Is buy-to-let on the brink of collapse?

The number of outstanding buy-to-let loans rose to 1,038,000 – worth £122bn – at the end of 2007, according to Council of Mortgage Lenders’ figures, up from 846,900 worth £95bn a year earlier.

But was this the last push before Britain’s property entrepreneurs finally abandon a fading investment and can landlords still make money out of buy-to-let?

Buy-to-let – then and now

The problems facing buy-to-let can be traced back to the root of its popularity – Britain’s decade-long house price boom. When buy-to-let first took off in 1997, the average property cost £70,000 according to the Halifax House Price Index, compared to £197,000 at the end of 2007.

The seemingly inexorable rise of property values has enticed increasing numbers of landlords into buy-to-let in the hope of turning a handsome profit.

With house price inflation delivering big capital gains, many landlords have moved away from the original concept of buy-to-let, which was that rental income paid the mortgage and then delivered healthy returns on top. In January 2002, the average rental yield, according to buy-to-let lender Paragon, was 9.84%, with £8,630 worth of rent a year delivered by an average property costing £87,714.

In January 2008, this had fallen to an average yield of 6.2%, with £11,581 worth of rent delivered by an average property costing £187,748. This means that nowadays the average landlord would need to buy a property that cost £100,000 more than six years ago, to get just £2,951 more rent per year.

And not only have returns fallen, but the cost of entry to buy-to-let has soared with a 15% deposit for an average property more than doubling from £13,000, in 2002, to £28,000 today.

Buy-to-let mortgages

With landlords struggling to meet traditional 125% rent-to-mortgage payments and 85% loan-to-value requirements, lenders loosened lending criteria and in some instances took landlords’ personal income into account.

But the credit crunch and fears for the property market have led to many easy buy-to-let deals being pulled.

Boom town flats: The landmark Green Bank development in Leeds has been mothballed Alan Harper, of financial information specialists Moneyfacts.co.uk, says: ‘In May 2007, when property prices were rising and the market was booming, 13 buy-to-let lenders were prepared to offer 90% LTV – the highest ever offered on a buy-to-let mortgage. Now this number has dropped to five. ‘This suggests lenders are more actively competing for less-risky business and allowing landlords with larger portfolios, who can afford to put down more substantial deposits, to take advantage of the most competitive rates.’ Offering easier access buy-to-let deals may have appeared good business when funding was cheap and prices were rising rapidly, but with the cost of borrowing up and annual house price inflation slowing – from a 12-month peak of 10.3% in May 2007 to 2.7% in February 2008 – lenders are repricing risk. Tim Hague, managing director of buy-to-let giant Birmingham Midshires mortgages, said: ‘From November 2006 to the middle of last year there was strong competition in the market place and some lenders relaxed criteria to where some of us didn’t want to go – these are lenders that no longer exist.

Simon Lambert, This is Money

1 March 2008