Personal Finance: A house that's not a home

Buyer beware: a second property could leave you high and dry

Savers worried by continuing volatility in world stockmarkets, or those in need of a regular income stream, are reverting back to that traditional mainstay for investors: property. Buying a second home and renting it out is often seen as an attractive alternative to equity-linked investment. Would-be investors are seduced by the potential returns: up to 10 or even 12 per cent in gross rental income alone, plus any increase in the value of the property itself.

These figures ensure that a growing number of investors are beating a path to the door of institutions willing to lend them the money to go ahead with a property purchase.

Since the Association of Residential Letting Agents (Arla) launched its buy-to-let scheme in 1996, pounds 1.75bn has been invested, with 4,609 mortgages completed between November 1998 and January 1999 alone. This figure is currently boosted by the recent interest rate cuts, which have seen the cost of home loans drop to their lowest in more than 30 years.

Among cheap buy-to-let mortgages on offer, most on a loan-to-value of around 80 per cent, are a five-year fixed rate from Cheshire Building Society, pegged at 6.19 per cent, a 6.2 per cent fix over the same period from Legal & General Bank, and 5.99 per cent fixed for two years from UCB Home Loans, this last with a pounds 495 application fee. Yorkshire Bank also offers a two-year fix, pegged at 5.74 per cent, which is also available over 5 years. A number of discounts and cheap variable rates are available from various lenders.

Some experts believe the market is set for further expansion, with demand for rented property about to surge. Mark Chilton, managing director of Savills Private Finance, the financial arm of estate agency chain FPDSavills, says that while home buying remains the dominant choice for families, changing social trends mean renting will remain important.

This is caused by an increase in short-term contract working, more single-parent families and single occupiers, suggesting that individuals will need to rent to retain flexibility over their living environment. This, FPDSavills argues, helps explain why the average age of first-time buyers has moved from 21 in 1988 to 30 today.

However, Mr Chilton adds: "Although investors are attracted by the average gross UK residential yield of around 9.5 per cent relative to other assets, where equities are yielding 2.7 per cent, long-dated gilts 4.7 per cent and commercial property 6.8 per cent, caution is necessary.

"In order to maximise the yield from such investments, investors need to look much more at net yields, taking into account all the costs associated with owning and holding a property."

Despite this rosy scenario, some property experts believe investors taking out buy-to-let mortgages are not being warned about the pitfalls of investing in rented residences.

In particular, some lenders are allegedly not warning investors about the costs of letting property or poor prospects for rental growth. Nick Jopling at estate agents Allsop & Co says: "There should be a health warning on buy-to-let mortgages to make investors aware of issues like voids, management fees, maintenance costs and insurance, which add up to around 25 per cent of the investor's gross yield.

"Low mortgage rates are curbing the demand for rented accommodation. Investors should also take into account the quality of product and where the property is situated."

Indeed, the suggestion is that in London, one of the big recipients of buy-to-let mortgages, there has been a fall in demand for rental accommodation. This has coincided with a big increase in supply, fuelling further caution about rental growth.

According to FPDSavills' quarterly bulletin on the residential market, central London prime rental values will fall. Weakness in demand is likely to result in falling yields and a rise in voids.

The FPDSavills report warns: "A typical gross-to-net yield reduction is 3 percentage points from the original gross initial yield. Our comparative research has shown that this is typical for a variety of property types and locations. With current buy-to-let finance at around 6 per cent on an 80 per cent loan, it is not difficult to see a situation where debt repayment might become a problem for some landlords."

Charles Fairhurst, chief executive of Fairbridge Estates, a large new home builder, says his own industry is concerned about the buy-to-let schemes on new development.

"Housebuilders are not selling to end-users but `weak holders', who can't get the properties let. We are looking at acquiring a 20-unit development in Kensington in London. We had a meeting with all the top agents about the market, and it turned out that there were 681 residential units available for rent in that area alone."

At Arla, their spokesman Malcolm Harrison says that the association does advise buyers on the pitfalls of the market. "I don't know why the industry is so concerned. We have been getting the message across, through the press and advertising, that investors should approach letting agents first before applying for a mortgage."

Jeremy Wood, head of housing and business finance at Nationwide, which refused to join the buy-to-let venture, said: "We felt that buy-to-let was for the agents' benefit, not for anyone else. The risks were not being explained. Also, there is no obligation for agents to perform. There needs to be some kind of regulation."

Despite the growing popularity of buy-to-let schemes over the past two or three years, independent financial advisers are sceptical about its merits. Roddy Kohn, principal at Bristol-based Kohn Cougar, says: "The idea of owning your own bricks and mortar can sound very attractive. Much more so when compared to simply having a box file with flimsy bits of paper denoting an investment or a unit trust.

"But many people simply don't realise what is involved in the property. For a start, you have to be quite careful where you buy. You will have to pay legal fees, borrowers' fees and then pay for the place to be done up.

"Although repairs to a property while it is occupied are tax-deductible, it is a moot point whether you can claim a deduction in the same tax year if any repair or decorating work was carried out before the first tenant moved in.

"You have to pay for an agent to look after the property, who will probably take up to 15 per cent of any rental income. You pay tax at your own higher rate on the income, minus expenses, and are subject to capital gains tax on the property when it is sold.

"Moreover, many people don't factor in that if the place is empty for any reason, they don't receive an income. And what happens if the tenants don't pay? It can take weeks or even months to evict them."

Mr Kohn says his general argument is that most people already have a sizeable investment in property anyway - their own homes - and it does not make sense to place all their eggs in one basket.

He is particularly worried at the way in which investors are being advised on very substantial financial commitments without any regulation of those doing the advising: "If I were to recommend an investment of pounds 100,000, involving substantial borrowings, at least my advice is open to regulatory scrutiny. This doesn't appear to have any controls on it at all."

A spokeswoman at the Financial Services Authority, the City watchdog, says it is unable to regulate buy-to-let mortgages as distinct from ordinary home loans.

"To regulate one type of loan would mean imposing controls on the other, which would require changes to the Financial Services Act. This is currently a matter under review by the Treasury."

She adds: "We are not shirking our responsibilities in this matter. We have made it quite clear that we are prepared to regulate the sale of mortgages, if that is what is decided. Our consumer panel has argued for this for years, and this is really a matter for the Treasury."

Association of Residential and Letting Agents: 01923 896555

Amber Rose is a writer at `Estates Gazette'