Review of buy-to-let 2003, and predictions for the coming year

Landlords expect another solid year in 2004, with numbers of properties owned expected to grow at a slightly lower rate than in 2003 – but still a very respectable increase.

A year ago, Paragon Mortgages’ Landlord Buy-to-Let Trends survey showed the average landlord owning 9.0 rental properties, with an expectation that this would grow by 21.0% to 10.9 properties by Q4 2003 – an increase of almost 2 properties. In the event, the average landlord’s portfolio has now risen to 11.3 properties (growth of 2.3 properties) – 25.6% more than a year ago and 3.6% higher than forecast.

Landlords currently forecast that their portfolios will grow by 8.8% over the next year, from 11.3 properties to 12.3 properties by Q4 2004 – an increase of 1 property.

John Heron, managing director of Paragon Mortgages, says: “Buy-to-let is driven by tenant demand, and that demand has been sustained at high levels throughout the year. More and more people have had to wait before buying their first home, as rising house prices have forced them to save longer for a larger deposit. First time buyers have been hit hard, with transactions running at a record low level of around 30% of all purchases. That has led to strong demand for rented accommodation and, with an acute shortage of affordable homes and a contracting public rented sector, private rentals have been doing particularly well.”

“Reflecting landlords’ natural caution as businessmen, they are basing their commercial assumptions on a lower level of growth in 2004. However, the long term demographic and social trends of the UK won’t change from this year to next: we will still have a growing number of households in this country, owner-occupiers will still face affordability and confidence constraints and there will still be fewer homes in this country than we need. Indeed, the initial findings of the Barker Review highlighted the critical shortage of affordable homes in this country. All this means that the private rental sector will continue to be buoyant.”

Landlord rental yields, which have averaged around 7.60% over the past 6 months, are expected by landlords to remain stable over the next 12 months.

With interest rates widely expected to rise further in 2004, what are the potential risks to buy-to-let lending over the coming months?

Many commentators incorrectly assume that buy-to-let is of its nature higher risk than lending to owner-occupiers. John Heron explains: “Some mortgage lenders claim that they avoid buy-to-let because they view it as a riskier area of lending. Frankly, this flies in the face of the facts and the evidence of a now well established track record. In fact, the risk profile is lower on buy-to-let, with arrears at less than half the level of mainstream mortgage lending – 0.45% of buy-to-let loans are 3 months or more in arrears compared with 0.98% of mortgages overall. With a buy-to-let loan, there are three potential sources of repayment – the tenant, the landlord and, in extremis, the property itself. In addition, a landlord with a portfolio of properties won’t be unduly affected if one property is empty, while owner-occupiers who encounter payment difficulties have very limited options.”

Gearing for buy-to-let mortgages are typically lower than for owner-occupiers, with (according to Paragon Mortgages’ survey) average loan-to-value across the typical landlord’s portfolio of 42%. John Heron explains that applying more cautious underwriting criteria than for many owner-occupier loans ensures that landlords will not be squeezed should interest rates rise: “The average rental income on new loans exceeds mortgage payments by a factor of 1.93 times, so even if interest rates do rise a couple of times over the coming year, our landlords will have a substantial cushion. At the same time, rising interest rates would have the likely effect on consumers of discouraging house purchase and encouraging renting, so the astute landlord would often be able to achieve higher yields in response to growing demand for a scarce resource.”

“In summary, 2003 was an excellent year for landlords, who have made a total return of 25.6% on an average property bought 12 months ago – much more than almost any other form of investment has yielded. Will this be repeated in 2004? Maybe not to the same extent, but it’s certain that the astute landlord who understands the dynamics of the private rental business will continue to build his or her portfolio and to benefit from attractive returns over the long term.”