Buy-to-let: Prospects for 2008

Background

The buy-to-let investment market has been possibly the biggest success story of the recent property boom. The growth in property prices, particularly at the top and bottom ends of the market, has made people who got in early significant amounts of money. At the same time, price inflation in property has continued at the same steady pace for a number of years now, meaning that even people who have only begun to build their property portfolio in the past 12 months have still made a decent capital gain.

So successful has the buy-to-let market been, that it has contributed to the London Stock Exchange declaring property as the best-performing investment over the past ten years.

As the driver behind much of the growth in the property market in recent years, the buy-to-let phenomenon has thrived from the rise in the numbers of young people who are forced to rent in the early stages of their working lives by the rise in prices of the ‘starter’ homes they would be looking to buy. Many of these properties have become too expensive for the average young couple to afford, and sell quicker than most other homes due to the competition in the marketplace with the very same buy-to-let investors who will rent the properties out.

The impact buy-to-let has had on the UK property market in recent years can be seen in the proliferation of specific mortgage products for the investment market. Ten years ago, there were only a few finance deals in place for investors to borrow in order to rent out the properties they purchased. Now, the range and sheer number of finance options available to the buy-to-let buyer is huge.

Given all of this rampant buying of properties, mostly on shorter-term credit than with the purchase of a main dwelling, you would be forgiven for thinking that with the recent sub-prime mortgage problems, the near-collapse of one of the biggest buy-to-let mortgage providers, and the well-publicised ‘credit crunch’ afflicting everyone on the High Street, the market would be dead. However, reports from the final quarter of 2007 suggest that there was still plenty of movement in the market, and confidence was high. So what is in store for investors in 2008?

Credit crunch

While some commentators have been predicting the death of the property boom in the UK for well over a year now, it seems there is very little that can knock the buy-to-let investor. The recent problems in the money markets, highlighted by the sub-prime mortgage problems that came over from the US, and characterized by the strife at Northern Rock, seem to have galvanized the buy-to-let.

The sub-prime crisis has revealed the interesting idea that banks and financial institutions around the world buy and sell their debt ‘package’ on regular basis, which means that in many cases, no-one is quite sure where the liabilities lie at any one time.

This has led to problems for people like Northern Rock and Paragon, who do not have anything like the High Street and savings backing to allow them to lend when they find it difficult to raise money on the wholesale mortgage markets. In the short term, this did lead to a tightening of the conditions under which banks and other lenders will approve finance for new applications, but has stopped short of threatening mortgages currently held with the banks.

The knock-on effects of this are that consumer confidence has been low in the lead up to Christmas, resulting in profits warnings from many of the major chain stores. Additionally, new mortgage enquiries are at a three-year low, sparking concerns over the future of the whole property market in the UK.

In the past, buy-to-let investors have seen only opportunities where adversity strikes. Will it be the same for 2008?

Interest rates

As so much of the buy-to-let market in the UK is funded by mortgage lenders, the impact of any change in interest rates has a huge influence on the market buoyancy. The government policy has, in recent months, been to use the interest rates to stabilise the market, and to prevent the most aggressive speculation in the property markets. The policy of gentle rises as house price inflation threatened to get out of hand seems to have eventually paid off, with house prices slackening off in the latter part of 2007. As the squeeze of the sub-prime lending issues and the slow performance of the retail markets has hit home, and some property prices begin to fall slowly, the Bank of England has responded by lowering the rate by a quarter of a percentage point to reassure the public.

Further reductions are anticipated in the early part of 2008, though the Monetary Policy Committee decided to hold rates at 5.5 per cent in January.

Latest developments

While retailers have suffered a torrid Christmas, with two of the biggest High Street names, Marks & Spencer and Dixons, both issuing profits warnings and registering drops in sales, the buy-to-let market appears to remain optimistic.

The early part of January 2008 has seen more problems for the two beleaguered victims of the sub-prime crisis. Northern Rock has announced it is to sell off two per cent of it’s mortgage stock, valued at around £2.2 billion, to help it pay back some of the £25 billion in emergency funding it received from the government to bail it out.

At the same time, Paragon Mortgages, the buy-to-let lending specialist which suffered from not being able to raise funds following the sub-prime crisis, has been forced to invoke what is being referred to as ‘crisis funding’ in order to raise some £280 million to pay back a loan that becomes due on 27th February. This move, which directors said was necessary in order to build a platform to attract additional investment, sent the already-fragile share price plunging, losing 38 per cent of its value in a morning.

Prospects for 2008

The Association of Residential Letting Agents (ARLA) conducts a quarterly confidence survey to measure how the market has reacted to events in the economy. The latest installment of this survey has revealed that confidence remains high for the buy-to-let sector at the beginning of 2008. Some 40 per cent of investors are planning to make further purchases and additions to their portfolio over the next year.

The survey also shows that 90 per cent of investors have no intention of selling any of their properties in the next year, and expect an investment to last almost 17 years. This indicates not only that confidence remains in the market and investment model, but also that most investors are well-informed enough to have planned to stick out any temporary blips in the market for the long haul.

The other figure revealed by the survey was that there were more than 340,000 buy-to-let mortgages and re-mortgages granted to investors in 2007, a sign of a growing market.

The signs are there for a resilient buy-to-let sector in 2008, with some investors taking advantage of nervousness from parts of the residential sector to expand their portfolios. Many buy-to-let devotees will also be hoping for some degree of help from the government is reducing interest rates should the credit squeeze continue.