Special feature: Buy-to-Let profitability improves

The index, based on Bank of England, Nationwide and Association of Residential Letting Agents data, calculates the historic returns over 25, 20, 15, 10, and five year periods for a cash buyer or a geared investor with a repayment or an interest-only mortgage selling today.

Although our previous four quarterly indices showed losses over five year investment periods, primarily due to falling property prices, the model highlights what a difference a year can make.

A year ago our five year index was based on a purchase in quarter three 2007 when an average first-time buyer property was £156,634.

Five years later its value had fallen to £138,561, a £18,073 loss, which is an awfully large hit to be recovered over a short period.

Our latest index assumes a purchase in quarter three 2008 when the average value was £140,387 but five years later the value has risen to £142,930 producing a capital gain of £2,543.

If we look a year ahead the value of this property bought in quarter three 2009 was £133,611, four years on its value has already risen by £9,319 and property prices are still rising.

Investing in quarter three 2007 versus quarter three 2008 resulted in a £20,616 difference in capital gain.

Clearly, an understanding of the market and timing are both critical in maximising buy-to-let profitability.

Those investing today really need to be aware of this marketplace volatility. We have done a lot of work in this area and it is one of the factors that really jumps out from the data particularly on shorter investment periods with highly geared investments.

The issue is made more relevant given ARLA’s recent observation that the buy-to-let market has shifted from long-term investors to novice landlords who view property as a short-term investment. The red flags here are "short-term" and "novice".

Interest driving interest

Returning to the index other factors are contributing to improving profitability.

Generally rates are falling. We use a Bank of England monthly combined bank and building society rate and this has dropped by a full one percent over five years. Over the same period rental yields have increased leading to improved margins.

Over the same five years the Bank of England deposit rates we use have halved and are now at 1.72%. This reduces the opportunity costs, the comparative returns from investing the funds elsewhere, and this further increases buy-to-let profitability.

Obviously with savings rates at a nine-year low many investors are looking to buy-to-let.

Predicting future profitability

So what will happen to property prices and interest rates over the next five years?

We have been working on regional indices which we think may be helpful in better understanding the hyper-valued London market in relation to the regions.

London Central Portfolio said prices would have to fall by 54% to match price-to-income ratios elsewhere, while Knight Frank state that three quarters of new builds in the capital are sold overseas, off-plan, before they have even been advertised in the UK.

So London prices are less dependent on London incomes at least on new builds.

Taking the UK as a whole, the Money Advice Service reported that nine million more adults are struggling with money compared to seven years ago and the Chartered Institute of Housing said that overpriced property is choking economic recovery.

However many pundits believe that the Funding for Lending Scheme and Help to Buy may cause another property price bubble. This is against a backdrop of builders, lenders and estate agents all reporting that business is booming at the moment.

It is very difficult to reconcile the conflicting realities of optimistic providers including buy-to-let investors and over-extended consumers to predict the future.

Instead The Model Works has published a downloadable beta model on its website to allow investors to enter their own projections and read off the results.