The buy-to-let (BTL) market is celebrating its 10th anniversary in style. This sector is now worth an eye-watering £83.9 billion and represents 8 per cent of all mortgage lending.
But what next for the BTL
market, which will see the introduction of the tenancy deposit scheme in April 2007, possible further Bank of England Base Rate rises, and effects of houses in multiple occupation (HMO) licensing? The CML’s director-general, Michael Coogan, believes the latest Base Rate increase is likely to slow down the growth in BTL investment in the coming months but that the rental market remains fundamentally sound and is likely to continue to offer good long-term prospects for astute investors. This is a prediction that Rooftop happily concurs with and we believe that equally astute lenders can help realise the market’s full potential.
A different persective
It is important not to overlook the fact that the phenomenal growth in the BTL market in recent times demonstrates a different perspective on what this investment now offers. One possible contributing factor is that, traditionally, BTL was seen as an income-providing investment with the attractive bonus of longer-term capital growth. But this view has shifted and many more now see it as a capital play with any income being regarded as an additional benefit rather than an intrinsic fundamental element. In the past, lenders have relied on rental income from BTL investments to demonstrate a borrower’s ability to service the debt. But the market has shifted and providers of BTL mortgages are now starting to respond accordingly.
Back in 1996, the Association of Residential Letting Agents (ARLA) and a handful of lenders launched a new type of mortgage for individuals wishing to take advantage of opportunities offered by the new assured shorthold tenancy agreements. Investors at this time looked to BTL as either a way of immediately putting capital to work to generate income or as a way of creating a nest egg for their long-term future. This was very much an either/or situation. But now there is a growing number of BTL portfolios being put together by investors who are looking for a combination of both, people who are seeking long-term capital appreciation as well as income from the rental.
The concerns over the performance of pension funds has led many to consider investing in residential property and being prepared to service the debt if there are periods of rental voids in place of making regular pension payments. That, combined with increasing workforce mobility, the plight of first-time buyers, immigration factors and demographics of single person households putting increased demand on housing provision are additional factors driving the BTL boom.
While the BTL market continues to offer an attractive opportunity, there are the usual health warnings to those entering the market for the first time, including void rental periods and costs of property maintenance that must be accounted for in the investment decision.
Supply and demand
Thanks mostly to the exceptional boom in the rental sector in recent years, you only have to look at how much the balance between supply and demand has been dramatically skewed compared with 20 years ago.
A further consideration for the BTL investor is the fact that compared with rented accommodation in the early 1980s health and safety, as well as tenant, expectations on furnishings and finishes have risen significantly.
In the past, let accommodation was often poorly furnished and equipped compared with today. If the effect of inflation is combined with the extra money spent on interiors, the landlord’s annual net rental surplus may even have gone down, pro rata, in the last 20 years. Tenants expect a higher standard of fixtures, fittings, décor and white goods. Smoke alarms, rewiring, reliable and safe heating, and hot water systems will all require investment to attract quality tenants and protect the landlord from liability caused by defect. A landlord could even be jailed for causing the death of a tenant from carbon monoxide poisoning emanating from an unsafe gas fire.
Rental income does, of course, play an important part in the success of any BTL investment, especially if the purchase is being funded by a mortgage and there is a substantial debt to service. This is even more important if the investor wants to make capital repayments in order to pay down the mortgage quickly. But without making capital growth a key priority, many private landlords may be disappointed by the overall return, even over the longer-term. As with any major investment, speculators need to carefully assess their motives for investing.
Runaway success
It is not just the quality of the furniture in rented property that has seen a turn for the better. BTL mortgages and the market itself have undergone, and continue to undergo, a dramatic makeover.
Today’s BTL market is no longer the niche area of the mortgage industry it once was. The sector has grown from a handful of specialist lenders offering one or two products to more than 70 lenders offering literally thousands of products. The result is that BTL is now very much a mainstream offering of most lenders and while it is an area that is forecast for further growth, intense competition means lenders wishing to gain market share need to be on top of their game in terms of product innovation, design and distribution.
One growing trend that canny lenders are spotting is the increasing number of potential and existing investors looking for stand alone capital appreciation. For these investors, who are often prepared to cover any mortgage payments during rental void periods themselves, the traditional BTL mortgage – which requires proof of rent that covers the mortgage payments by at least 100 per cent, and as high as 130 per cent – is not the most appropriate product. Professional investors, and their lenders, are increasingly taking a ‘whole portfolio’ perspective so the void on a property by property basis becomes less relevant. Providing the combined incomes supply sufficient funds to service the debt across the portfolio the landlord, and the mortgage lender, can take a more relaxed stance than if the borrower is reliant on one tenant to service one repayment.
Rental cover can be particularly difficult to achieve in areas such as central London because of the high levels of borrowing required to meet the property cost. Not being able to prove the income stream – particularly when the property is being purchased for capital growth and not just for rental income – has proved to be a large stumbling block for a good number of mortgage applicants in the past.
The challenge for the industry going forward will be to make sure that this new breed of borrower is fully catered for through propositions that do not require investors to prove they can cover the mortgage payment simply by using rental income.
To meet this new market’s needs, lenders could choose to take a different view on their assessment of investors and their ability to service their debt repayments. Rooftop, for example, now places higher emphasis on the property investment and management experience of individual landlords. Our own experience tells us that if property investors can demonstrate that they have successfully managed three or more properties, and made all mortgage payments on them, then this is a better indicator of credit risk than a piece of paper confirming rental income.
The industry’s ability to react and adapt quickly to new trends is one of the main reasons the BTL sector has continued to develop and grow at the pace it has. Lenders – whether they be the latest raft of new entrants or the more established players – are doing their part to help the buy to let market flourish. Most notably the ones who have the wherewithal to read the market accurately and the conviction to respond when it shifts. This includes lenders reviewing entrenched risk assessment methods without increasing their overall exposure and Rooftop’s BTL portfolio product is a case in point. By focusing on the portfolio, landlord’s property management experience rather than some arbitrary rental cover percentage, our product reflects the trends in the market and the way it is developing.
