eing asked to offer an opinion on the state of the buy-to-let market seems akin to jumping on a bandwagon that has already rolled out of town. There’s been so much conjecture on the future of this market in recent months that it is hard for any commentator to provide a fresh analysis without repeating someone else’s views. But what is becoming acutely evident is that the buy-to-let market is undergoing significant changes that will affect the working environment of all connected parties.It is easy to forget that buy-to-let is a relatively new phenomenon. The number of tenants living in the private rented sector rose from 1.7 million in 1989 to 2.5 million in 2003 with the Centre for Economics and Business Research forecasting a further rise of nearly 40% by 2014. Many tenants have become aware of the benefits of renting and the general improvement in the condition and presentation of tenanted property has seen an increase in those renting out of choice rather than necessity. Tenants are increasingly from the professional and service industries, under 35 years of age, unable to get on the housing ladder but aspiring to the same living standards as owner occupiers. This puts an increased pressure on landlords to get their choice of property purchase and location correct. There are of course many investors who acquire residential property with a view to owning the asset for several years. But for many investors the term buy-to-let is grossly inaccurate and the phrase buy-to-sell would be a far more apt description. But the recent slowdown in house price growth is changing the dynamics of this sector. Cash-rich investors can no longer exchange contracts on off-plan, new-build properties and then sell on the contract before completion, often doubling their initial outlay as they used to. This strategy – known as flipping – has done little to advance the cause of those looking to promote residential property as a fully fledged asset class. The process has often circumvented the role of specialist buy-to-let brokers, with secondary buyers likely to be an owner occupier, paying the uplifted purchase price. The end of double digit house price growth will inevitably mean residential investors will have to switch to a longer term approach and this in turn will place advisers in a far more prominent position. Two years ago an investor who planned to flip on a contract would have been unconcerned about the rate of a mortgage they may never need to take out. On the odd occasion that Bthey completed on the purchase of a property, whether the interest rate on the mortgage was 5.25% or 5.49% was largely immaterial to the overall investment performance if the underlying value of the asset was rising at 15% a year. Not so any more. With capital growth assuming far more restrained levels, the rate of borrowing and allowable levels of gearing will become crucial elements for many in deciding whether or not to acquire a residential investment property in the first place. And from a broker’s perspective, the change to long-term holding patterns is also likely to mean an increase in remortgages in the buy-to-let sector. One frequently overlooked virtue of residential investment is its inherent defensive mechanism that tends to see rental demand and returns increasing at times when the growth in capital values is subdued. This is the process that seems to be occurring in the market at present, with the latest research reports pointing to rising rental yields across most regions. This may be mainly anecdotal evidence but it seems to point to the fact that the slowdown in house price growth has removed the impetus for those in the rental market to make the move to home ownership. Two years ago a first-time buyer living in rented accommodation who delayed the decision to buy for as short a period as three months was faced with the distinct likelihood that the value of the typical property could have risen by 10,000 during that time. Remove that key driver from the market and those living in rented accommodation are satisfied to remain there for longer. And the rising number of students, divorced and separated persons and those taking employment on short-term contracts means that in a relatively short period of time the rental market can shift from an over-supply of property to a more balanced environment that can see the market tolerate a gentle upward movement in rental values. So the buy-to-let market is in an interesting transitional phase. In the short-term, there is unlikely to be the substantial growth in capital values that has driven the market for the past five years or so. But for investors who are prepared to look long-term there is the likely benefit of a long awaited rise in rental yields. And historical analysis shows that in any past period of 10 years or longer, the all round performance of residential property – looking at both rental income and capital growth – outstrips the returns achieved from other property investment assets such as commercial, retail or industrial, as well as equities and gilts. The growth in single person households will undoubtedly be one of the main factors driving forward the buy-to-let market in the years ahead. Currently accounting for 30% of all households in the UK it is anticipated that by 2021 single person households will account for 40% of the market. This reflects a rising divorce rate and an ageing population, both of which are already having a significant effect on the level of demand for housing. The Office of the Deputy Prime Minister has indicated that 3.8 million homes will have to be built to cater for this rise in single households in the years prior to 2021. Planning constraints and delays mean it is unlikely this target will be met. This will result in more pressure on house prices and in turn a further stimulus for the rental market, with owner occupation becoming unattainable for a growing proportion of the population. The change in legislation from A-Day, April 6 2006, will provide an additional boost to the buy-to-let market. From this date it will be feasible to invest directly in residential property through self invested personal pensions. The opportunity of using a tax efficient pension environment to invest in residential property will appeal to many investors. Couple this with the tax relief on pension contributions and the furore surrounding the SIPPs market is understandable. But in reality direct ownership of residential property via SIPPs is likely to be practical for only a small number of high net worth individuals. The Inland Revenue has imposed a strict limit on the level of gearing for SIPP purchases, limiting exposure in this market, so investors will only be able to borrow at a 33% LTV ratio. So to be able to acquire a property at the average house price, which now stands at 184,000, any investor will need to have funds in excess of 120,000 in their pension. Taking into account the fact that only around 1% of the population has pension assets in excess of 200,000, it becomes obvious that direct ownership of residential property within SIPPs will really be a niche area for a select few. And this low level of borrowing raises a further issue. At present some investors are prevented from buying a property because rental income is sufficient to cover interest payments. But with such a low level of gearing allowed for SIPP purchases this should cease to be an issue and provide lenders and brokers with an opportunity to offer bespoke mortgage products for this market. As the buy-to-let market continues its development and the residential market becomes increasingly accepted as a viable asset class in its own right, the role of an adviser in endorsing the benefits of this investment to a property hungry clientele will become more prominent. There will be heightened focus on mortgage products and the level of advice on offer from brokers. And for more innovative intermediaries, significant commission driven opportunities will arise for the promotion and sale of residential investment property and in particular packaged solutions that combine property with financial management expertise. Simon Halls is director of Vivacity, part of City Lofts Group
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