Is the Buy-to-Let Bubble About to Burst?

UK landlords were left feeling rather shaky this week as media speculation mounted over the miserable prospects for the UK buy-to-let market. A set of concurrent circumstances has left landlords at the lower end of the market feeling a definite pinch in their wallets, with all the signs pointing towards that pinch getting even tighter in the near future as buy-to-let financing gets tougher.

With news yesterday that the Bank of England elected to hold interest rates as expected, at 5.75 per cent following five consecutive interest rate increases since August 2007 and finally the first sign that house prices have gone off the boil with figures out yesterday from the Halifax average national house price survey, showing that, for now, house prices this year fell by 0.6 per cent in September for the first time since December. Annual house price inflation however still stands in double digits at 10.7 per cent and this first drop is fuelling fears that next year the economy maybe hit hard by a prospective downturn in the property market brought about global credit issues.

Add into the mix, the recent Northern Rock hoo-ha and landlord confidence in what has been the key engine for the economy in recent years, is at an all time low, especially now the crisis has had a knock-on effect with the Treasury’s present forecasted growth prospects for next year, being downgraded by the Chancellor from between 2.5 to 3 per cent next year, to perhaps as little as 2 per cent.

Fundamentally, it’s simply a matter of doing the math. Landlords who have borrowed more than half the value of their property and who are earning a rental yield of 5% or less, are likely to be losing money at these interest rates, once basic outgoings have been thrown into the equation. With gross rental yields down to 4% and under in London and the South East and 6% in the north of England, it doesn’t take a genius to work out what’s going to happen if those landlords are borrowing money at today’s typical rate of 6.5%. And if you’re one of those who jumped on the landlord bandwagon with poorer quality properties, such as student accommodation in anything less than a great campus town, where void periods are possible and frequent, the future is looking particularly bad.

As always, in times of a mounting property crisis, owners look towards inflated capital values as a way of bailing out their losses but market shifts are indicating that even this could be a vain hope. Yes, the prohibitively high capital prices have meant that people are preferring to continue to rent rather than buy, waiting for prices to drop and so landlords have been cashing in on this mini boom, but this could prove to be short term and unsustainable. While talk of a drop in UK house prices has been on the grapevine for some time now, it really does look as though Britain is about to experience some kind of readjustment. The sudden, shocking drops in the formerly watertight US and Spanish markets have only fuelled the fear that the UK and Ireland won’t be far behind. With Ireland and Britain experiencing the sharpest rises in property prices in the past year, worldwide, a slowdown is on the cards. This slowdown could be quite marked, if a study by Professor Morgan Kelly of University College Dublin, is to be believed and makes for particularly difficult reading for landlords hoping to sell and run. It shows that house prices adjustments after property bubbles are consistent, with house prices typically losing a massive 70% of what they gained during the last boom. With house prices across the UK, with the exception of certain pockets, up consistently month on month, the drops are going to hurt. As the market’s boom fizzles out, there are a minority of City economists expecting the annual rate of increase in prices to tumble into low single figures by next year, as homebuyers faced with cheap, fixed-rate deals coming to an end are faced with more expensive repayments. A Reuters poll of economists yesterday showed an average prediction for house prices to rise by just 2.2 per cent over next year as a whole and a one-in-three chance of a year-long drop in house prices in 2008.

However, the Bank of England’s borrowing figures do nothing to suggest that there is much concern out there, the survey of mortgage lending for the second quarter of 2007 showing that buy-to-let mortgages were as popular as ever, continuing in their role as one of the main reasons for mortgage borrowing. Indeed, a survey conducted in August by ARLA, the Association of Residential Landlords, stated that 90% of respondents had no intention of selling their properties and that 54% expected to buy more properties for the purpose of letting them out. But this was before the Northern Rock crisis and the resulting focus on the quality of loans being offered seemingly willy-nilly to anyone with dreams of becoming the next property millionaire. The tightening up of inter-bank lending means that lenders are becoming more discriminating about who they dish the cash out to and so buy-to-let investment is expected to struggle as it becomes more expensive. It’s not all doom and gloom, though. While the smaller players with hefty loans and sub-standard properties are expected to be hit hard this year and into 2008, those with better properties and lower levels of borrowing will survive relatively unscathed, notwithstanding the expected cut in bank base rates predicted by a few economists however most believe its nagging worries over inflation will see it hold firm into 2008.

As a result, it can only be good news in the end for those looking to purchase property, especially those looking to get a foot on the property ladder, as prices readjust and become more reasonable. With troubled landlords being forced to sell to sell at a loss, a downward shift can only be a good thing.