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The yield shield

In the UK there is a general tendency to knock anything that is good, be it in sport, popular music, fashion or business. This rule has also applied to the buy-to-let sector.

This market has grown at a great rate of knots over the last few years but it is constantly knocked. We are always hearing there is an oversupply of rental property, falling rental yields or that house prices are going to crash. Whatever the issue, it seems some people think the bubble is going to burst.

The continued growth of the BTL sector has shown that such predictions are unfounded. But with interest rates rising, will this be the straw that breaks the back of the buy-to let camel or will the market continue to defy predictions and continue growing?

We need to put things into perspective and look at some of these concerns.

There is insufficient evidence that there is going to be a housing crash. With interest rates rising, a slowdown can be expected but, with demand outstripping supply, any crash in the housing market is unlikely. A recent survey by Arla showed that most landlords would keep their property if house prices fall, meaning there would not be a mass exodus as they have bought for the long term.

In terms of oversupply of rental properties, this issue appears to be affecting specific areas of the country. It should be remembered that this issue affects all rental properties not just buy to let. Many lenders, such as GMAC-RFC, insist that the rental property is let via a professional letting agent who will normally insist on a high-quality property for their clients, making buy-to-let properties more marketable in oversupplied areas.

The next issue to examine is falling rental yields. It is important not to confuse this with a fall in rents, as rental yields are all about the relationship between property prices and rents.

If a property is worth £180,000 and the rent each month is £750 (or £9,000 a year), then the yield is 5 per cent (£9,000/£180,000 x 100).

At present, property prices continue to grow faster than underlying inflation so rental yields are falling because rent rises are not keeping pace with this.

For example, the property above could rise to £200,000 and the rent increase to £800 a month but the rental yield would fall slightly to 4.8 per cent.

So yields would have fallen although the rent has still increased, which is expected at a time when capital growth remains strong. When capital growth slows, rental yields will rise so it is pretty much a win-win situation.

None of these factors so far is sufficient to cause a downturn in the buy-to-let sector. But what about interest rates? Rates will probably rise again this year, perhaps more than once. Yet we need to put this into perspective because interest rates are still low relative to the past.

A rate rise will affect landlords whose buy-to-let mortgage is on a variable rate. For example, a 0.5 per cent rate rise will increase repayments on an interest-only mortgage of £100,000 by £42 a month.

The effect of a rate rise will depend on the level of gearing and the number of properties a landlord has, because a landlord with a lower loan to value ratio has more of a buffer between rent received and the mortgage repayment. This could cause problems in the future if rates continue to rise but only if rent prices remain static and this is unlikely, given the mechanics of supply and demand.

Demand for rental properties will continue to rise due to shifting demographics and changing work patterns, which will also con- tinue to attract new landlords into the market. For example, people are stepping on the property ladder much later now and renting for longer.

More people work on a contract basis and many require the freedom to move geographically as employment opportunities arise. These people, who are a growing number, need greater flexibility and mob-ility which owner-occupation does not provide but which renting does.

There are more ambitious career people who are focusing on their work. They do not want to be tied down by the responsibilities of relationships and having a family or even owning their own home. They too want flexibility and prefer renting. Job mobility also affects others. Some workers, with or without families, relocate to other areas of the UK on the basis that it will be just a short-term career move and will prefer to rent a property in the new location, until they return home. In addition, there will also be others who relocate on a permanent basis and who will need to rent until they find a new home. Job mobility, relocations and redundancies are part and parcel of today&#39s working life and will continue to increase demand for rented properties.

This will also be aided by the growing number of single households and rising divorce rates, coupled with a reduction in social housing. All these factors will increase demand for rental properties, which will attract further investment into property via buy to let.

Attitudes towards renting continue to improve and the growth of professional letting agents has enhanced consumer confidence and improved the quality of property and tenants alike, which have helped widen the appeal if buying to let and renting.

The buy-to-let market will stay strong because demand for rental properties will increase, as will the demand to own property as a form of longer-term investment.

Despite all the fuss, there will not be any mass panic and the sector will continue to offer potential for advisers and their clients. The sector has not yet reached maturity. There are areas of the country that are experiencing an oversupply of rental properties but buy-to-let properties should remain more marketable.

Poor returns in other asset classes will create new landlords and even when the bull returns, a mass exodus from buy to let is unlikely as investors have realised that property is a long-term investment that works alongside other asset classes.

Demand for rental property will rise due to socio-economic and demographic reasons and intermediaries should expect increased business as new clients approach them and existing clients return for advice on building portfolios.

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