to-let investment is not the pot of gold at the end of the rainbow it was made out to be and bringing this to light is not necessarily a bad thing.

“The credit crunch helped rid the market of speculative investors and property investment clubs, and that can only be a good thing,” says Heron.

“Too many people who didn’t understand property investment were attracted to the market on the promise of capital gains and they got burnt. They were speculators rather than buy-to-let investors - the two should not be confused.

“Figures from the Council of Mortgage Lenders show there has been a marked downturn in buy-to-let lending but this is due to the dearth of mortgage products rather than a fall in demand,” he adds. “Demand from investors for traditional buy-to-let properties has remained strong but many have been unable to secure the finance required to make the investment.”

That’s an understatement. The number of firms offering buy-to-deals let has fallen considerably, especially in the non-bank sector, and criteria have tightened.

A quick comparison of buy-to-let products offered in 2007 with those available in 2010 (see box) illustrates the problem. Four of the six top buy-to-let product providers in 2007 - CHL Mortgages, Mortgages Express, Paragon Mortgages and West Bromwich for Intermediaries - are no longer in the market.

And while the top fixed buy-to-let product in 2007 with a headline rate of 4.49% was 1.5% higher than the leading fixed rate deal in 2010 at 2.99% it’s a different story when you compare criteria. To get the top product in 2007 you only needed a 15% deposit, and you only had to pay a product fee of 1%.

In 2010, to get the best buy-to-let deal at 2.99% you’ll have to find a 40% deposit and pay a product fee of 3.75 %.

But if the credit crunch and resulting challenges have sorted the wheat from the chaff when it comes to landlords, is buy-to-let regulation as suggested in the MMR necessary? And if it is to be introduced should it only apply to new and inexperienced landlords rather than professionals who have their portfolios under control?

“Regulating buy-to-let mortgage products and advice will help prevent a repeat of past abuses and excesses,” says Brown. “Before the credit crunch there was an influx of amateur landlords who borrowed irresponsibly or investors who were poorly advised by property clubs.

“Regulation will prevent this from happening again as the market recovers and ensure that the private rental sector continues to become more professional. It’s the duty of brokers to ensure new landlords are aware of the pitfalls of investing in property as well as the virtues.”

But Norris disagrees, arguing that the prospect of buy-to-let regulation is a concern for landlords not only because it will increase the cost of investing in property but also because it would heighten uncertainty in the market and could therefore further limit the availability of finance.

“One of the biggest problems facing the private rental sector at the moment is the lack of buy-to-let finance and regardless of who is targeted by prospective regulation it’s unlikely to help matters,” he says.

Norris adds that it is arguable whether buy-to-let regulation is required at all but says that if it is introduced experienced landlords would not require the same level of protection as owner-occupiers applying for residential mortgages.

Heron is of the same school of thought and says that if the FSA is given the power to regulate the sector it would only be appropriate for first-time landlords buying their first residential property to let with their first buy-to-let mortgage.

He argues that individuals purchasing their second or third properties with buy-to-let mortgage finance can hardly be characterised as accidental, unwitting or novice landlords.

“They have made a conscious and commercially-motivated decision to expand their investment portfolios and are therefore operating in a commercial manner,” Heron adds. “Consumer-style regulation would not be appropriate.”

But there is an argument that a buy-to-let investment is the same whether you have 10 properties in your portfolio or one.

The credit crunch took everyone by surprise and while the experience may have given some investors the confidence to weather the storm it has not left all unscathed.

“It seems certain that the buy-to-let mortgage market will be regulated at some point despite it operating successfully for years without control,” says Andy Young, chief executive officer of The Mortgage Business Company. “As the financial risks involved are the same for new landlords as for experienced ones there doesn’t seem to be an obvious argument for treating them differently. Either investors need protecting when purchasing buy-to-let property or they don’t.”

But how much protection would regulation offer? Geoff Laird, principal of brokerage Buy-to-Let Funding Services and who previously worked at a buy-to-let lender, is not sure it would resolve much.

“During my time with a buy-to-let funder that understood the dynamics of the sector I was surprised at the number of IFAs who chose to use only lenders that sought little or no information to underwrite applications, given the default ratio of many such loans since the credit crunch hit,” he says. “Can the FSA claim that regulating these mortgages and the classification of brokers is the way to ensure there will not be a repeat of such a problem?”

Heron also believes the advice element is key to a safe market, although mortgage brokers may not always be the best people to give that guidance.

“I am not sure brokers are best placed to get involved in buy-to-let,” he says. “It is essentially a commercial transaction and while brokers may be able to highlight some issues, novices need the advice of a number of professionals to build a comprehensive picture of risks and benefits.

“It should not be forgotten that buy-to-let is a business rather than a passive investment and anyone new to the sector will need to gain a thorough understanding of the business of owning and letting property from the professionals and trade associations that are there to help.”

Regulation and advice aside there are some steps investors should take to protect themselves when entering the buy-to-let sector.

If the FSA is given the power to regulate the buy-to-let sector it would only be appropriate for those investing for the first time

“Landlords can take the sort of precautions any prudent investor should before taking the plunge,” says Young. “These include researching the property market, choosing a good location for their property, talking to letting agents to gauge the likelihood of rental voids and making sure that their expected rental income covers the mortgage payment with some room to spare. Taking out rental guarantee insurance is a good idea too.”

Laird says that steering clear of anything that looks too good to be true is a good starting point.

“Avoid responding to property wealth companies or any other organisations offering get rich quick schemes that involve investing in property,” he says. “The property investment business is for those who intend to remain in the market on a long-term basis. But the most important thing is to seek out a commercial broker who understands this niche and is preferably a member of the National Association of Commercial Finance Brokers.”

So the consensus is that the buy-to-let market is slowly coming back to life. It’s been a brutal few years but with house prices on the up, confidence rising and more products available the resuscitation has begun. But hurdles such as regulation and liquidity mean it’s not off life support just yet.

So those willing to take the plunge should be prepared to sink or swim in a cold and murky market. There are opportunities to be grasped for serious investors but would-be landlords looking to make a quick buck would be better off staying on dry land and standing well clear of the edge.