Page last updated at 00:01 GMT, Wednesday, 14 November 2007

Buy-to-let becomes more complicated

Money Talk
Jonathan Moore
Mortgages for Business

Jonathan Moore
Jonathan Moore
The past decade has seen phenomenal increases in property prices across the whole of the UK, making buy-to-let an attractive investment option.

Buy-to-let lending in the UK now accounts for 12% of all mortgage advances, compared with just 3% five years ago.

It has never been easier to invest in property, from solid terraced homes to city centre new build apartments, property investment clubs, and even companies offering investment in hotel rooms.

But with so much advice on offer to property investors it can be difficult to make an informed decision before taking the plunge.

With house prices now cooling, and with lenders becoming more wary in the wake of the Northern Rock crisis and the "credit crunch", careful analysis of the costs and potential pitfalls of being a landlord is vital.

Bigger deposits

Anyone making any investment decision should do their research thoroughly, a point that is all the more important when it comes to property.

It is never a good idea to buy a property you haven't seen

The property market is awash with new-build city centre flats and it is here that many investors find that they will lose money, both on the capital they have invested and on rental income.

Many lenders now refuse to lend on new-build properties because of this very problem.

Others are demanding much higher deposits of about 25% to ensure there is some equity in the property.

This is a particularly pertinent point for those who choose to enter the buy-to-let market via property investment clubs.

Location and regulations

It is not a good idea to buy a property you have not seen, in an area you do not know, and where you have little idea of rental income and resale values.

To Let and For Sale signs in York
To Let signs vie with For Sale signs in many towns and cities

Successful investors should be able to demonstrate a good understanding of the area and the type of tenant they wish to attract.

Our own research shows that investors make the best returns from family homes, with good transport links, good schools, evidence of regeneration and so on.

The old adage "location, location, location" still rings true.

Investors need to be aware that in 2006 the government introduced a new licensing scheme for houses in multiple occupancy, making the property and landlord adhere to certain standards before it can be legally rented.

Without a licence obtained from the local authority it will not be possible to secure funding.

New investors will also need to be aware of the tenants' deposits scheme.

Tenants' deposits are no longer held by the landlord, but by an independent government-appointed company.

This step was taken to avoid disputes between a landlord and tenant.

Doing the maths

Buy-to-let mortgages, unlike residential mortgages, are generally not calculated as a multiple of the applicant's income.

Investors should consider the scenario of higher interest rates

Instead, they are calculated against the monthly achievable rent for the property - the "rent-to-interest" cover.

Put simply, the rental income a property can achieve must be greater than that of the interest-only mortgage payment.

Historically, buy-to-let lenders look for a rent-to-interest figure of 130%, meaning that rental income exceeds the interest only mortgage payment by 30%.

However, as interest rates have increased, lenders have softened this requirement and it is now possible to find mortgage products with a 100% rent-to-interest figure.

It should be noted that such products typically attract a higher arrangement fee.

Investors should consider the scenario of higher interest rates and whether the rent will be sufficient to cover possible increases.

Bank rates

Libor (London Interbank Offer Rate) also forms the basis of some buy-to-let mortgage loans and is more common in the buy-to-let market than the residential market.

Libor is the rate at which banks lend each other money.

Because banks are currently less willing to lend to each other, this rate has been pushed up significantly.

Libor is normally on a similar level to base rate. However three month Libor has been as high as 6.75% recently, making Libor-linked mortgage much more expensive.

A number of buy to let lenders also use Libor as a benchmark for their standard variable rate.

Changing deals

Buy-to-let lenders are increasingly offering extremely competitive headline interest rates and gaining their margin through a higher arrangement fee of up to 3% of the loan.

Buy-to-let, like most investments, should not be seen as a way to a quick buck

This is a particular issue with one year, fixed rate, buy-to-let mortgages.

The process of remortgaging means investors will incur fees each time they remortgage, and the value of a mortgage must be assessed against the incurring of these fees in future transactions.

Lenders tend to be risk averse and many will avoid certain types of property including bedsits, studio flats, high-rise flats, DSS tenants, ex-local authority properties, houses in multiple occupancy and flats over commercial premises.

That said, houses in multiple occupancy and flats over commercial premises tend to attract higher rental yields, thus making them attractive for investors.

This year has seen lenders introduce specialist buy-to-let products designed to finance these types of property.

Capital growth

Buy-to-let, like most investments, should not be seen as a way to a quick buck.

Whilst rents have increased steadily and demand for rental properties remains high, investors are unlikely to see substantial revenue from rental incomes alone.

Investors need to have a long term investment strategy that looks for capital growth on their property or property portfolio.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

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