Bright B2L ideas

Buy-to-let now accounts for 14% of the mortgage market, having more than doubled in size in just five years from the 6% it held in June 2001. The market, which is now worth 73bn, shows no sign of slowing.

But how can these growth levels be sustained? In such a rapidly expanding sector it is crucial that product inn- ovation drives the market to provide investors with the best deals and help landlords reap maximum long-term returns from their investments.

Buy-to-let is no longer an area of investment exclusively inhabited by professional portfolio landlords. As the sector has become more popular and accessible to the average person, borrowers are turning to it as an alternative to personal pension plans. As a result, lenders have had to evolve their products to ensure mainstream borrowers are provided with competitive deals. Even young professionals are looking to buy-to-let as an alternative to saving for retirement.

With uncertainty and controversy surrounding government support in old age and the feeling they have left saving for retirement too late, people are realising the benefits of bricks and mortar in achieving healthy returns on investment.

As more people enter the market and landlords expand their portfolios competition between lenders is fierce. This means they are keen to develop innovative products to win business from investors entering the market as well as retain the business of existing landlords.

Looking back over the past decade of buy-to-let, the sector has grown tremendously and this can be put down to rapid innovation and the increased accessibility of buy-to-let as an option for investors. Until 1996, lending for buy-to-let purposes was restricted to professional landlords through commercial loans.

It was only when legislation gave landlords the power to evict tenants who were falling behind with their rent that buy-to-let entered the mainstream. Specialist buy-to-let loans were launched and buy-to-let became populated by private individuals for the first time, promoting the rapid evolution of products for landlords.

The transformation of the market since that time has seen the appeal of buy-to-let broadened beyond all recognition as many more people have been attracted to the sector.

This shows how crucial innovation is when it comes to maintaining the momentum of growth, especially at the rate seen during the past decade. Increasing competition between len-ders has seen rates for buy-to-let mortgages fall significantly. Landlords once had to pay higher interest rates on their mortgages but now buy-to-let loans can be obtained at similar rates to standard residential deals.

The deposits required have fallen too, with LTVs available on at least 85% of a property’s value these days. Compare this with 75% LTVs 10 years ago and it is clear how quickly the market has evolved. This will continue to be the case as lenders fight for market share.

We are now seeing LTVs as high as 90% and we should not expect innovation to stop there. It won’t be long before investors are offered a service whereby lenders will accept gifted deposits on new-build properties and lend on the total gross price. This will result in 100% lending on new-build buy-to-lets and is something we could see before the end of this year.

In a market where lenders are typically withdrawing from new-build developments, the possibility of seeing 100% LTV is exciting for the buy-to-let market and its investors.

Meanwhile, rental cover has come down significantly. When buy-to-let started in 1996, lenders demanded that rental income should be 130% to 150% above the mortgage interest to give landlords sufficient cover for void periods and maintenance costs.

Lenders have gradually become more lenient. Until recently, the typical rental cover was 125% above mortgage interest but this year it has been possible for investors to get products with required cover of just 100%.

This means more risks can be taken with buy-to-let lending and, as we see more high street lenders joining the market, traditional sector specialists are being faced with the need to offer better rates and rental cover. This will result in more lenders reducing their rental cover.

Lenders can afford to take a few more risks with buy-to-let because of the healthy condition of the market. Data from the Council of Mortgage Lenders shows that mortgage arrears of three months or more on buy-to-let properties stand at only 0.68% of all loans compared with 0.9% of residential mortgages.

It is estimated that one-third of landlords depend on the income from their buy-to-let properties as their primary income. Len-ders now understand that buy-to-let is a business, not a hobby, and mortgages should be set against the earning potential of the property rather than the salary of the individual. This frees up lending criteria, allowing lenders to be more creative with their lending terms.

Lenders now understand that if investors have good credit which is not dependent on their salary income, that the property purchased is marketable and that it offers the right level of rent and valuation, they can offer more competitive rates to investors.

One area where we have seen lenders offer products based on the property rather than the individual is the provision of mortgages for student accommodation. Almost half a million people will head off to university this autumn and as the student population grows, we are seeing more parents opt for buy-to-let investment as an economic alternative to paying rent to a landlord while their offspring complete their degrees.

Many parents are opting to buy a property in their son or daughter’s name while at university to avoid hefty tax penalties. Of course, investors can find it hard to get a mortgage in their children’s name as the latter don’t have any income. But as innovation in the buy-to-let market sees more lenders offer mortgages based on the earning potential of the property and not on the individual, this problem is being overcome. Lenders are also allowing parents to act as guarantors, taking their salaries into account.

The popularity of parents investing in property in university towns has increased so much that in some areas lenders have introduced ‘buy-for-uni’ mortgages. A buy-for-uni scheme is based on the predicted rental income of the property and means mortgages can be obtained for 100% of the value, removing the need for deposits.

With these products already implemented in Bath and Bristol, it is predicted that as more parents realise the benefits of buying property rather than paying rent we will see them become available nationwide.

The future of buy-to-let looks rosy. The base rate has just risen to 4.75% as expected, but this will not discourage buy-to-let lenders from creating products or improving their criteria. In a competitive market, lenders will have planned their commercial strategies at the beginning of the year. They will have targets to hit and can only achieve these through winning new customers and encouraging existing borrowers to remortgage with them.

All lenders need to maximise their market share and want to increase their profits. As one lender improves its criteria, others will follow. Lenders that provide a first in the market, are exclusive or take the lead in providing the best products will prosper. This all helps to boost lenders’ reputations, which is important when building brand awareness as an innovative, exciting and dynamic firm.

Competition has a dramatic effect on product design, development and innovation. Being the first buy-to-let lender to offer a low rate or innovative product in terms of rental cover or LTV will reap rewards in market share. It will also enhance that lender’s reputation and boost its profits.

Product innovation is here to stay. As the buy-to-let market expands, lenders know this potentially lucrative market is demanding the most suitable products for its investment needs, and that brokers and their buy-to-let clients will search until they find the deals they are looking for.

Gary Winter is projects development executive at The Money CentreB