Should you gamble by investing in property?

Published 11th May 2009

With Legal & General seeking to be buy-to-let landlords under government scheme here are pros and cons of lettings market


Pension funds are seeking to become the new buy-to-let landlords amid growing signs that the residential property market is over the worst.

Legal & General, the insurer, is contemplating its first foray into residential property through a government scheme to develop new homes that it will let to private tenants.

L&G said it plans to contribute £1 billion to the Homes and Communities Agency’s “build-to-let” scheme through a residential property fund.

Bill Hughes, head of property at L&G, said: “House prices have fallen 15%-20% since their peak, making residential property significantly more attractive to us. As capital values have fallen, the income we can make from investing has increased. Supply of new housing remains constricted, and this boosts the prospects for the sector.”


Fund manager Schroders has also committed to fund a housing development in Croydon, south east London, through a limited partnership, and is preparing to launch a fund to provide seed investment for more projects.

William Hill, head of property, said: “If the pilot project looks like it’s going to work, we will set up a fund, potentially open to retail investors."

This interest from institutions could signal the bottom of the market, some say. Lucian Cook of Savills, the estate agent, said: “They know we’re sufficiently close to the bottom to see capital appreciation at least in the medium-term. Their investment should stimulate growth in the private rented sector.”

Hughes said he would hope to get a yield of 6% after costs, which is particularly attractive given that only two years ago buy-to-let investors couldn’t hope for much more than 4%.

L&G hopes to build as many as 12,000 homes for rent via the fund, which would be let to key workers, including teachers, hospital workers and police.

Cook said: “With pension funds chasing yields of 6%, the attraction for investors is clear. That said, the institutions have the advantage of huge economies of scale and government support. The amateur buy-to-let market is also more constrained by mortgage finance.”

The Sunday Times assess the pros and cons:

Yields are rising

Rental yields — the income from rent earned on a property as a proportion of the purchase price — are expected to average 6.3% during 2009, said Savills. Last year, yields averaged 5.6%.

Ian Fletcher of the British Property Federation said: “The fall in property prices during the current downturn has made the yields offered by residential property, which are typically modest, much more attractive.”

New-build properties, which have fallen by about 50% in price, are yielding as much as 10% in Liverpool and east London. At the March Allsop auction the average rental yield was 8.19%.

The improvement in yields, and cheaper borrowing costs means that investors can expect better returns than when the property market was at its peak in October 2007, according to Savills.

Investors who purchased an average house priced at £186,044 with a deposit of £18,604 in October 2007 would have been able to get a mortgage of 6.23%, or £5,795 a year. With a typical yield of around 4.6%, or rental income of £5,662, they would have been £132 out of pocket, Savills said.

However, an investor who bought an average house for £151,861 in April with a deposit of £37,965, could have got a mortgage of 4.95%, or £3,758 a year. With the typical yield now 5.56%, or rental income of £5,488, they will make an annual return of £1,729.

Tax favours buy to let

Higher-rate taxpayers are being advised to move into property investment after the budget, which introduced a tax rate of 50% for those earning above £150,000 from next April.

Leonie Kerswill of Price Waterhouse Coopers, the accountant, said: “We have seen wealthier investors take a renewed interest in residential property investment. It’s a preferred option for high net worth clients no longer wanting to save into a pension.”

Property sales — aside from homes used as a principal private residence — are liable to capital gains tax at 18%.

While investors must pay income tax on the rent, mortgage interest payments can be offset against the income. Losses incurred on the sale of an asset can be set against other capital gains of that year and future years — including profits made on share sales.

Furthermore, if the rent fails to cover the mortgage interest repayments on one property, this loss can be used to offset any profit from other properties that year — or the same property in future years.

THE CONS

Costs are increasing

Government proposals that will require all private landlords to register before letting residential property could add to costs.


Landlords would pay £50 to be registered, and would have to comply with an industry standard for repairs and dealings with tenants.

Damian Greenish of Pemberton Greenish, the property law firm, said: “The market is already heavily regulated — for example, landlords who invest in houses of multiple occupancy (HMOs) are already required to apply for a licence and all landlords comply with health and safety regulations.

“Unnecessary rules could prevent people from moving into the market.”

Mortgages are still hard to come by

The number of buy-to-let deals has plunged 95% from 4,384 to 213 over the past two years, according to the comparison site, moneysupermarket.com.

Rates on deals have also failed to come down despite the 4.5 percentage point cut in Bank rate. Buy-to-let rates have fallen just 1.5 points against 2.6 points for standard deals since October 2008.

The lowest buy-to-let rate is a tracker from Nationwide-owned The Mortgage Works at 3.39% — however this has a 3.5% fee. Some lenders, such as Coventry building society, now require a deposit of 50%, while rental income at 130% of repayments is now standard.


However, brokers said that wealthy investors looking to put together a portfolio of more than £1m could get better deals with a private bank or foreign banks, such as Handelsbanken of Sweden or Bank of China.

Ian Gray at largemortgageloans.co.uk, a broker, said: “You can organise finance at around 5% provided your income covers the loan. Lenders usually want your salary to cover the loan by a multiple of five before they will commit.”

THE ALTERNATIVES

You can gain exposure to the residential property investment market without buying bricks and mortar via funds.

For example, CBS Property, set up by Pointon York Sipp, the self-invested personal pension provider, invests in high-yield student lets and HMOs.

The “buy-to-sell” fund, which aims to convert residential homes to student lettings, is looking to attract syndicates of cash-rich investors who will share the equity.

A minimum of investment of £10,000 is required, with no reliance on mortgage finance.

L&G also said that it was considering allowing retail investors to buy into its build-to-let residential property fund.

Hughes said: “The attraction of this type of investment should and could be widespread and could involve retail investment.”

Profit in panic selling

Luke Doonan bought two flats in an old conversion in Bow, east London, this month — and paid £100,000 below the asking price.

On sale for £350,000 each, Doonan paid only £250,000 for each flat.

Doonan, 38, an interior designer from Great Dunmow, Essex, has been buying and selling properties since he was 18 and has built up a portfolio of about 30 flats.

He said: “This is a great time to buy. Panicking buy-to-let landlords are selling now because they think the market is going to get worse; I think that’s really silly.”

Doonan got the finance from The Mortgage Works — owned by Nationwide building society — with a deposit of only 25%.

“The deals are out there and it’s worth shopping round for the best rate.”

Source: ' Sunday Times '

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