Buy to let

Buy-to-let is a phrase used in Britain to refer to the acquisition of a building specifically to rent it out to tenants. A buy-to-let property is one that is bought solely to be let out, and a buy-to-let mortgage is for landlords who buy property for this purpose.

The history of buy-to-let

Before the 1980s, there were only a handful of private individuals who owned property which they let out. At the time, it was the general perception that only professional landlords and sufficiently wealthy individuals could afford the huge deposits required to secure a mortgage for commercial property.

People did not have access to the buy-to-let mortgages that are available today, and most simply did not think of investment property as a viable source for funding their retirement income. At the end of the eighties, the rental market slumped because people were beginning to see reasons why it made sense to own their own homes. Many became sure that renting would fade away because there were phenomenal returns to made by owning a property. However, the recession that hit in the summer of 1990 brought with it exceedingly high levels of demand for property to rent.

With the 1988 Housing Act and further amendments in 1997, landlords were given a huge boost and lenders did not hesitate to make loans available to prospective landlords because both parties were assured that tenants would not exceed their pre-arranged term of occupancy. ARLA (Association of Residential Letting Agents), now ARLA Property mark, helped make buy-to-let more favourable by launching a platform that put together panels of lenders who were more than willing to offer buy-to-let mortgages at highly competitive rates.

From the mid to late nineties, the buy-to-let market grew exponentially with market prices soaring once again due to the number of people who were taking mortgages on second properties. The Council of Mortgage Lenders puts the number of buy-to-let loans advanced by lenders between 1999 and 2015 at 1.7 million. In 1999, the figure was 44,000, and by 2001, the annual total of buy-to-let loans that had been agreed was over 72,000, all worth £6.9 Billion. 2006 saw reports of up to 700,000.

Benefits of buy-to-let

Due to the rising prices of properties in the United Kingdom, buy-to-let has become a popular method of investment. One of the benefits of buy-to-let is the owner or landlord can earn money in two different ways. First, they will have access to a reliable source of income from rent paid by tenants occupying the property. Also, depending on the area where the property is located, the landlord can expect capital growth as long as house prices continue to rise over time.

The nature of buy-to-let is such that even if a unit is unoccupied and remains so, the rental income lost over that period could be covered by appreciation of the property in the long run. This advantage of buy-to-let applies more to landlords who invest in apartments, which are typically cheaper than houses in the first place.

Risks of buy-to-let

The biggest risk in buy-to-let is the landlord’s projection of profits or income not meeting expectations. Normally, when an investor takes a buy-to-let loan to purchase a property, he or she will expect that rental income will cover the cost of the loan, or that they can sell the house later at a profit. The outcome desired by every landlord is to meet or exceed their expectations for profit, meaning that they have gained a benefit from using the loan provided by the lender and have been efficient at allocating the capital. On the other hand, should the landlord be unable to comply with the conditions of their repayment then the mortgage lender will have to claim the property and sell it in order to get back the money they loaned.

Another risk is the possibility of prices falling which could have the landlord land in negative equity. For landlords whose primary aim is to receive consistent income from their investment, a minor drop in the prices of houses may be inconsequential.

There’s also the possibility of a drastic change in the government’s policies as regards buy-to-let, or any other area that could affect buy-to-let landlords. Another situation dreaded by landlords is a rental void where the agent can’t find new tenants to replace old ones or tenants suddenly move out.

Yields

For many years now, global gross rental yields have been going down the slope, particularly since the housing crisis. According to the National Landlords Association (NLA), 19% of landlords who rented out two to three properties and 27% of landlords who rented out a single property either run at a loss or break even. This was the situation by September 2014.

The average gross buy-to-let yield was marked at 5.1% in December 2014 which was a reduction of 0.2pp from the figures in December 2013. Gross rental yields across the UK differ with yields in London standing at 4.1% while Scotland and cities in England’s North saw yields of 6.1%.

Tenant protection

The government has created policies in the best interest of tenants, such as making it mandatory to license homes in multiple occupation, and including mandatory third party deposit protection schemes.

Buy-to-let mortgages

Offered in the United Kingdom since 1996, a buy-to-let mortgage is a mortgage which a lender gives to an investor in order to buy property in the private rented sector for the purpose of renting it out to tenants.

The formula used to calculate exactly how much they would lend an investor is different from that used to calculate the mortgage loan for an owner-occupied house. For buy-to-let properties, they take into consideration the amount of rental receipts expected from tenants on a monthly basis. Some lenders permit the borrower to include his or her personal income and factor that into the calculation of the maximum loan the lender is willing to give. A first-time landlord may need to have a minimum annual income of £25,000.

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Published on 7th June 2017

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