30th of August 2006
iPropertyGROUP News
Investing in Property - Financial Times
comments by Bernardo Moya, Prestigious Properties MD

UK property investors retain faith in the buy-to-let market, despite a recent slowdown, but more are seeking opportunities overseas. Jeff Salway casts an eye over the sector

The buy-to-let (BTL) market is a remarkably buoyant one that continues to float on the British love affair with property. The best time to enter the BTL market was probably in the early days of this century, when house prices were relatively accessible and rental incomes provided more than sufficient cover. It has uncannily reflected investor behaviour with equity markets, with people leaping on to the bandwagon when the opportune moment has already passed.

Margins have narrowed significantly in the last three years, with property prices having risen and rental yields subdued, but it remains a popular market. There is a school of thought that rental property will play a bigger part in the housing market of the future, with fewer people owning their own property. This is an anticipated result of housing becoming more scarce due to demand rising, smaller households, immigration, increased mobility and poor pension provision, among other factors.

It is predicted that up to four million new dwellings may be required in the UK by 2020. The obvious impact of this level of demand on the rental market would be substantial, with the pattern of home ownership in the UK shifting towards that seen on the European mainland, where there is a higher incidence of renting than in the UK at present.

But as an investment opportunity, expectations for the BTL market are mixed. Each sector has its bears and bulls, regardless of prevailing conditions and property is no exception. In the former category is Willie Gething, head of HSBC’s real estate operation. He believes that the property opportunity lies in collective investment with residential prices in the UK – except London – likely to see little growth in the near future.

Peter Roscrow, managing director of Close Property Management, concurred, but also emphasised the durability of the BTL market.

“You will always get BTL investors that want control over their investment, but I was initially surprised at the strength of that. I thought that people would want to get out when they began to have problems reletting their property, but there has been no big drop-off. There are still long term capital growth prospects in residential property, if not to the extent of recent years”.

The appetite among landlords for BTL opportunities remains buoyant, despite the Government’s about-face on the inclusion of residential property in SIPPs (although the ability to include existing business properties in SIPPs has been widely overlooked). Research conducted earlier this year by the Mortgage Trust found that landlords were significantly more optimistic than providers when it came to the long term outlook. The majority believe that house prices will continue to rise and that yield levels will remain stable – annual rents currently average 5.8% of portfolio value – for at least the coming year.

Graph 1, which shows property yield fluctuations between November 2001 and November 2005 broken down by regions of England and Wales, reveals a gradual overall decline from the start date. It confirms that BTL is now well past its peak, although expectations are that the market will consolidate over 2006.

According to John Heron, managing director of Paragon Mortgages, there are several reasons for this, including the relentless increase in property prices detailed in Graph 2.

“What has happened over the last five years is a combination of increased prices, a reduction in funding costs for landlords and greater competition creating better choice and quality for tenants, but balanced with an increased demand”.

This has levelled off in the last two years, as the stabilisation in yields in the graph demonstrates. The exception to the most recent rule has been Greater London, which has become more buoyant over the last year, although it has remained below the overall yield throughout the period covered. London has been stabilised largely by demand in areas such as Docklands, particularly since confirmation that the area would host the 2012 Olympics.

Over the longer term, the high house prices in the capital have created a gap between the BTL returns available there and those elsewhere in the UK. When the market peaked early in 2002, the London yield of 8.5% suffered badly in comparison with the highest yields of nearly 13%, found in the North and North West. That gap has narrowed since 2003, with the North West in particular giving way to Wales and Yorkshire as the BTL hot spots.

The fluctuations in property values across the various regions, given in Graph 2, make similarly intriguing reading. In Wales, for example, the average property price has risen by £82,488, an increase of 163%. In the South East, the average price is at its lowest since late 2004, while there have also been sharp falls recently in London and the East Midlands.

Yen for yields

Projected rental yields are becoming a greater priority, as investors are becoming increasingly savvy and aware that instant capital gains are unrealistic. With uncertainty growing over the sustainability of the pensions system, these investors are using property as their default retirement income, as mentioned in Box 1.

This is reinforced by data from the Association of Residential Letting Agents (ARLA), which has reported that just 5% of investor landlords invest purely for income, the criterion historically used in property investment. Instead, more than half of investment landlords are seeking capital growth to fund their retirement. Of the landlords questioned by ARLA, a significant 90% say that they would not sell their properties if house prices fell and would hold on to properties for at least 15 years – a strong indication of their long term intentions. Heron points out that the rental sector has always attracted the longer term investor.

“The private rental sector is illiquid and has large acquisition and disposal costs, so it has never attracted short term investment. What has developed, however, is a greater acceptance that the returns are a balance of income and capital uplift”.

The market forces driving BTL are intensifying, adds Heron, who points to the growth of demand caused by demographics, immigration and a shortage of affordable, flexible housing in the UK.

Few landlords perceive the introduction of real estate investment trusts (REITs) later this year as a threat to the BTL market. Of those surveyed by Mortgage Trust, 19% say that they would invest in REITs as well as BTL and just 3% intend to forego BTL entirely in favour of REITs. This betrays a prevailing cynicism of the merits of investing directly in property on an individual basis.

Most mortgage brokers – as you might expect – still insist that people will be better off in the short to medium term by investing directly, rather than in property shares, although the proportion of brokers who believe that the opposite is true is apparently growing.

