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Landlords ride out the downturn

Created:
28 April 2008
Written by:
Faith Glasgow

In recent years, many inexperienced buy-to-let landlords have bought overvalued property, often flats in large new-build blocks that have proved difficult to let. For the sums to work, these landlords were relying on the promise of what has proved to be an unrealistically high rental income.

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Now they are staring into the abyss: on the one hand, rising mortgage costs and the disappearance of cheap remortgage deals are making it even harder for them to cover their costs through rental income alone, while, on the other hand, property values are tumbling below the prices paid, trapping them in negative equity.

Fears have also been voiced that small landlords facing falling capital values would decide to take the profits of recent years' strong price rises and leave the market, or simply panic and dump their properties on the market - either way further depressing property prices.

Digging in

But evidence on the ground suggests that, while speculative investors and some private landlords may be trying to get out, the great majority intend to remain in the market and ride out the downturn.

According to the review and index for the first quarter of 2008 produced by the Association of Residential Letting Agents (Arla): "Nine out of 10 investment landlords continue to state that they have no intention of selling their investment properties, should house prices fall. This majority proportion is virtually unchanged on the last quarter."

That's perhaps not so surprising, given that 80 per cent of the UK's private rental stock is owned by just 16 per cent of large landlords, according to the government's latest English House Condition Survey. Professionals with multiple portfolios built up over the years are relatively untroubled, and indeed "have weathered tougher storms" in the past, according to Steven Hilton of the National Landlords' Association (NLA).

They are not too worried about dips in the property market because they have already built up substantial capital gains within their portfolios. They tend to have strong ongoing relationships with their mortgage lenders, too, so they are able to get funding if they want to restructure or add to their holdings.

Small landlords may be more vulnerable, for instance if they borrowed most (or even all) of the cost of the property and cannot remortgage, or if they bought in an area of oversupply and rents do not cover the mortgage. But Arla spokesman Malcolm Harrison emphasises that most small landlords are doing okay because they are inherently cautious investors. Arla's data indicates that less than a quarter of landlords have loans to value (LTV) of more than 75 per cent, and the average is under 60 per cent.

And, adds Mr Harrison, most buy for the long term, holding their properties on average around 17 years. "Those with one or a handful of properties think of them as a pension or savings plan," he says. They want the property to cover its own costs, but their investment aims are focused on the long-term capital appreciation available.

"There may be some belt-tightening necessary if they have to get a new mortgage at a higher rate - profits could be eroded, and some landlords might even have to supplement the rent with other income to cover monthly payments," agrees Mr Hilton at the NLA. "But I guess most will take a long-term view and weather it.

"Vulnerability is not to do with the size of landlords' portfolios so much as their attitude." He points out that the casualties are likely to be the speculative investors who bought into "riverside schemes in northern cities" a couple of years ago (in many cases having been seduced by property clubs promising sure-fire returns). They borrowed almost the whole value of the property using the high LTV mortgages that have since evaporated from the market, charged high rents, and are now short on tenants and struggling to renew their mortgage deals.

New build is vulnerable, though

Hilton's view is supported by the results of a survey of 12 major cities conducted by property market data analyst Hometrack, highlighting the differences in rental increases according to location within the UK. Particular difficulties are faced by those who have invested in central developments in certain cities where an oversupply of new-build residential schemes is pushing both prices and rental income down. Liverpool and Nottingham, for instance, have seen rents fall by 2 or 3 per cent over the year to the first quarter of 2008.

Yet landlords in Manchester, Birmingham, Oxford and Cambridge have all enjoyed average rent rises in double digits over the past year. The survey found a 9.6 per cent increase in rents from the first quarter of 2007 to the first quarter of 2008. Other sources report even bigger increases in rent levels. According to data from specialist lender Paragon Mortgages, for example, rents rose 15 per cent over the year to March 2008.

