When the government announced in September that it was being forced to nationalise Bradford & Bingley, many commentators took the announcement as sounding the death knell for the buy-to-let market.
B&B’s Mortgage Express subsidiary was one of the biggest lenders in the sector and when it pulled its range of products choice for buy-to-let investors was drastically reduced.
That was just the latest blow for landlords, as other lenders, including NatWest and Bristol & West also withdrew a number of competitive loans.
Due to the lack of liquidity caused by the credit crunch and a drop in house prices of 12.4 per cent over the year, according to Nationwide Building Society, many major lenders are shying away from buy-to-let.
After the boom years, when rental yields soared, some landlords are now struggling to generate enough from tenants to cover their mortgage. The IPD Residential Index found that net yields were down to 3 per cent in the UK last year from 4.4 per cent in 2002. For investors borrowing at a rate approaching 7 per cent, and stomaching falling capital values as well, buy-to-let is clearly not good business at the moment.
The current market conditions are of particular concern to the millions of borrowers coming to the end of their cheap fixed-rate deals and being forced onto higher interest loans or their lender’s standard variable rate.
Louise Cuming, head of mortgages at comparison site Moneysupermarket.com, says: “House prices are falling and landlords are likely to be hit particularly hard by this. Rental yields are being squeezed as it is and falling values will only make things worse.”
Landlords tend to mortgage to as high a loan-to-value as possible because the higher debt attracts tax relief, according to Katie Tucker, technical manager at Mortgageforce. However, the tax relief may not be enough to cover the expense of increased monthly repayments.
A landlord who took out a two-year fixed deal of around 5.29 per cent in spring 2007 on a £150,000 loan will be used to paying £661 interest per month. If they revert to their lender’s SVR their interest payments alone will be pushed to around £875.
Tucker warns: “Many landlords won’t have seen sufficient rent increases, and those with multiple properties or larger loans who can’t find a cheap enough remortgage could be forced to choose between subsidising from their own income, raising risky capital from their own homes, or selling.”
As well as higher mortgage repayments, landlords have a number of additional costs and responsibilities, that other investors do not face.
For example, boilers break down and can costs thousands of pounds to repair, every time a tenant moves out the cost of wear and tear becomes clear and cleaning bills mount up.
Unless a landlord is in the rental business full-time, they will want to employ an agent to manage the property. Generally, they will take around 15 to 20 per cent of the rental income a month. Most agents will also charge a fee for renewing contracts with tenants.
In such tough times, investors with a small portfolio of properties are considering selling-up and putting their money elsewhere – often in cash while they wait to see where the next investment opportunity will arise.
While a number of IFAs view this as a wise option, there are a number of factors to consider before deciding if it makes good business sense. A key issue is the 18 per cent capital gains tax (CGT) that will be paid on any profit when a buy-to-let property is sold.
Ken Taylor, director of Mackenzie Taylor Wealth, says: “Residential property prices are set to fall much further in the coming months, as more and more buy-to-let properties hit the market.”
Although Taylor believes, like the majority of commentators, that significant Bank of England base rate cuts are on the cards in the coming months, following the 0.5 per cent reduction in October, he warns there is no guarantee lenders will pass these on to borrowers.
He adds: “For those investors who can do so, I would be thinking of selling and initially holding the proceeds in cash – as securely as possible.”
Many buy-to-let investors have put some of their money in property as part of their planning for retirement, but Taylor advises that this could be a good time to rethink such plans.
“There is likely to be a phenomenal buying opportunity opening in equities before too long, so there is a real chance for people to rethink their retirement strategy altogether,” he explains.
He is also concerned that too many inexperienced investors have dabbled in buy-to let and have no other form of pension savings. In his opinion, they should diversify into more liquid assets, such as collectives or shares within a pension arrangement which will not incur CGT on disposal.
Tax is indeed one of the major considerations in deciding whether to stay in buy-to-let or move into other investment areas, such as equities, and the odds seem to stack against property in this respect, especially if inheritance tax planning is an issue.
Graeme Forbes, director at Intelligent Capital, a firm of chartered financial planners, points out that having a buy-to-let investment in an estate can prove costly. When someone dies the property, less the value of any borrowings, could be taxed at 40 per cent. If IHT is a consideration, a pension is likely to be a better option.
He says: “In a pension plan, capital gains are tax-free and if the member dies before starting to draw the pension then the entire value of the fund sits outside of the estate for IHT purposes.”
If someone generates cash from the sale of a buy-to-let property and that money is then paid into a pension the government will top the amount up by basic rate equivalent tax-relief. And since contribution rules were relaxed in 2006 it is now feasible and potentially attractive for higher earners to put significant chunks of the equity from buy-to-let properties into their pensions, and gain 40 per cent tax relief into the bargain. What’s more, from age 50, or 55 from 2010, 25 per cent of the fund is available as a tax-free lump sum.
While it seems that the majority of IFAs would recommend clients sell their residential property, it can be difficult to find somewhere to put the proceeds in the current recessionary economic climate.
If an investor has a particularly lucrative buy-to-let investment in a relatively recession-proof area, such as a student town, it may be worthwhile holding on to as part of a diversified portfolio.
According to a poll by the Property Investor Show, Nottingham, Durham, Manchester, Hull and Bangor are the best student towns in which to own rental property.
In Edinburgh, where house prices have held up during the credit crunch, some landlords will be able to increase rent by 50 per cent over the next year as tenant demand increases, according to David Alexander, owner of rental agency DJ Alexander.
And figures from Your Move, a letting agent, have revealed that demand for rented accommodation has risen by 50 per cent over the past year. This is largely a result of potential first-time buyers not being able to get on the housing ladder as lenders demand higher deposits than before.
In September alone the number of new lettings Your Move arranged jumped by 4.3 per cent and it said it was seeing the strongest tenant demand ever.
Therefore, if an investor is fortunate enough to be mortgage-free or has a property in an area hit particularly hard by the drop in prices where it will be difficult to command a decent selling price they should consider keeping their property.
The outlook is not entirely gloomy, as Simon Gordon, head of communications at the National Landlords Association, says: “For the cautious and mature investor who has bought the right property in the right location, they will be seeing an increase in rents and can expect demand to keep climbing.”
Landlords sitting on cash could also consider taking advantage of sellers who are desperate to get rid of their property, often because they are caught up in a chain.
Whether to sell-up or stay in residential property really depends on individual circumstances, how close to retirement an investor is and the location of the property.
While demand for rented property is high in certain locations, competitive buy-to-let mortgage deals are hard to find and yields are declining – providing compelling reasons why now could be a good time to cut and run.
The case for staying put
Despite the gloom in the sector, the mortgage industry believes there are good reasons to stay in buy-to-let. Here the Council of Mortgage Lenders, the industry trade body, explains why it thinks buy-to-let can still be a worthwhile investment.
“Some commentators have been quick to interpret recent developments, including the nationalisation of Bradford & Bingley, as signalling the death of the buy-to-let market. Perhaps this is not surprising, given current market and media sentiment, but it is wrong. Buy-to-let remains underpinned by strong market fundamentals that will not change.
“In the immediate aftermath of nationalisation, some lenders raised rates on buy-to-let products. But we have seen the same thing happen in the mainstream mortgage market at other times during the credit crunch.
“The reality is that pockets of difficulty will arise for particular types of property – some newly built flats, for example – to which amateur landlords may have been attracted. But the scale of the problems should not be overstated.”