Thinking of buy-to-let? Do the sums
Safe as houses? Yields have fallen, interest rates are rising - yet people still think it is a sure bet
Ashley Seager
Monday August 21, 2006
The Guardian
If something looks like a bubble and smells like a bubble, there's a good chance it may be a bubble. Figures out last week showed a renewed frenzy of buying in the buy-to-let market, an area of the economy that is flashing warning signs as never before.
The new figures from the Council of Mortgage Lenders were a shock. In the first half of the year, they showed that buy-to-let mortgages jumped by a fifth in value, or a record £17.5bn, a figure that almost matches the amounts paid in City bonuses in the same period. Buy-to-let mortgages now account for 8% of the total, having grown from zero just a few years ago. Were it to go pop, that is a big enough chunk to drag down the whole housing market.
The surge in borrowing, along with the Bank of England's interest rate cut in August last year, helps to explain why the housing market has been robust so far this year in spite of relatively low numbers of first-time buyers, who are at the limits of affordability and are being squeezed out by prospective landlords.
Buy-to-let investors have apparently responded to rising rents, in turn caused by large-scale migration from eastern European countries. Poles and the like are the new tenant class, especially in London and the south-east.
But a small rise in rents does not alter the fact that the economics of buy-to-let are now very unfavourable, as they have been for some time. At the heart of every investment decision should be a consideration of return, or yield. This is when you divide the price you pay for the investment by the income flow from it. In the case of rental property, you take the purchase price and divide it by the rent. For example, if a property costs £100,000 and you can get £10,000 a year in rent, the yield is 10%.
The main reason that the buy-to-let craze started a few years ago was because rents were high relative to property prices, giving nice fat yields of 10% or more. Now, after years of strong price rises, and some periods where rents fell as new landlords found themselves competing for tenants, the average yield in Britain is down to 5%, with London at 4.5%, according to the Royal Institution of Chartered Surveyors. That is bang in line with interest rates, also known as the cost of capital.
That is a gross yield. Once you deduct running costs, agents' fees and so on, you get to an average net yield of 4%. If you have a month or two without a tenant, your yield in one year could fall to 3% or lower. You also have to pay stamp duty and solicitors' fees on the way into the investment, and capital gains tax, estate agents' fees and more solicitors' fees if and when you sell. All of which eats into your returns.
Brave
Basically speaking, your monthly rent is now very unlikely to cover your mortgage, even on an interest-only basis. What worries me, though, is that people are not doing these basic sums. You hear people saying: "I am getting a buy-to-let because everyone else is and property always goes up in value." What the average yields show is that many investors are making no income from their property investment, and are relying exclusively on capital growth to provide a return. It is the same as a gamble on a share in a dotcom company that is not making any money but which investors hope will nevertheless rise in price. And this at the end of a 10-year period in which property prices in this country have tripled. Betting on further large capital gains to compensate for low yields is brave as well as risky.
People are being encouraged to go into buy-to-let by the banks, which are keen to grab a larger slice of this rapidly growing market. The banks are busy relaxing their lending criteria in an attempt to keep the market expanding. But in so doing they are allowing investors to take ever bigger risks. Is that responsible behaviour?
Ah, you might say, the economy is strong, demand for property is strong - thanks at least in part to inward migration - and the housing market did not collapse last year as many gloomsters (me included) were predicting, so property prices can keep on growing. Maybe so, but you wouldn't want to bet the house on it.
For me, the key to rising prices this year was last year's cut in interest rates, both by the Bank of England and in the money markets, which lowered the cost of fixed-rate mortgages. Long-term rates fell below 4% in January this year - a 50-year low - pulling down fixed-rate mortgages and further boosting demand.
The Bank of England recently raised interest rates. Long-term rates are now at nearly 4.7% but fixed-rate mortgages have only started to move up in response. They have further to go. The cost of capital is rising - the squeeze is on.
I worry that there are a lot of people buying off-plan, buy-to-let investments in new apartment complexes in city centres that may simply struggle to find tenants over the medium- to long-term even as interest rates are rising. They are also buying at questionable prices and being promised unachievable rents. There is a racket going on.
And remember the recent news that house prices have fallen by 13% in Nottingham over the past year. Estate agents there blame the bursting of a bubble in buy-to-let, particularly in newly-built flats.
It is a simple fact that many people seem to have forgotten: property prices can go down as well as up. They have fallen over the past couple of years in parts of Australia, they are falling now in Florida and many other parts of the United States, and the markets in Spain and France are starting to wobble.
Interest rates are rising in the US, in the eurozone, in Japan and in Britain. The days of cheap money are drawing to a close, and with them the days of big rises in property prices.
This does not necessarily mean that house prices are about to collapse in Britain, where the economy remains strong and employment high. Other figures released last week illustrate a key reason why property prices are high in Britain: supply is limited.
Trough
The government said 165,000 houses were completed in the year to June - up 28% from the post-war trough of five years ago but still far below the 210,000 that it is estimated will be needed each year over the next 15 years to keep up with growth in the number of households. Fred Harrison, of the Land Research Trust, which campaigns for a tax on land value as a way to encourage more land to be made available for housebuilding, remains bearish on the housing market. He thinks it will peak next year and then go into freefall. You may disagree but he successfully predicted the last crash.
Buy-to-let is an accident waiting to happen. A stampede out of it could trigger the housing market collapse that Mr Harrison is predicting. They say that in a bubble you always find the last fool to sell to. You wouldn't want to be that fool, would you?
---------
Chico - why did your God made so many people people so greedy?