According to Nationwide, FTSE 100 growth outstripped housing market growth by about 13% last year. But while house prices are double their level in 1999, the FTSE is still short of its level at that time, Nationwide adds.

Missing margins

Mortgage lenders have done their bit to keep the market busy in the face of a drop in activity levels since a peak in 2004. With competition remaining intense, a number of lenders have responded by further relaxing the terms that they offer on their BTL packages. For example, Northern Rock is among the companies that have reduced the expected rental cover (income) to as low as just 100% of the monthly mortgage payment – compared to an industry average of 125% to 130%. Elsewhere, Bristol & West now has offers where the rent has to cover just 115% of the mortgage payment.

Those firms insist that such deals are carefully targeted at customers that access them through advisers and are therefore aware of the risk that they entail. The flip side of this is that a more inclusive market could become increasingly vulnerable to small shifts in the economic environment, such as a rise in unemployment or unstable inflation and interest rates.

The narrower margin allowed could easily be wiped out by periods of vacancy and the costs of upkeep, while a drop in rent levels may mean that an investor has to cover shortfalls out of his own pocket.

The flexibility that has allowed lenders to offer reduced cover BTL mortgages would surely be threatened if the FSA paid more attention to the sector than it does currently. Yet the regulator has continued to play a relatively hands-off role when it comes to BTL.

The mortgage industry came under the remit of the FSA in October 2004, but BTL remains outside that, despite calls from various quarters, such as the Liberal Democrats. The shadow chancellor for the party, Vincent Cable, said last summer that the criteria being offered by the less prudent providers in the market made it vital to ensure that BTL followed stricter guidelines.

There are currently just a handful of circumstances under which BTL would fall under the FSA mortgage conduct of business rules, such as where the loan is secured on the borrower’s own home rather than on the property that is bought to be let.

Offshore ownership

Moving even further away from FSA jurisdiction is the growing band of property investors that are seeking opportunities overseas. This is an increasingly adventurous market that continues to move away from its traditional axis of France, Spain and Portugal. It is also a market that is characterised by the pursuit of capital growth rather than income.

The last official figures released by the Office of the Deputy Prime Minister in 2004 revealed that the number of English people owning property abroad had doubled in just 10 years, and the proportion is expected to have increased in the interim two years. What has changed is the spread of that investment, with Eastern Europe, Asia and even parts of South America featuring more prominently in prospecti.

Much of this has been prompted by the squeezing of the UK BTL market, as described above, where margins have narrowed and genuine growth opportunities are harder to find. Another simple reason is that cheap flights have made various locations more accessible and encouraged more frequent visits. It is almost possible to map the overseas BTL trend by the new flight paths opening up from the UK.

The locations currently in vogue include Bulgaria, which offers cheap property in the vicinity of popular ski resorts; Croatia, which has experienced a rapid growth in popularity among UK holidaymakers; and other areas of central and Eastern Europe that offer attractively low property prices. Bulgaria has also benefited from its bid for the 2014 winter Olympics and, like Turkey, its application to join the EU next year – a development that prompted a wave of investment in the last round of EU accession countries two years ago.

The promotion of the overseas opportunity has been aggressive and even hyperbolic in many cases, however. A glance at the average weekly television schedule will quickly identify a handful of programmes that profess to tell people how they can buy their dream home in an exotic location and make money. There are dangers that many investors may not be aware of, both inherent in buying overseas property and related to specific markets. Every country has different costs and risks, such as taxes, charges, rental demand and commercial customs.

For example, in Morocco and Bulgaria, property transactions are generally cash-in-hand affairs and mortgage arrangements are rare. In those countries and others such as Croatia, the danger of buying property to let as holiday homes is in the dependence on both the local economy and the broader European economy. A safer bet is residential development that is focused on the local population, although in places such as Bulgaria it will not be clear for several years just how robust demand will be.

There are also the tax implications to consider, as UK domiciled individuals have to absorb the impact of overseas taxes. These can include capital gains tax on property sales, local stamp duty, income tax on rent and annual wealth tax. All can be mitigated, but usually with specialist advice to avoid causing tax difficulties in the UK.

Spanish eyes

Elsewhere, people investing in Spanish property – now a relatively conservative BTL market – are encouraged to do so through Spanish limited companies in order to mitigate tax liabilities, particularly where the property is worth E400,000 or more. As Spain does not recognise trusts and inheritance tax rules are quite different to those in the UK, advice is essential, according to Bernardo Moya, managing director of independent property specialists Prestigious Properties.

The firm, based in Spain, provides back end support for companies – including IFAs – with clients looking to invest in property overseas and acts as an introducer for them.

According to Moya, the potential pitfalls associated with overseas property investment are reducing. He points to the introduction of new regulations in Spain that seek to improve the transparency of property transactions, adding that other countries were taking similar steps to fall in line with EU requirements.

Among the consumer protection measures present in Spain are guarantees that buyers’ deposits for offplan homes are refunded with interest if the developer defaults and a requirement for all defects to be insured for 10 years, says Moya.

But he adds, “a lot of IFAs still tend to shy away from overseas opportunities, despite the potential money involved, because they are dealing with unregulated markets”.



Source: Financial Times