The fall and rise of buy-to-let
Buy-to-let is starting to look like the technology sector. In investment style they are polar opposites, of course – the one physical, unchanging and easy to understand, the other ethereal, fast-moving and based on arcane mathematical languages. Yet both have had near-death experiences that in the long run may serve to prove their resilience.
It was easy to write off the tech sector in February 2003, by which time the Nasdaq Composite index – the embodiment of dotcom speculation – had fallen by nearly three-quarters from its millennial high. A decade later, many companies have disappeared and the index is still 37 per cent below that absurd peak. Yet few now would deny the ongoing disruptive power of their survivors and successors.
Analogies should never be pushed too far, but I wonder if the British buy-to-let sector is undergoing a similar renaissance. The Council of Mortgage Lenders announced last week that buy-to-let lending in the second half of last year totalled £8.8bn. That was 63 per cent below the peak in the second half of 2007 – but still healthily up on the £7.6bn advanced in the preceding period and £8bn in the second half of 2011.
There are two big reasons for the recovery, neither of which looks set to fade. First, banks prefer investors to homebuyers. Buy-to-let lending accounted for 11.5 per cent of total gross mortgage lending last year, up from 9.8 per cent in 2012.
That's because investors can afford larger deposits – typically 40 per cent, but 25 per cent at the very least. The average first-time buyer deposit is only 20 per cent, and they can be as low as 5 per cent. This matters because regulators are forcing banks to hold more regulatory capital against higher loan-to-value assets. Being less capital-intensive, relative to other loans, buy-to-let loans are more profitable.
A bigger deposit also reduces the risk that a loan turns sour. Only 1.14 per cent of buy-to-let loans ended 2012 in arrears, compared with 2.03 per cent of owner-occupier loans. Moreover, defaulters are easier to bring to justice. After the recent spate of public relations crises, banks are very reluctant to evict struggling homeowners. But they risk no negative headlines by dealing unemotionally with struggling landlords. Last year's repossession rate for owner-occupiers was just 0.27 per cent, compared with 0.48 per cent for investors.
The other reason for the buy-to-let recovery is growth in demand for rented accommodation. The English Housing Survey for 2011-12, published this month, showed that the private rented sector now shelters 17.4 per cent of English households, up from 10-11 per cent a decade ago.
It is growing at the expense of both alternative tenures (see graph). On the one hand, owner-occupation peaked at 71 per cent of households back in 2005 and continues to decline slowly but steadily – by 0.4 per cent last year. In economically healthy areas such as London, high house prices mean young professionals now wait until their early 30s before buying a home. In other regions, the problems are different – a sluggish jobs market, weak consumer sentiment and tight credit.
On the other hand – and perhaps more surprisingly in a recession – the numbers of social renters also fell last year. There is no shortage of demand for affordable rents; instead the problem is a ballooning shortage of supply. The current government cut capital grants for building subsidised housing by about 85 per cent when it came to power.
The big question for landlords is to what degree these forces are cyclical or structural. Some are easy to categorise. An unambiguous economic recovery would give reluctant renters greater confidence in the stability of their jobs and income, prompting them to buy. On the other hand, some renters may find owner-occupation unsuited to their needs in an increasingly globalised and fast-moving jobs market.
But other forces fit less neatly. Financial regulation is making banks risk-averse now, but how long will it take for lenders to forget the lessons of 2008? Above all, it's unclear where we stand with house prices. In the 1990s they proved cyclical, but their resilience in the current downturn has prompted much talk of a structural shortage of homes. If that's true, causing house prices to remain at their current multiple of earnings, only richer renters will be able to buy when sentiment recovers. In the longer term, inheritance may shape the housing market as much as income.
On balance, I suspect these big trends will play out in landlords' favour, causing a slow but profound shift in social expectations. But owner-occupation remains entrenched across vast swathes of the country, so buy-to-let investors still need to think locally. This is a theme to which I will return in a major special report in May. For now, suffice it to say that the city that ticks the most boxes – including surprisingly high yields and a deep, growing private rented sector that already shelters a quarter of all households – is London.
Spot the growth story
Source: English Housing Survey, Investors Chronicles