In the last three years, the popularity of buy to let has grown far beyond expectation.
Figures from the Council of Mortgage Lenders show that in 2000 gross advances increased from £3.9bn to £19.3bn in 2003 – a nearly fivefold rise.
Buy to let has undoubtedly been the shining star of the specialist mortgage market in recent years. With this success has come speculation that the market is overheating and the so-called buy-to-let bubble is about to burst.
Earlier this year, investment bank Durlacher released a report that predicted that house prices would drop by up to 30 per cent within two years because of a collapse of the buy-to-let market, due to a range of factors, including low rental demand and the large number of new entrants to the market.
This report was widely dismissed as being sensationalist. Even so, the report received a great deal of media coverage and speculation about whether the BTL market had peaked or whether it was in decline.
The argument that the buy-to-let sector is on the brink of collapse is not supported by the facts. There has certainly been a huge increase in the number of people using buy-to-let for investment purposes but this does not represent a speculative bubble.
The demand for buy-to-let loans reflects a number of key factors, including the yield on private rented properties, the comparative yield on alternative types of investments (equities, gilts, commercial property) and the cost of investment, primarily interest rates, but also affected by loans to value. The expectation of making capital gains is another factor.
Rental levels are governed by the balance between supply and demand in the private rental sector. Rental yields for buy-tolet investors are determined by the relationship between rental levels and house prices.
Rental yields have fallen in recent years as a result of the rise in house prices – this is to be expected, given the fall in underlying interest rates and in yields on alternative investments.
Total yields for buy-tolet investors, have however, tended to rise because of the capital gains coming from the increase in house prices.
Taking all these factors into account, the environment for buy-to-let investment has been highly favourable in the past five or six years, resulting in the boom in the market.
The underlying balance of supply and demand in the private rental market has tended to reflect a shortage of supply, which in turn has kept the rental levels up, although there are regional variations and supply and demand have moved more into balance recently.
Additionally, capital gains from property investment have been very strong. Although rental yields have been decreasing, interest rates have also fallen so that the “real” yield has remained attractive.
The supply of funds to the private rental market has increased as a result of mortgage lenders offering buy-to-let loans at significantly lower rates than the commercial loans previously provided by banks.
The level of buy-to-let mortgages reflects, at least in some part, this switch of lending source from the commercial banks to mortgage lenders. Finally, yields on alternative investments, notably equities, have been very weak We have established that a number of specific factors combined to make buy to let such a popular form of investment. The conditions are unlikely to be as favourable over the next two to three years but, contrary to predictions by analysts such as Durlacher, neither are they likely to be significantly adverse.
There is no sign or expectation of sharp falls in rental yields and general opinion suggests that property prices probably will not drop, even if further significant increases are unlikely. Although interest rates are rising, the increase is expected to peak at about 5.5 per cent to 6 per cent – still low by the UK's historical standards of the past 30 years.
Added to this is the fact that yields on alternative investments are not much more attractive than the returns on residential property. There remains considerable distrust of equity markets, and investment in property offers a greater degree of control than investment in equities through unit trusts or pensions, etc.
The results of the Mortgage Express buy-to-let confidence survey confirm that the market remains buoyant and landlords retain confidence in it.
Results from the first quarter of this show that demand for rental property has steadily increased over the past year. Forty-five per cent of respondents say they believe rental demand is increasing.
There appears to be no significant change in the length of void periods, with only 6 per cent saying that void periods had increased in the last six months and 86 per cent saying they had stayed the same and 7 per cent saying they had decreased. In fact, 63 per cent of respondents had no void periods at all in this time.
Underlying economic factors suggest that the growth in buy-to-let investment is likely to slow down over the next 18 months from the high levels recorded in 2003 and the first half of 2004.
But there is little reason to believe that investors in the private rented sector will seek to liquidate their holdings and cause the market to crash.
The indicators remain healthy. Returns in the sector are still good while returns on alternative investments are little better and research confirms that investors remain confident.