This is a good time for lenders to support the increasingly confident buy-to-let sector if they have access to funding, says David Brown, commercial director at LSL Property Services
After a challenging couple of years landlords have got stuck into 2010 in a cheerier frame of mind, giving reason for optimism in the private rented sector.
For 14 months between summer 2008 and autumn 2009 landlords made negative annual returns, taking account of rental income and changes in capital value.
But in October last year that position swung round dramatically and this has continued since. By December, investors were enjoying returns of 7.6%.
This has left landlords significantly better off. With capital depreciation only partly offset by rental income the typical investor lost over £15,000 in 2008. In contrast, in 2009 the value of their properties rose 3% while rental income after voids added a further 4.6%.
This meant a typical landlord made a return of £12,740 last year, comprising a modest capital gain of £4,831 on each property plus £7,909 in rental income.
One reason for this is that arrears were significantly lower than predicted. At the end of December a total of 12.5% of rent was unpaid, far less than the seasonal peak in 2008 when 15.9% was late.
Serious arrears were stable, with 1.1% of rent unpaid three months after it was due. This better than expected performance was partly attributable to the high proportion of delayed first-time buyers, who are financially stronger than other tenants.
Landlords have also become aware of the need to be rigorous in their collection of overdue rent. In our recent research among landlords 27% said they plan to grow their portfolios in the next 12 months and 3% expect an expansion of more than 25%. Some 62% plan to sit tight with their current holdings and only 11% intend to reduce their involvement.
But landlords remain constrained by the availability of mortgage finance. Some 49% think now is a good time to buy as property prices are attractive, demand is strong and returns are good. But only 27% intend to buy. Strikingly, the availability of finance is way down the list of reasons encouraging landlords to buy for the simple reason that it is not readily available.
Of course, this leaves investors who can buy without recourse to mortgage finance in a relatively fortunate position, and 31% of landlords told us they do not have mortgages secured on their properties. Indeed, we have seen many opportunistic landlords taking advantage of recent price dips in some areas.
The 69% of landlords who finance their portfolios with mortgages have average loans outstanding equating to 62% of their value, although new acquisitions are likely to be funded by a greater proportion of borrowing than existing ones if finance is available.
One of the casualties of the credit crunch was the buy-to-let mortgage market. This was to an extent the preserve of specialist lenders, many of which have now either retrenched or withdrawn from the market. With buy-to-let typically funded via wholesale markets, when this source of funding dried up the availability of loans to investors became severely restricted.
But buy-to-let is not of its nature a risky type of loan. The lender benefits from three potential sources of repayment – rent, the covenant of the investor and the value of the property.
The relative safety of buy-to-let is reflected in the low level of arrears and repossessions seen in Council of Mortgage Lenders statistics. Figures for Q3 2009 show arrears over three months at 2.2%, down on the two previous quarters, and properties repossessed at just 0.14%. Very low figures.
Indeed, repossession of a buy-to-let property can usually be avoided even if a landlord hits trouble. The lender can appoint an Law of Property Act receiver or a property can be sold on the open market.
The problem arises when property investment clubs and sometimes fraud leads to properties being sold at inflated prices. In these cases an experienced asset and property manager can help lenders work out portfolios to maximise their income stream.
The other potential issue for investors in 2010 is regulation, with the Financial Services Authority’s Mortgage Market Review suggesting this as a possibility.
This is not a straightforward matter – it would make no sense to regulate residential property investment per se although buy-to-let mortgage advice and products could be regulated. In our survey, it is perhaps surprising that most landlords would welcome the regulation of both advice and mortgages.
So the building blocks are there for a significant resurgence in buy-to-let subject to the improved availability of finance. But we would not wish to see a return to excesses in, say, new-build. Property investment must be closely aligned with demand, and both landlords and lenders have a duty to ensure that purchases make sense.
Even with these provisos, growing tenant demand and improving confidence among landlords will generate opportunities in 2010 for existing lenders and new entrants to support investors. Let’s hope it happens.