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Welcome to Buy to let

The phrase buy-to-let can refer either to the investment strategy of buying a residential property to be let for profit; or to a particular category of mortgage used to purchase a property for letting.

For many years landlords have invested in residential property to be let for profit, but since the mid-nineties there has been rapid growth in the property market leading to a surge in demand for rental property which is being exploited by many mortgage providers keen to encourage new amateur landlords.

Benefits and risk

As for all property rental, the benefits for a buy-to-let landlord can include a stable income from rental receipts, as well as an accumulation of wealth if house prices go up over time. Rising house prices in the UK have made buy-to-let a popular way to invest. The main risk is that the property might not be occupied for all 365 days of the year, while the owner still has to pay a monthly mortgage payment. Also, buy-to-let landlords would suffer along with all property owners should prices fall.

Yields

Recent research by BDRC for Alliance & Leicester showed that 71% make a profit, but 29% break even or make a loss.

Buy-to-let mortgages

Buy-to-let mortgages have been on offer in the UK since the late nineties; they are specifically designed for investors to borrow money to purchase property in the private rented sector in order to let it out to tenants.

Lenders take different approaches. The amount of money investors can borrow is determined by the rental valuation of the property. Usually the annual rental income has to cover a certain percentage of the mortgage repayments, somewhere between 120% and 150%. This is to allow surplus rent to cover other costs such as property maintenance and void periods (periods when there are no tenants living in the property and therefore no rental income).

Typically the interest rates that are offered on BTL mortgages are fairly close to residential mortgage rates but will on average be higher and typically charge higher fees. This is due to the perception amongst banks and other lending institutions that BTL mortgages represent a greater risk than residential owner-occupier mortgages.

This type of investment has become very popular in the UK over the last five years or so, as house prices have dramatically increased. Another reason for their popularity is the tax advantages that are available to UK BTL investors. Rental income is considered in the same way as salary, and is therefore often taxed at 22% or even 40%. However, landlords can deduct costs from the taxable portion of their rental income, and these costs can include the interest portion of their BTL mortgage repayments as well as maintenance costs on the property. This tax set-up has made BTL investments more popular over the last few years.

Recent credit problems have had some investers maintaning the same percentage of equity in the property should prices fall and so rapidly find money to cover these downturns

Effects on Society

In the UK, "buy to let" has attracted some negative publicity. It has been described by some as the epitome of what is wrong with British society. The basic ideas behind buy to let (according to this analysis) are "How do I get someone else to work for me?", "How do I get money without having to work?" and "How may I leverage my privileged position to enable me to make further gains at the expense of my fellow citizens?". This forms much of the basis of real estate investment. Buy to let owners (it is argued) can effectively do little work and yet still receive substantial incomes, not only making money from rent, but potentially realising large capital gains on the sale of their housing stock. The suggested result in the UK is that of a wealth divide never seen since Victorian times. Buy to let, as a form of real estate investment, together with complicit lending practices and legislation, has arguably been one factor behind the huge rise in house prices in the UK since the late 1990s. First time buyers frequently struggle to get a foot on the housing ladder.

One suggestion is that the main reason for rising house prices is one of straightforward supply and demand: the number of households has been rising faster than the number of homes. In these circumstances, there are increasingly too few homes to go around, and the price is forced up. This trend has been the case in Britain since 1992. A counterargument to this, however, is that rents have not increased in line with house prices, which is what one might expect if a genuine shortage of dwelling units were the sole or main reason for the increase in purchase prices.

Another suggested effect of BTL is that buy to let landlords tend to buy property that the first time buyer would otherwise have tended to buy therefore forcing up the price in this market and forcing the FTB to rent a property of a landlord rather than being able to buy the property instead which has been shown. This would make BTL a type of monopolistic strategy.

General disillusionment with the property market has resulted in the boundaries becoming blurred between the perceived dangers of buy-to-let, the existence of a property bubble and the global credit crunch that has made it harder to obtain mortgages at attractive rates for some customers.

Assured shorthold tenancy

One of the key innovations required for widespread property investment was the reform of tenancy agreements and specifically the introduction of the assured shorthold tenancy (AST) agreement.