Buy to Let has been haunting the UK press with much gusto in recent months for many reasons. The government decided to encourage institutional investment by changing Stamp Duty rules and opening up the REIT sector to permit residential property. Mortgage lenders have been citing a rise in lending and subsequently new mortgage products in a bid to "cope" with rising demand in the arena.
So all is peachy and Buy to Let is back with a vengeance – or is it?
As frequent readers will be aware, personally I am not a fan of the concept as it is marketed within the UK property sector – largely because it relies upon borrowing to make the whole thing work, which is fine in some respects when you have a stable economy, but the UK is in no such position at the moment.
Government bail outs of banks on a titanic scale, more cuts than an exploding razor blade factory and interest rates sat in a rocket that's just started its final launch phase – all of which do not bode well for the UK economy in the short to mid term.
We only need to wind the clock back a few years when the hype started the first time round about buy to let as an investment concept, money was made available very easily and incredibly cheaply – the public lapped it up, spurred on by the relentless barrage of TV shows and the press citing Buy to Let as the easy mans investment product.
Only recently has it begun to dawn that perhaps the hype was a little mis-guided, and only realised as the cuts and bail outs begun – and yet here we are full circle.
So what has changed?
In essence – not a lot. The same old banks and mortgage houses are wheeling out remarkably similar mortgage products. Similarly, property companies are pushing Buy to Let again, all egged on by the press and TV with fantastic statistics that appear to back it all up.
Aside from the obvious – what's my problem?
In fairness, there appears to be slightly more responsibility being taken by the banks as far as lending is concerned – marginally less excessive loan to value mortgages are being made available. My problem with the UK Buy to Let market is pretty straight forward.
The problem starts with how Buy to Let property investment is funded in the first place – mortgages.
Most other investments don't permit investing with credit. Try going to the bank and asking for a mortgage to buy some Microsoft stock – not only will your bank manager likely ask you to leave his office and retain your dignity while you can, you have more chance of Bill Gates himself delivering the stock certificate to you in person. Why? Because despite the fact that Microsoft is worth more dollars than any of us can count to in a lifetime, it is perceived as too big a risk.
There are a couple of situations where you can legitimately borrow for investment such as leverage in currency positions or commodities, but these are on a fixed time-span with high interest and subject to being called (when the investment time span has expired you have to pay for the leverage) – whether you can afford to pay them or not.
Don't get me wrong – there is a lot to be said for Buy to Let as an investment, the commercial REIT world relies upon it, it works there, why not at consumer level?
Simple – for all the statistical analysis the banks undertake and publish on the UK property market, the results are only useful to them if they are averaged out across the country or region. This is great if you think the world runs on averages, unfortunately it doesn't. What might seem like a bargain on one side of a county is incredibly expensive on the other – simply because it is a different area and prices vary as a result.
Aside from the averaging that goes on – there is more statistical data to muddy the investment waters with the vast differences between reports themselves; this week alone we have seen "asking prices up", "house price falls continue" and "brickor mortis sets in" with such differing of data it's little surprise the market is in the state it is.
So when IS Buy to Let a good idea?
It all comes down to debt ratio and occupancy. If you start with relatively high debt in the first place and are reliant upon occupancy to cover it – guess what? Unless you are very lucky the wheels are going to fall off your shiny investment plan sooner or later, whether it is due to rising interest rates, or a period of vacancy.
Buy to Let does work however when you start to eliminate some of the variables that control the success of your investment.
At the moment in the UK few lenders will give you a Buy to Let mortgage with any loan to value over 75%. Assuming you intend buying something that actually has some appeal, is a rentable property and doesn't need rebuilding from the ground up, the likelihood is that your total spend will be in the realms of say 100,000 GBP, which means you theoretically have a 25,000 GBP deposit.
25k is a reasonable chunk of change to be putting into any single investment, but when you think about what a down-trending market and rising borrowing costs actually does, your 25k can evaporate very quickly indeed – even if you have a tenant in your property. Rental rates might be rising, but so is unemployment and wages are making no sign of improving anytime soon. As much as putting the rent up might be the obvious solution, if the money isn't there from tenants to rent your property it really doesn't matter what you put your rent up to if no-one pays it!
Whilst leverage can be a fantastic thing when the market is moving in the right direction, when the economy is in meltdown one needs to be careful not to get caught out by the eye of the storm that is (what appears to be) attractive lending.
Buy to Let starts to make sense though when you remove the debt element of the equation. If you aren't buying with debt in the first place it doesn't matter if the cost of borrowing rises. If anything it's a benefit – more people rent and rental rates rise as a result of good old supply and demand. As demand rises and supply drops – better quality tenants exist because they want to retain a well kept property to live in.
So where is this magical Nirvana of affordable Buy to Let property?
Sadly, we haven't found some mysterious place that the world has yet to uncover – more something we have been working with for some considerable time now. The USA.
US property can be bought at a fraction of the price of UK property. The American housing market is on its knees – and it needs you.
The US has seen its mortgage market thrashed to within an inch of its life – beaten by sub-prime lending and "flipping" of property to make a fast buck – and now it's paying the price.
America also has something the UK doesn't – Section 8. A government funded scheme to provide quality housing for low earners – basically in the form of property rental payments. Section 8 is heavily regulated, both on the standards of properties themselves, and the tenants that can claim it.
Section 8 tenants get a decent place to live, and landlords get their rent cheques – simple.
My view on Buy to Let investing might be a little different to the mainstream property journalists and commentators out there, but with good reason.
Hopefully this post has highlighted the different angles with which Buy to Let can be approached and help you as an investor understand both the positives and negatives when it comes to this style of investing – rather than the old "do it now 'cos everyone else is" tack that's often taken by the media to generate readers and advertising.
As much as borrowers should be aware of the responsibility they undertake when borrowing, the lenders should be even more aware, and so far, in the UK this doesn't appear to have been the case.
- Friday 20 May 2011