Safe as houses? Yields have fallen, interest rates are rising - yet people still think it is a sure bet
Ashley Seager
Monday August 21, 2006
The Guardian
If something looks like a bubble and smells like a bubble, there's a good chance it may be a bubble. Figures out last week showed a renewed frenzy of buying in the buy-to-let market, an area of the economy that is flashing warning signs as never before.
The new figures from the Council of Mortgage Lenders were a shock. In the first half of the year, they showed that buy-to-let mortgages jumped by a fifth in value, or a record £17.5bn, a figure that almost matches the amounts paid in City bonuses in the same period. Buy-to-let mortgages now account for 8% of the total, having grown from zero just a few years ago. Were it to go pop, that is a big enough chunk to drag down the whole housing market.
The surge in borrowing, along with the Bank of England's interest rate cut in August last year, helps to explain why the housing market has been robust so far this year in spite of relatively low numbers of first-time buyers, who are at the limits of affordability and are being squeezed out by prospective landlords.
Buy-to-let investors have apparently responded to rising rents, in turn caused by large-scale migration from eastern European countries. Poles and the like are the new tenant class, especially in London and the south-east.
But a small rise in rents does not alter the fact that the economics of buy-to-let are now very unfavourable, as they have been for some time. At the heart of every investment decision should be a consideration of return, or yield. This is when you divide the price you pay for the investment by the income flow from it. In the case of rental property, you take the purchase price and divide it by the rent. For example, if a property costs £100,000 and you can get £10,000 a year in rent, the yield is 10%.
The main reason that the buy-to-let craze started a few years ago was because rents were high relative to property prices, giving nice fat yields of 10% or more. Now, after years of strong price rises, and some periods where rents fell as new landlords found themselves competing for tenants, the average yield in Britain is down to 5%, with London at 4.5%, according to the Royal Institution of Chartered Surveyors. That is bang in line with interest rates, also known as the cost of capital.
That is a gross yield. Once you deduct running costs, agents' fees and so on, you get to an average net yield of 4%. If you have a month or two without a tenant, your yield in one year could fall to 3% or lower. You also have to pay stamp duty and solicitors' fees on the way into the investment, and capital gains tax, estate agents' fees and more solicitors' fees if and when you sell. All of which eats into your returns.
Brave
Basically speaking, your monthly rent is now very unlikely to cover your mortgage, even on an interest-only basis. What worries me, though, is that people are not doing these basic sums. You hear people saying: "I am getting a buy-to-let because everyone else is and property always goes up in value." What the average yields show is that many investors are making no income from their property investment, and are relying exclusively on capital growth to provide a return. It is the same as a gamble on a share in a dotcom company that is not making any money but which investors hope will nevertheless rise in price. And this at the end of a 10-year period in which property prices in this country have tripled. Betting on further large capital gains to compensate for low yields is brave as well as risky.
People are being encouraged to go into buy-to-let by the banks, which are keen to grab a larger slice of this rapidly growing market. The banks are busy relaxing their lending criteria in an attempt to keep the market expanding. But in so doing they are allowing investors to take ever bigger risks. Is that responsible behaviour?
Ah, you might say, the economy is strong, demand for property is strong - thanks at least in part to inward migration - and the housing market did not collapse last year as many gloomsters (me included) were predicting, so property prices can keep on growing. Maybe so, but you wouldn't want to bet the house on it.
For me, the key to rising prices this year was last year's cut in interest rates, both by the Bank of England and in the money markets, which lowered the cost of fixed-rate mortgages. Long-term rates fell below 4% in January this year - a 50-year low - pulling down fixed-rate mortgages and further boosting demand.
The Bank of England recently raised interest rates. Long-term rates are now at nearly 4.7% but fixed-rate mortgages have only started to move up in response. They have further to go. The cost of capital is rising - the squeeze is on.
I worry that there are a lot of people buying off-plan, buy-to-let investments in new apartment complexes in city centres that may simply struggle to find tenants over the medium- to long-term even as interest rates are rising. They are also buying at questionable prices and being promised unachievable rents. There is a racket going on.
And remember the recent news that house prices have fallen by 13% in Nottingham over the past year. Estate agents there blame the bursting of a bubble in buy-to-let, particularly in newly-built flats.
It is a simple fact that many people seem to have forgotten: property prices can go down as well as up. They have fallen over the past couple of years in parts of Australia, they are falling now in Florida and many other parts of the United States, and the markets in Spain and France are starting to wobble.
Interest rates are rising in the US, in the eurozone, in Japan and in Britain. The days of cheap money are drawing to a close, and with them the days of big rises in property prices.
This does not necessarily mean that house prices are about to collapse in Britain, where the economy remains strong and employment high. Other figures released last week illustrate a key reason why property prices are high in Britain: supply is limited.
Trough
The government said 165,000 houses were completed in the year to June - up 28% from the post-war trough of five years ago but still far below the 210,000 that it is estimated will be needed each year over the next 15 years to keep up with growth in the number of households. Fred Harrison, of the Land Research Trust, which campaigns for a tax on land value as a way to encourage more land to be made available for housebuilding, remains bearish on the housing market. He thinks it will peak next year and then go into freefall. You may disagree but he successfully predicted the last crash.
Buy-to-let is an accident waiting to happen. A stampede out of it could trigger the housing market collapse that Mr Harrison is predicting. They say that in a bubble you always find the last fool to sell to. You wouldn't want to be that fool, would you?
---------
Chico - why did your God made so many people people so greedy?
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