Is Buy-To-Let Still a Good Investment?
Anthony Rommens
16-Oct-06
This month instead of looking at an industry that involves small business equity investments, we explore Buy-to-Let property. This article should appeal to a wide range of investors who have small or big interests in the rental property markets. We will answer the following basic questions; “What is ‘Buy-to-Let’?”, “What are the advantages and disadvantages?” and “Is it still a good area to invest?”
‘Buy-to-Let’ is a concept regarding Property that refers to an investment strategy of purchasing residential property in order to rent it out at a profit.
It is also referred to as the type of mortgage used to buy a property for the purpose of letting. The general sector has been popular for years now and it is constantly growing in popularity with investors.
Over the last decade the increased demand for property investors to ‘buy and let’ property for a profit has given rise to the term, Buyto- Let (BTL). Mortgage lenders have been keen to take advantage of this trend and have created special lending agreements, known as Buy-to-Let Mortgages or BTL Mortgages to enable this type of investing to grow in popularity, especially with new property investors.
The interest rates charged on BTL Mortgages are close to normal residential mortgages but on average tend to be a little higher and have higher fees than the residential mortgages. The reason for the small difference is the perception that Buy-to-Let lending represents a greater risk than owner dwelling mortgages.
TAX ADVANTAGES
Despite higher costs of borrowing, there are significant tax advantages for Buy-to-Let investors. This has been the reason for BTL financing to become popular in recent years. The advantage is that landlords may deduct costs from their taxable rent income. Rent income is viewed the same as salary by the government, it gets taxed at around 22% and even up to 44%. The Income deductibles for specific BTL mortgages include interest and maintenance expenses. Thus being able to reduce rent income with such expenses makes the BLT mortgages very attractive to many investors.
LENDING AMOUNTS
Buy-to-Let Mortgages are designed for people to borrow money to buy property for private rentals in order to lease out to tenants. There are various approaches by lenders based on the various cash flows that can pay for the property;
- Rental Income: Some lenders allow the amount of money to borrow be determined by the rental valuation of a property. The yearly renting income needs to cover a specified amount of the mortgage repayment, usually being about 1.2 to 1.5 times. The reason for the high multiple figure is to pay for maintenance expenses and times when there are no tenants renting.
- Salary & Rental Income: A straight three times the amount of an investor’s salary plus one half the income from property rental can also be used to calculate how much one is qualified to borrow.
- Mortgage Payment less Salary Income &a,p; Deduction Multiple: This type of lending determination is based on both Investors personal income and the existing loan commitments, but then a ‘deduction’ is applied to calculate the maximum borrowing amount. Normally under this calculation, it is the annual mortgage payment (at a set level of interest) less Investor annual income then multiplied by 3.5 times (or whatever multiple). For example; An investor earns £400,000 per annum and the outstanding mortgage on a current property is £1,200,000. The calculation of annual mortgage repayment (with the set interest level) might be calculated as £100,000. This annual mortgage repayment amount would be then deducted from annual salary to obtain £300,000. That amount would be multiplied by 3.5 to give the maximum amount that can be borrowed which is £1,050,000.
RISK & BENEFITS
There are both risks and benefits to the Buy-to-Let investing strategy for investors. Significant risk exists in having to pay monthly mortgage payments regardless of possibly not being able to collect rent for every day of the year. Another major risk factor is that property might not continue to appreciate like it has in the past and could actually fall in value. Benefits include a stable income, tax savings and extra profit from property appreciation.
Over the last ten years ’Buy-to- Let’ investing has outperformed both the gold and stock markets. It continues to grow in popularity. This leads to us ask the question, “How long will the good times last?”
To understand this type of investing, we need to look at its background and by doing so may be able to extrapolate our own conclusions.
TREND BACKGROUND
It all basically started in 1988 when changes to the Housing Act made it much easier for Landlords to remove tenants. These, among other landlord friendly legislation changes, made it much more attractive for many property investors to become landlords.
The Assured Shorthold Tenancy (AST) and other smaller agreement changes provided major reforms to tenancy agreements and really created widespread popularity for landlord property investment.
AST in particular provides both the tenant and landlord assurance of tenancy and is specific about the term that a property is to be rented. It also specifies the notice period for both renter and property owner landlord. Falling house prices from 1990 to 1994 also saw an increase of citizens to lose their homes through repossessions. As a result many of these people became new renters and entered the house letting market as customers.
AGENTS
In 1995, the Association of Residential Letting Agents (ARLA) popularised ‘Buy-to- Let’ as a marketing term for special financing although this type of lending had previously existed. ARLA is well known in the UK by tenants and landlords. Both groups recognise that agents with ARLA membership represent high quality professionals.
ARLA does a survey each quarter of residential landlords to check their views of the actual market. Last year (2005) many showed good commitment to their residential letting investments. Most owners revealed that they will hold their investments even if prices fall. Over half plan to hold property for ten or more years. Many also revealed that they hope to invest in more BTL properties in the near future. The average life of property investment is 16 years. See www.arla.co.uk
LENDERS
The Council of Mortgage Lenders (CML) began collecting statistics in 1997 on ‘Buy-to-Let’. CML is the industry body that represents 98% of UK mortgages and the members are made up of specialist lenders, building societies and banks. See www.cml.org.uk
Some interpreters of the statistical information say that there has been such a growth in BTL mortgages that there is a boom situation. The Council of Mortgage Lenders info however only deals with the growth of specialist BTL lenders and omits the overall residential loans to property investors by regular lenders. In close inspection of overall numbers, It is clear that the growth of Buy-to-Let lending is caused by these lenders taking market share away from traditional mortgage lenders. Most of the new mortgaging for BTL, (up to 40%, has occurred) when established, property investors change from the more expensive commercial mortgages.
Despite the popularity of the Buy-to-Let market, the private residential rental field still has room to grow. There is only about 20% of total properties mortgaged. There is massive potential remaining for expansion in BTL housing.
SECTOR MAKE UP
The Private Landlords Survey (in the English House Condition Survey) from the Office of the Deputy Prime Minister is the most thorough study of the private rental market. The study is done every four years and shows the changing make up of ownership in the private rent sector.
The Buy-to-Let sector is made up of both experienced investors and new property investors. The press overall tends to describe newer investors as amateurs who have little chance of making profits. In reality however this is not the case. Many are doing well letting properties and are making gains on increasing property values.
The Office of the Deputy Prime Minister suggests that there has been a large growth in the number of small sized landlords. These small landlords have less than four properties. However, the BTL sector is still overall largely made up of professionals. These are landlords with large property portfolios.
There are views that that investing in Buy-to-Let housing is less risky than professionally managed equity based investing. Small investors even tend to see BTL as an alternative investment to pensions especially when considering the negative publicity that pension investments have recently received. The logic behind all of this is a decade of steady rental incomes, rising house prices, and general perception of overall lower risk.
Many small landlords are smart investors who use Buy-to-Let as an alternative to pensions or even to provide for their retirement. This could be seen as being a very risky strategy especially if property prices decrease or fall as they have occasionally in the past. No one is ever sure of what will happen to property markets in the future.
CONCLUSION
Despite the entire sector’s growth and press warnings of property crashes, provided that home values remain consistent, the private rental business has still more room for new players and more investment.
Buy-to-Let has been proven to be a sound investment strategy over the last ten years. Obviously, one should avoid relying on it 100% as a retirement strategy. For personal investing, there needs to be some type of balance with other investments for common sense dictates not to rely on just one sector. It is always best to have diversified investment eggs in your basket.
