FOOL'S EYE VIEW
Buy-To-Let: A Bubble Or Not?

By Stuart Watson (TMFTiger)
March 12, 2002

Carburton Street, London -- Much has been written over the last year or so about the potential of a bubble being created in the buy-to-let market. The very fact that so many people have issued words of caution means that the likelihood of a full-blown bubble of gargantuan tech share proportions is unlikely. But it is undoubtedly true that people have been showing more interest in this area recently. Many people have pointed to the increased traffic on our Investing In Property discussion board as yet another indicator of this. I suspect that there are few of us who haven't heard at least one friend or family member raise the subject in the last twelve months.

Whilst some may have made a decision to enter this market based upon research and a look at the underlying numbers, many have been drawn in by the lure of quick and easy gains and the fact that other people seem to be making money at it. It's the latter route will leads to disaster, as with any form of investment.

The Rise In Buy-To-Let Lending

The increased interest in buy-to-let can be seen from this table:

Period             H1 99  H2 99  H1 00  H2 00  H1 01  H2 01 
Mortgages ('000s)     19     19     19     26     28     41
Value (£b)           1.5    1.3    1.6    2.1    2.5    4.1

Source: Council of Mortgage Lenders 

In 1999, buy-to-let mortgages accounted for about 2% of all mortgage lending by value. In the latter half of 2001 this rose to around 4.6%. So, whilst the sector is still relatively small compared to the overall mortgage market, the increase in its popularity is based upon more than just anecdotal evidence. At the end of 2001, about 186,000 buy-to-let mortgages were outstanding, so you can see a significant proportion relating to loans taken out in the last 18 months.

According to the Council of Mortgage Lenders, the ratio of mortgage to property value remained at around 80% and the rental income typically covered 130% of the interest costs. Both these are generally reckoned to be sensible limits. The average buy-to-let mortgage taken out in the last six months was £100,000 and the most popular type of property is the unfurnished flat. Default levels on buy-to-let loans are lower than for those for people's own properties. So it looks like many new landlords, on the whole, aren't overstretching themselves although no doubt these averages hide more than a few cases of those that are pushing their luck.

Rental yields have fallen for the fifth successive quarter, according the Royal Institution of Chartered Surveyors. With falling interest rates, a rapid rise in house prices and an increase in the supply of properties this isn't particularly surprising. The average rental yield is currently between 7% and 8%.

These sorts of numbers all point to the fact that the balance of risk and reward in buy-to-let is possibly about right, perhaps having been particularly favourable a few years ago. So, a repeat of the recent healthy gains is unlikely and new landlords should probably expect returns in line with long-term averages. In amongst all this, though, there will those that do particularly well and those that do particularly badly. Whenever you hear people drawing sharp breaths at the merest mention of the topic, that may be a good indicator that the buy-to-let has become a good idea again.

A Viable Alternative To Shares

Should property be a significant element of your retirement fund? In most cases it already is. If you own your home, you probably already have a significant part and probably the majority of your wealth tied up in residential property. However, in this case you are both landlord and tenant, paying rent to yourself (I hope you're a good payer!)

So the question is, should you invest even more in property? If it's part of a long-term investment plan then it makes sense. Property, like shares, represents a real asset that protects your money from the ravages of inflation over the long-term. On the other hand, dipping in and out of the buy-to-let market over the course of a couple of years hoping to double or treble your deposit is asking for trouble. Investing directly in property is a much more hands on affair than shares, although you could argue the time required to invest directly in shares is probably similar. As with shares, paying someone to manage your investment will carve a hefty slice out of potential returns.

With a greater supply of rented properties, is there the demand to meet it? If there isn't, rental yields will fall further and many landlords will be left with empty properties for long periods of time. There are some signs that demand will increase. More and more, people are choosing to live on their own and the average age of first time buyers is now in the early 30's, with people taking their time to build up a suitable deposit.

Like all investment strategies you need to find the one that suits you. If you have a strange fascination with unblocking pipes and find yourself reading the property ads section of the local paper in your sleep then your investing sub-conscious is obviously trying to tell you something. Either that or you're just a little bit odd!

For more on buy-to-let see our homeowning centre