Business Money – Finance and Banking for Business

Buy-to-let 10 years on
October 2006

Amazingly the buy-to-let market is only
10 years old but it demonstrates a maturity that belies its young age

David Whittaker

As buy-to-let celebrates its tenth birthday amidst an avalanche of positive national media coverage, readers of this publication might be forgiven for adopting a more cynical observation that this is only residential investment property re-marketed under a new brand. But what a re-branding achievement by Andrew Reeves of ARLA and those early lenders including The Woolwich, Paragon and Mortgage Express – something that John Heron of Paragon describes as “a hallelujah moment” when the idea was first put to him.

In 1996 the launch of buy-to-let was attended by less than 100 people of which a good number were probably linked in with ARLA or those first few lenders – yet in the first six months of 2006 new BTL lending, as reported by the CML at £17.5bn, accounted for 11% of gross mortgage advances. Beyond the back slapping approach of the tabloid and broadsheet press, all sectors of the industry have been preparing for the next 10 years.

The future prospects for the BTL sector will be determined by the willingness of landlords not only to remain in the sector but also to continue to invest steadily over time. No amount of lender ingenuity or pricing competitiveness can overcome sentiment so it is crucial to understand what challenges landlords see on their radar.

Buy-to-let landlords
The property and mortgage industries have differing perspectives on what constitutes a buy-to-let landlord as the letting agent will encounter a broad swathe of property owners, a surprising number of whom may have inherited a property, and mortgage debt is the last thing on their mind. Equally a mortgage company will deal with the larger landlord who runs his property empire as a full-time business and may not use the services of a letting agent at all. Not withstanding these differences there is some compelling data in “Buy-to-let – The Revolution – 10 years on” commissioned by ARLA from Professor Michael Ball of The University of Reading Business School (http://www.arla.co.uk/news/250906.htm).

The often-stated demographic trends are well laid out and supported by authoritative source data, albeit the recent influx of some 600,000 Polish nationals looking for rental accommodation only warrants a passing mention. The new breed of landlord, created over the past 10 years, has brought a more responsible approach to property ownership and management than was hitherto the case. And tenant satisfaction levels, especially in the increasing number of tenants in their late 20s, are high. Government seeks to take credit for some of these achievements but the reality is that landlords face an increasing regulatory burden as David Salusbury, chairman of the National Landlords Association, recently commented: “With around 50 acts of Parliament and 70 separate sets of regulation, there is certainly plenty for the small scale landlord to get his or her head around. These cover a wide variety of different issues, such as gas and electrical regulations, the safety of furniture and furnishings, the provisions of the various landlord and tenant acts, and licensing of houses in multiple occupation – to name but a few.”

This final piece of legislation has prompted the RICS to report in August that some landlords are exiting the market because of not only the cost and complexity of the regulation but also because of the confusion amongst some lenders who have yet to grasp that many such properties are not HMOs in the classic definition. To the landlord with experience in this sector and well supported by a lender well versed in the intricacies of the legislation, this is a time of opportunity and bargains are for the taking – however equilibrium will soon be re-gained in this small sub-sector of what is now a broad market of property types.

Lesser businessmen would probably seek alternative ventures at this juncture but resilience amongst landlords seems to be a recurrent theme which lenders also note in the debt performance characteristics of BTL mortgages where delinquency levels beyond 60 days runs at much lower levels than domestic mortgages.

Regular market surveys amongst landlords reveal a long-term commitment to the sector and whilst yields have slipped against rampant capital value growth over the past five years, there is evidence of higher rental growth in London in a September RICS survey – and where London goes much of the rest of the UK will eventually follow. Landlords may have a wary view of new entrants to the EEC on a personal level but as businessmen many hope for a repeat of the influx of nationals from Eastern European countries similar to the surge on the entry of Poland just two years ago.

Buy-to-let lenders
Incredibly the market still only has one BTL sole purpose lender in Paragon Group – the City seems to think so too as their share price continues to march up the FTSE 250 month-by-month. Paragon competes with some powerful brands and sub-brands of other FTSE companies which makes for a potent cocktail of competition and product innovation.

Early 2005 saw many lenders struggling to separate out their BTL offering from their newly regulated mortgage activities (they should have taken some lessons from their landlord borrowers on the real meaning of government regulation). But to their credit, BTL lending recovered quicker than residential lending thanks to some quick thinking from The Mortgage Works on fees and rent to interest cover to compensate for tightening yields.

This trend continued into 2006 with the advent of the first range of mortgages to 90% but sadly the initial offerings tended to leave borrowers stuck at 86% or 87% with higher fees and interest rates to pay. Take-up was modest and following the summer recess several lenders re-launched with a variation based around a product model quietly innovated by GMAC in 2005 whereby the rent to interest equation, traditionally based at 120%, could be lowered in stages to 115%, 110% and even 100% by the expedient of paying a higher completion fee. This method served two purposes: firstly, it gave the lender “cash up front” for the perceived greater risk; and secondly, by abandoning the traditional approach of increasing interest pricing for greater risk, it avoided the pitfall of having to counteract the benefit of lowering the rent to interest multiple by pushing up the interest rate.

The broker community, already faced with four new BTL lenders entering the market (Basinghall, Edeus, Alliance & Leicester and DB Mortgages), now have to contend with potentially four products for every one that previously existed – it will allow many transactions that hitherto stumbled on an unsympathetic valuer’s view of rent to be safely secured by the expedience of a “one off” higher completion fee. The brokers that will win in this new environment will be those with significant investment in technology as none of the current mortgage sourcing systems yet have this degree of in-built sophistication.

Some pundits have already observed that these changes were necessary as the first base rate increase in August for two years took its toll on rent to interest calculations – and with a real expectation of a further 0.25% rise in November, such innovations are a necessary market dynamic if lenders are not simply to cut pricing or abandon credit stance in order to maintain business volumes.

All lenders look to make efficiency gains both on and off balance sheet and the successes of the structured finance teams at many institutions have delivered more finely tuned pricing to the product front line. Transparency would have been unthinkable 10 years ago but Paragon’s Investor Reporting (www.paragon-group.co.uk) illustrates both the quantative and qualitative successes of their lending programmes – with its second issue in the summer of 2006 measured at £1.5bn and a further issue before year end, there really can be no better sign of the confidence and health of the BTL sector.

David Whittaker, managing director,
Mortgages For Business Ltd, tel: 01732 471600

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