Buy-to-let, boom-to bust fears?

By Michael Robinson
BBC File On Four

Is the housing market heading for a fall?

The buy-to-let business has boomed in the past five years and the number of buy-to-let mortgages has more than quadrupled as ever more people come to regard it as the dependable alternative to uncertain savings and pensions.

This market has dubious deals and misleading numbers which tempt investors to borrow more than they should to grab themselves a piece of the buy-to-let action.

At the heart of this problem is what is called "creative financing", enabling buy-to-let investors to borrow 100% of the cost of their new properties - not the 85% maximum most lenders permit.

The difference between borrowing 85% of the cost of a property and borrowing 100% is immense.

With 85% loans, investors have to come up with money of their own, and so are limited in how much they can buy. But with 100% mortgages, the brakes are off and there's effectively no limit.

The "creative financing" was made possible by discounts - typically 15% or more - which property developers offered to buy-to-let investors who bought flats in bulk.

It is simple when you know the trick.

Say a developer had flats on offer at a list price of £100,000.

An investor would buy at a 15% discount, and £85,000 per flat, but they would apply their mortgages on the basis of the full list price.

An 85% mortgage on £100,000 amounts to £85,000. Bingo - the entire cost of the flat is paid for and the investor has effectively obtained a 100% mortgage.

Everyone's putting them up back for sale hoping that they'll get a buyer Paula Jones

This "creative financing" has helped power a construction boom as new gleaming blocks of flats and apartments have mushroomed in city centres for the buy-to-let market.

Budding investor Andy Peers used a string of 100% mortgages to buy a £3m portfolio of buy-to-let flats in Machester.

He only had to find money for solicitors' fees and furnishings.

At the time he was investing, in 2002 and 2003, he said "a lot of people were doing it".

In late 2005, Matthew Wyles, the head of operations at the Portman Building Society (recently taken over by Nationwide) realised that something was badly wrong.

"It became clear to us that, in certain parts of the country, not only was this going on, it was endemic," he said.

Alarmed that the Portman was lending too much, Matthew Wyles pulled out of the new-build buy-to-let market altogether.

'Creative financing'

Other lenders stayed in the market, hoping their valuers would be able to spot discounts and take account of the "creative financing" trick.

But "creative financing" did not just help to open the borrowing and lending floodgates.

It has resulted in data at the Land Registry - the official record of property transactions - being misleading as well.

That is because, although investors like Andy Peers paid for their flats at a developers' discounted price, the full list price would end up on the Land Registry.

So a false picture of the price of those properties is conveyed to any investor or valuer using the Land Registry's prices to study a market.

Worse, those wrong prices are now disseminated through property price websites, widely used by investors and valuers to study local markets.

Interest rates

Like the self-cert scandal, this "creative financing" has been largely hidden from public gaze, because unless someone like Andy Peers tells you what has happened, it is impossible to detect.

But there is no doubt some investors have borrowed too much.

Before the financial crisis struck, Liverpool estate agent Paula Jones decided to try her luck with a buy-to-let flat.

Now with higher interest rates, she cannot find a tenant to pay enough rent to cover her outlay and she is losing £120 a month.

In the classic sign of a boom turning to a bust, the wall of Paula Jones' estate agency branch is covered with the details of properties that other buy-to-let investors are trying to sell.

Housing bubble

Her flat is now among them.

"Everyone's putting them up back for sale hoping that they'll get a buyer", she explained.

"A lot of people just tend to be losing on them."

In the face of the present financial turmoil, lenders are raising interest rates and tightening their lending criteria so, if there is a bubble in the British housing market, it will soon be revealed through the pain of people who have borrowed too much.

This week one lender, justifying new and far more stringent lending criteria, explained they were designed to ensure that people did not borrow more thay can afford.

Quite! But it would have been handy if they and their fellow lenders had thought of that sooner.

This story was first broadcast on BBC File On Four, Tuesday 25 September 2007 2000 BST and repeated on Sunday 30 September 2007 at 1700 BST.