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Could the Buy to Let Boom be Entering its Final Stage?

Property trader Paul Ribbons offers some highly controversial opinion on the potential direction of the UK residential property market

This article may not appeal to the faint hearted. Through any economic growth cycle, or 'boom and bust' as the headline writers like to call it, there are points at which danger signals shout the loudest.

We are now entering a danger point as I write this and even though it is not yet obvious, I'm very concerned that as with any cycle, timing is crucial.

After recently reading an article in the 'The Mail on Sunday' in the personal finance section there was a special report on: 'BTL the new landlord's investment boom'.

It was reported that the results of a survey had revealed that 65% of investors are making BTL their new pension. The reasons given were poor interest rate returns, a new generation being 'forced to rent' and extremely poor pension pots. All of these issues are causing even more people to consider BTL as an investment vehicle.

So, what do I mean when I ask the opening question?

Well we need to go back a few years to a time before the height of the 1980's UK growth cycle. This was a time of great optimism and general government reform. Two things happened in the Thatcher era that directly affect your property investing business, whether you think this is good or bad will be down to how well you fare over the next five years.

Let me explain…in 1986 the Financial Services Act changed and this allowed the shackles to be removed from the banks. These had been placed on the banks in the last major financial market crash back in the late 1920s. The banks were heavily restricted because of their irresponsibility when lending in the stock market boom. #S

The Financial Services Act was revamped by Ronald Reagan and Margaret Thatcher and at the time this was to great acclaim. This subsequently led to a period of massive growth because banks now didn't have to answer to government because they were self-regulated and really could do what they wanted, (this is a very simple explanation).

Some even say (including me) that this led to the credit crunch in 2008; did they (Ronnie and Maggie) have any idea what could have arisen from this reform? I doubt it.

So where does this come through to our BTL boom? Well, in the late 1980's, the Housing Act was also reformed and this directly affected your chances as a landlord because it now meant that tenants had no rights to a long-term tenure within a rented property. In other words the law was on your side as a landlord. This led to private sector landlords taking up the slack from central government in providing rental accommodation and to help the housing supply crisis to gradually take place. This has certainly had the desired effect although it has taken many years.

So these two things together helped to create the BTL lending products that were made popular for private landlords. In 1996 the BTL mortgage was created due to another housing reform to tweak the AST which gave confidence to lenders who were hungrier for a new product to make money from.

Now it is being widely reported that the expansion in rented properties has been 40% since 2005 making it currently 3.8m and this figure is growing every year by at least 150,000 properties.

I suspect this figure could substantially increase over the next couple of years as property prices start to rise dramatically and while interest rates remain low. And, after reading that 'Mail on Sunday' report, for me it's a foregone conclusion.

Now…because of low interest rates, some large companies are starting to look at income producing assets. Where do they park their money to get a good return? This has got the attention of a couple of the biggest insurance companies in the country (Prudential and Aviva) and they have recently announced that they intend to enter the UK's residential rental market and supply more purpose built rental units.

This is an interesting move and shows just how lucrative they see property investment in the long-term. These big professional outfits are now starting to look at hedging against inflation and are looking at yields. The rise in rental demand over the last few years has pushed average rents up to all-time highs. It is regularly reported that (nominal) rents have gone up by over 20% during the last five years and in some areas they are still rising.

So a brief overview is that:

  • Property is now seen as low risk to investors.
  • Lower borrowing rates and higher rents equal better net returns.

Because there are not many other income producing assets around at the moment, property looks like a sure thing…right?

Wrong! There is no such thing as a sure thing unless you have a one horse race but then obviously that would not be a race and I will come back to this point later.

Let's take a look at what has helped this market. We have to remember supply and demand in any market.

So what has fueled the 20% rise in rents over the last five years?

Well unless you have been living on Mars during this time then you will know the answer. It's all down to finance - well the lack of it, as according to Savills, over a million good quality buyers have been denied mortgages because of the lack of credit available or because of the increased deposits needed. Also, another half million less credit worthy buyers have also been denied. So this means many people have had to rent rather than buy and this has fueled the buy to let boom.

Now my question is this: If you were young and could not get your hands on a mortgage through no fault of your own how would you feel?

