Buy to let: should you get out while you can?
By Chris Gilchrist

The rise in base rate to 5.25% and increases in mortgage rates will cost some buy-to-let investors more in interest than they get in rental income. That's no way to get rich!

Many new investors entered the Buy-To Let market in 2003 and 2004 when thBuy ey were able to borrow at little over 4%. If they have to replace a mortgage today, they will get a nasty shock: they will pay over 5% for the best deals on the market and if they want to borrow more than 80% of valuation the rate will probably be 5.5% or 6%.

Of course over that period property values have increased by as much as 50%, so investors who have been in the market for a while are showing healthy profits. But when a market ceases to be attractive to new buyers, it becomes a game of chicken for those sitting at the table. Quit early and cash in at high values, or wait in the hope that everything turns out OK, and risk seeing the market value fall 10% or more from current levels?

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A scramble for the exit by sellers could spell disaster
It will not take many people trying to sell to outweigh the shrinking number of buyers. A sharp downward spiral in prices is not only possible but has become more likely as a result of January's base rate rise - because most people believe there is at least one more quarter-point rise in the pipeline.

Today, most buyers of new-build BTL property in the South East are getting rental yields of 5% or less on the purchase price. Allow for maintenance, insurance and rental voids and the real yield is nearer 4%. Borrow 80% of the purchase price at 5.5% and you are losing money.

Purchase of new-build in the South East is attractive now only if you believe you will get capital growth. For that to happen rents must rise, yet there's a lot of new property coming onto the market. So it's quite likely rents won't rise in the short term. Rising interest rates create more uncertainty. And low-end BTL for recently arrived migrants, even in London, can still generate 7% yields, so the new-build market looks overpriced.

Property demands a blood sacrifice every twenty years or so
Today's BTL investors weren't around when prices crashed in 1990-91. I have friends who bought new-build in London from the liquidators of building firms at that time for under half the original asking price.

It's unlikely we'll see that kind of bloodbath again, because the economy is strong, unemployment is still low and even if interest rates reach 6% in the next six months, it's unlikely to provoke a panic. But overall, the chances of getting capital growth over the next few years in the new-build BTL market in the South East now look remote.

If enough people agree with me, then sales by investors will add to the supply of property and prices will come under pressure. That's the scenario I expect over the remainder of the year.

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A tale of two BTL markets
Meanwhile, there's a completely different alive-and-well BTL market amid the semis and terraces in the North, where yields are still 7% or more. Rising interest rates will affect this market too - if base rate hits 6% then even this 'in-the-money' market will grind slowly to a halt - but there's unlikely to be much selling pressure.

BTL investors had better factor mortgage availability into their plans. Once prices start to drift down, lenders will become far more demanding; mortgage valuations will typically be 5-10% below market prices, making re-mortgaging tougher; and cheap deals on BTL mortgages will vanish from the shelves.

Semi-detached market
As I've been saying for some time, none of this need worry the owner-occupier of a typical suburban semi. These houses are a poor BTL proposition because families prefer to buy than rent, and will pay over the odds to be near the right school. Provided the government doesn't take away even this choice from parents.

And families value amenities (parks, transport, crime-free) more highly than investors. So it's perfectly rational for family owner-occupiers to pay more for this type of house than a BTL investor would.

Effectively, the BTL and the owner-occupier markets have become semi-detached. As a result, I think we could have a significant drop in the new-build BTL market without it having much effect on suburbia.
That also means the picture's likely to be confusing over the next few months and you will see wildly different predictions in the media. The ones you should ignore are those from the BTL builders, estate agents and mortgage brokers. The louder they puff, the less I trust them.

Everything's relative
Property, cash, fixed interest and shares are all priced off each other. Which is most attractive at any time depends on how all the others are priced. Over the past five years, property prices have doubled while rents have risen by a third; over the past four years, share prices have doubled while company profits have almost doubled.

That means shares are cheap relative to property. Rising interest rates (up from 4% to 5.25% over the past five years) make fixed-rate investments unattractive but encourage people to keep money on deposit.

For low-risk investors, this suggests having a bigger proportion of your money on deposit; for gung-ho investors it suggests having more money in shares. And it suggests property investors should be cashing in some of their chips.