Demographics offer support

In general, pressures on the UK rental market as a whole continue to work in landlords' favour. In part, rent levels are being pushed upward by demand from people who would otherwise have bought but prefer to stay out of the market in the current uncertainty; they may hope that prices fall further or that mortgage availability will improve.

So far, there has not been a huge slump in average property values; the March Halifax house price index shows that they are still marginally higher than they were a year ago. But, says John Heron, chairman of Paragon, this change in consumer sentiment towards the owner-occupier market has had a marked effect on the rental market.

Because the private rented sector is not huge - totalling around 2m dwellings - and people tend to stay in their rented accommodation for around 18 months on average, the pressure on the rental market is likely to continue to grow through 2008, says Mr Heron. He forecasts "probably the fastest increases in rent since the early 1990s". Richard Donnell, head of research at Hometrack, is somewhat less bullish, but he suggests rents could rise by 4-5 per cent this year as a result of increased demand.

There are other, more fundamental imbalances supporting rental growth. Despite the market correction, says Mr Heron, "the UK housing market continues to have a serious excess of demand over supply, bolstered by inward migration, by demographics such as the trend towards smaller households, and by a growing student population. None of those factors has gone away."

The combination of a strong rental market plus the opportunity to pick up new properties at good prices in this buyers' market are two good reasons why established landlords are unlikely to leave the market. Indeed, as Richard Donnell says: "Cash flow, in the shape of rental income, is king at the moment, so landlords are busy streamlining their portfolios, minimising the risk of void periods by taking profits on any properties that have proved hard to let, and reinvesting where they have had most rental success."

Spots to watch

Mr Donnell suggests that landlords looking to enter or re-enter the current soft market should avoid new-build properties because of the risk of oversupply. Crucially, they should look in areas with strong economies where the gap is greatest between average rents and comparable house prices: "The greatest potential for rental growth is in areas where rents are lowest compared with buying; once rents rise above 90 per cent of mortgage costs, tenants start to buy rather than rent at higher cost," he explains. Good options in this respect include Worthing, Hove, Brighton, Harrow and south Oxfordshire.

Loan supplies squeezed

Buy-to-let mortgages have certainly been brutally hit by the banks' new ultra-cautious attitude, according to Margaret Saunders from financial data provider Moneyfacts. "July last year seemed to be our peak number of buy-to-let products, when we were listing over 3,600. Today, we have just under 600 products."

"There are buy-to-let deals out there, but the lending criteria have been tightened," Mr Heron observes. "Most notably, the 90 per cent LTV deals that could be found before Christmas have all disappeared. The top LTV available is now 85 per cent." And lenders are continuing to reduce the proportion they're willing to lend. The latest Moneyfacts-listed lender to tighten up was Platform, which previously lent up to 85 per cent but will now only lend up to 75 per cent. But many others have already taken the same steps.

Other criteria have also become steadily tougher. Minimum rental calculation requirements have slowly been increasing, there are fewer specialised products and fees have been gradually increasing, says Ms Saunders. "Some lenders have also reduced the size and maximum advance on borrowers' portfolios," she adds.

Established landlords are much more likely to be in a position to meet lenders' stringent requirements; and they are the only ones still lending in this unsettled market - although many continue to sit on their hands and wait. "It would be an odd time for newcomers to jump in, although they may be watching and waiting for signs that prices are bottoming out," says Mr Heron at Paragon. Of course, calling the bottom of any market is notoriously difficult.

The bottom line, however, is that, notwithstanding the disaster stories, landlords are not flooding out of the market; and, in due course, those with access to funding may go bargain-hunting in a buyers' market. "The fundamentals, in terms of tenant demand, remain good," stresses Mr Hilton at the NLA. "But we don't want the increase in rental demand to be seen as carte blanche for the rise of irresponsible landlords."

MORE ON PROPERTY...

Look out for more on the buy-to-let market later this week, or see this Friday's Investors Chronicle.

For more advice on investing in property, see our Property investment guide.

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