I'll leave you with that thought. So this situation has pushed rental prices in an upward trajectory and everything is now 'hunky dory'? Well just as I mentioned earlier there is no such thing as a sure thing.

So where is all this going Ribbons, come on get to the point!Well I don't want to be the bearer of bad news, I just want to be the voice of reason and I'm very concerned that the BTL boom is about to enter its final stage.

You see if you keep adding lots of property to the rental market and demand does not increase, then what will happen to rents? Yes, they will soften.

LSL the largest estate and lettings chain in the UK with brands such as Your Move and Reeds Rains has recently reported that rents for the first time for many years have not risen.

But…and I accept it is still a big but…what will happen when all those people who were denied mortgages, can, all of a sudden, get one and on top of that property prices start to increase?

Yes you know…they will be buying again and quickly, because from January 2014 residential mortgages for property valued below £600,000 will be underwritten by a guarantee from the government, so the banks can start to lend at 95%. This Help to Buy scheme is for three years and it will underwrite up to £130bn worth of mortgages.

So you know those one million quality buyers who are renting. What will they do?

Yes you got it, many are going to look to buy and do you think they will take their time and make sensible decisions or are they going to panic buy before the money runs out? Well I suspect that as they would have already been denied in the last five years many won't want to hang around. Would you? Remember I asked you how they would have felt; just imagine being in their position.

And this is my key point…I believe that this is going to fuel the biggest price rise we have seen in property for a long time. A rise not seen since the early-1970's when values doubled between 1970 and 1972 and doubled again between 1975 and 1979. And I think it could do the same, yes that average prices could double in two to three years.

In east London I have seen prices rise by as much as 40% recently, and this has not yet reached the mainstream media headline news but be ready, as it will encourage even more BTL landlords to buy properties.

Watch over the next few years as you see the property gurus encouraging people to buy because it's boom time and 'capital appreciation' becomes the new buzz phrase instead of 'cash flow'.

Now this is surely great news? Well I'm not so sure.

As prices rise, portfolio values increase and remortgages will be back in vogue so investors will increase their capacity and buy more because that is what is being taught and more investors look to BTL for their new pension.

The problem is what will happen if property values get out of control? How can the BoE stop a property bubble of magnitude proportions?

Yeah you guessed it, they will raise base rates.You see most investors know that interest rates will rise and many sensibly do stress test their portfolios at 6-8% levels but they don't take into consideration a substantial drop in rents, and up until now why would they.

Do you remember all those one million tenants who are potential buying, so what will that do to rents? I believe demand will drop off substantially just around the time that there is a surge of rental stock from Prudential and Aviva, plus all those landlords buying like crazy in the next two years.

This will cause a massive imbalance and the effect will be sliding rents.

And the worry is this has already started as LSL say that average rents for the first time for some years have not risen due to an increase in first time buyer activity. There is also a by-product of an oversupply of any market which is take-up so what do I mean by that?

Well as demand slides there will be voids and also the quality of the tenants will diminish and demand won't be as strong as it has been over the last few years.

Landlords will be fighting for the best tenants and only the best quality properties will let well. Are you starting to get the picture now?

One million people leaving the rental market ASAP, starting from next January. More rental stock and the quality of tenants dropping equal's a potential collapse in average rents.

This I believe will cause rents to slide and quickly by as much as 10-25% and this combination will cause the next big crash which will be landlord led.

All because of inexperienced, uninformed landlords who enter at the final stage of the boom cycle, not knowing what could potentially happen:

  • Sliding rents between 10-25% lower than current levels
  • Higher rates 5-7% mortgages - Coupled with voids and late paying tenants.

All this could lead to massive minus cash flow for the unprepared which will make it 'Repo City' I'm afraid - it's been seen before and I think we'll see it again. My concern is that the BTL business model has never been properly tested and as lending gets slacker and loan to values go higher this is when the market becomes vulnerable.

It could be a disaster waiting to happen; so what are you supposed to do?

Well I know and believe that property investment can yield fantastic returns if properly managed but the most important thing to remember is never to take it for granted. Things can and will change so always buy in the best locations and please don't say you were not warned.

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