1 November 2004

Has the stall in the housing market put paid to the rush into buying-to-let?

Turnaround and recovery specialist Nick Hancock, partner at our Manchester office and advisor to numerous institutional lenders on property investment and matters, peers into his crystal ball.

The buoyancy of the UK housing market as a whole rests heavily on the buy-to-let sector, with an estimated 10-15% of all residential property transactions being carried out by investment landlords.

However, commentators are suggesting that investing in the buy-to-let market may no longer be an attractive proposition. Rental yields are falling as low as 1% of property values, after costs. With house price inflation set to stall, property doesn't appear to be as attractive an investment as it has been over the last few years, at face value.

If house price growth stalls under pressure from low rental yields, investors may find that they can achieve a greater return from a building society account, with neither the risk nor the hassle.

It follows that if they cash in their gains, it will lead to a rise in the supply of investment property at a time when demand is falling. This could be sufficient to trigger an across-the-board fall in prices in the housing market. Some commentators are suggesting a fall in values of as much as 30%.

Is it all doom and gloom?

Does this mean doom and gloom for all property owners, particularly those in the often heavily geared buy-to-let sector?

It should be remembered that property has been one of the best performing assets over the long term and even in the short term, we have seen property price increases across the UK of 15.6% last year and 25.3% the year before. Even a 30% fall would only bring prices back to the level they were in June 2002.

Interest rates are now at a 40-year low, and even if they are set to rise a little higher, they still remain historically low. This provides for an interesting environment for investing in the property market.

Rather than predict doom and gloom for all buy-to-lets, it is probably fair to say that the current market will see some losers, but also winners.

The buy-to-let market has expanded rapidly over the last five years. Much of the increase has been from ‘first time' landlords who have entered the market for easy pickings, not only from rental income but through the huge capital appreciation in property prices.

Despite these recent benefits, there are many aspects of the buy-to-let market where even the experienced landlord can encounter problems.

Potential pitfalls

In a rising market, there is huge demand for ‘any' property - not necessarily the ‘right' property. Sometimes the old adage of ‘location, location, location' is forgotten. In a falling market, properties that aren't in the ‘right location' fall the fastest and the furthest.

Our experience in the present market is that in some areas prices appear unsustainable for investment purposes, with low yields, an abundant supply and too few tenants. However, there are other areas where demand is strong and property prices are increasing.

So for both the experienced landlord and the first time buy-to-let investor the key issues remain unchanged. Finding the right type of property (not easy), paying the right price and getting a sufficient rental to pay the mortgage.

Landlords must always consider what happens if suitable tenants can't be found for several months? They must be in a position to maintain the mortgage payments and also need to be aware of their legal options if a tenant refuses to pay the rent. These pitfalls can be mitigated provided the investor has done his homework, taken the right advice and planned his acquisition properly.

At the present time property is an uncertain market. It appears that property prices are reflecting higher interest rates and will fall further on the expectation that interest rates will increase. According to various surveys and reports, parts of the country have recently experienced falling prices.

That said, the Bank of England has said that it doesn't want to increase the base rate in the near future. We are told that it is likely to peak at around 5.25%, probably some time in early 2005. The only real uncertainty is the reaction of the housing market. If house prices continue to defy present interest rate rises, the Bank of England has indicated base rate will have to be increased again.

So what's in store for the future?

So has the buy-to-let bubble burst, never to return again? Well, yes and no. For those looking for large short-term gains, yes - for those with a longer-term view, no.

Property investment should always be seen in the long term. Investors should look at a 10-year investment term, at least. A decade from now we will have weathered the current interest cycle and probably be into the next one. My view is that the property market is more likely to be skewed by the state of the economy and the direction that it's taking than interest rate fluctuations.

There are numerous ‘professional' landlords in the market who have kept their powder dry over the last few years. In their view, the rising prices were unsustainable and many have simply retained their existing portfolios and only added to them very selectively. When the market falls, these investors will be ready to pounce.

It is possible that these investors will cushion any possible fall in the market in those areas with sustainable investment opportunities.

To support the property market, first and foremost, we need an economy that is growing through real job creation and real economic activity, as opposed to artificially created growth fuelled by high public spending.

The answer, in my crystal ball, lies in our economic prospects. If you think the economy is strong enough to continue growing, by all means buy into buy-to-let.

If not, don't.

For more information on our Property Sector visit our Sectors area

Nick Hancock