I predicted a crunch in the Buy-To-Let market almost two years ago, but now that the blood is flowing in the streets and the newspaper headlines are screaming doom, I am on the verge of becoming optimistic.
In fact I think BTL investors will save the housing market from the pessimists’ doomsday scenario. One of the reasons for the BTL crash was the activity of the investment clubs. One of the biggest promoters of this type of investing, Inside Track, folded this week and went into administration.
Every week sees new reports in the press of auction sales at knock-down prices of flats originally bought ‘off-plan’ by new BTL investors on dodgy mortgages at inflated valuations. This is pretty much what I predicted two years ago.
New build flats are the main disaster area
By the end of 2007, the biggest category of properties repossessed by lenders being sold at auction were BTL flats.
And analysts have warned that in cities like Manchester, Nottingham and Leeds there are still lots of flats nearing completion at a time when there’s already a surplus. But developers are canning new developments, so we can be sure the supply of new-build will dry up over the next 12 months.
But the picture isn’t as gloomy as all that. Rents are still rising, though more slowly than a couple of years ago. And the proportion of BTL mortgages in arrears is actually lower than that on homeowner mortgages. So far, there’s no meltdown.
A big chunk of the BTL market is landlords owing ten or more properties, and the ones failing or bailing out are typically more recent entrants to the market owning just one or two properties.
Little credit and lower prices are great news for landlords
According to the biggest mortgage lender Paragon, BTL rental yields now average 6.3%, up from under 6% a year ago.
With the number of first-time buyers plunging to 10-year lows, there’s more demand for rental properties, and that will be good for landlords unless or until there really is a recession and unemployment rises significantly.
The evidence to date suggests that BTL mortgage lending has fallen less than homeowner loans, and for landlords with 75% or better Loan-To-Value ratios, refinancing shouldn’t be a problem at about 6%.
But the real question is about yield. What is the right yield for BTL? Until the boom started in 2002, BTL yields were 7-8%. If you assume 10% voids and 2% annual maintenance and insurance costs, then a gross yield of 7% gives you a yield of 4.3% before allowing for financing.
Yields will tell you when it’s time to buy to let
Because financing improves net after-tax yields, professional landlords will always use it, but the numbers have to stack up assuming outright purchase. This suggests that 8% is a more realistic figure for long-term gross rental yields, though of course valuations also depend on the prospects for rises in rental income.
In many parts of the country, BTL gross rental yields of over 7% are attainable. In the South-East, average yields are lower, but given population pressures and the lower likelihood of voids, this is justifiable.
So the scenario I expect over the next 12 months is that prices of new-build flats will continue to fall until they reach a sensible relationship with old-build. Recent off-plan flat purchasers will continue to be repossessed or bail out, so a lot of this stuff will be sold at auction and there will be plenty more doomy headlines. But professional BTL investors will be happy to snap these properties up if they can secure rental yields of 7% or more.
Without unemployment the position should improve next year
The big unknown is how much damage the mortgage famine will inflict on the homeowner market. If the latest Bank of England ‘bond aid’ plan works, the mortgage market will gradually return to normality, but that won’t happen until late summer at the earliest, so things could be very sticky over the summer, with fewer properties being sold and the market effectively being frozen.
While there’s a danger of that causing a downward spiral – some analysts are predicting a 30% fall in prices over the next two years – this still seems unlikely unless the economic scenario worsens more than anyone expects.
Even lower GDP growth of under 1% for the next year or two won’t create 1990s-style (let alone 1980s-style) unemployment, so my view remains that only a major worsening of the economy could produce a big property slump.
That’s why I think the next year will be a good time to look for opportunities to become a BTL investor.
