A return to the stone age?

As the fallout from the ‘credit crunch’ and the Northern Rock debacle continues to make waves, the risk profile of lenders’ mortgage books comes under increasing scrutiny. Even the Chancellor of the Exchequer has stepped in to call for financial institutions to go back to ‘good old fashioned banking’.

I must take issue with Darling’s implication that the UK financial services industry as a whole is failing to assess risk effectively and price accordingly. The fact is that, while the ready availability of funds and the steadily upward trend of house prices may have created pressure to ease lending criteria, the UK mortgage market is categorically not riddled with irresponsible lending.

Buy-to-let (BTL), for example, is an area of the market where credit quality remains consistently strong.

No decline in quality

Latest data from the Council of Mortgage Lenders shows BTL mortgage arrears at consistently lower levels than the wider market. Accounts more than three months overdue stood at 0.63 per cent, compared with 1.06 per cent in the market overall. Even more important, there has been no significant deterioration in BTL lending quality, unlike other parts of the mortgage market. Arrears were marginally up on end 2006 levels, but were lower than one or two years ago.

There are good reasons why BTL consistently outperforms the wider mortgage market’s credit profile. The bulk of holdings in the private rented sector is held by professional landlords with substantial portfolios. Average gearing across these portfolios is less than 40 per cent, so rental income covers mortgage payments very comfortably.

These investors are financially sophisticated, with a cross-section of other investments (equities, bonds, cash savings as well as property) and often have a ‘day job’ too. That means they can, if need be, cover any temporary shortfalls on one particular property from another source of income.

Furthermore, in the event that a landlord encounters some financial pressure, they will generally sell the property voluntarily rather than wait for the lender to foreclose. However, most landlords are in BTL for the long term, with the average holding being 16 years, and have proven to be fully prepared to ride out any fluctuations in the market.

Buoyed by demand

The BTL market is also being buoyed by soaring levels of rental demand. The Royal Institution of Chartered Surveyors (RICS) recently reported that rents are growing at record levels, with surveyors noting a surge in demand. RICS’ data was supported by the Association of Residential Letting Agents, whose quarterly survey showed that tenant demand outstripped supply in all areas of the rental market.

In the current housing market, this makes perfect sense. First-time buyers are deferring house purchase, while those actually in the process of buying a property are questioning whether it is the correct decision for the present. In addition, you have the people who are deciding to sell their property at what they believe is the top of the housing market, banking the profits and renting.

When you add these groups into the already highly competitive rental market, competing with first-jobbers, students and immigrants, it’s easy to see that there is a solid platform for rental income in the residential market. As the impact of this year’s interest rate rises continues to filter through to consumers’ pockets, we should see that demand for rented property grow even further.


In the final analysis, it must be remembered that BTL has counter-cyclical characteristics, meaning that when prospective home buyers step back from purchasing, investors step forward to acquire properties at good value prices that can be rented to those same people who would, in other circumstances, have purchased.

Tellingly, the period when the private rented sector saw the strongest growth was not, as some people might guess, the past five years or so, but rather than early part of the 1990s, coinciding with the housing market crash precipitated by sky-high interest rates and a loss of confidence. People could not or chose not to buy, and needed a roof over their heads – so they rented.

Today, none of the contributory factors of that crash are present, but we are seeing a slowdown in the market. Like in the last market blip in 2004, investors are stepping up and investing, confident in the knowledge that tenant demand will continue unabated on the back of growing household numbers, prompted by changing demographics, inward migration, growth in the student population as well as the deferral of first-time purchase.

In a housing market that has seen soaring prices across the country, a slowdown could provide some welcome relief for the BTL landlord, enabling yields to edge up and slackening the pricing pressure when adding new property to a portfolio.

With these dynamics, BTL looks set to continue to outperform the credit quality of the wider mortgage market.

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