A blip, not a burst bubble: the door is still open for buy-to-let landlords

The market is cooling but Melanie Bien finds that rental income is still buoyant and capital growth will rise again

Diminishing confidence in the housing market is starting to seep into the buy-to-let sector. According to a new report from UCB Home Loans, the specialist subsidiary of Nationwide building society, landlords are becoming more cautious about expanding their buy-to-let portfolios.

Diminishing confidence in the housing market is starting to seep into the buy-to-let sector. According to a new report from UCB Home Loans, the specialist subsidiary of Nationwide building society, landlords are becoming more cautious about expanding their buy-to-let portfolios.

"The [lettings] market is still very buoyant, as would be expected in a sector which is relatively young," says Charles Reed, UCB Home Loans managing director. "But we are seeing the first signs that enthusiasm is calming down a little in some areas, as rising interest rates and increased house prices begin to have a cooling effect."

But while critics of buy-to-let have long talked of a bubble about to burst, the evidence suggests that the market is slowing down rather than collapsing, as landlords take stock of their existing investments and expand cautiously. Figures from the Council of Mortgage Lenders (CML) reveal that the buy-to-let market continued to grow in the first half of this year, albeit at a slower rate than in the past.

"For a number of years, growing property prices, a buoyant rental market and low borrowing costs have produced an attractive combination of income and capital growth for buy-to-let investors," says a CML spokesman. "More recently, rising interest rates have increased borrowing costs for investors. But the evidence suggests that borrowers are taking a sensible approach and adjusting to tighter market conditions."

As a result, there is little evidence of significant loan repayment problems in the buy-to-let sector, with arrears running at low levels.

It is unlikely that enthusiasm for buy-to-let will be dampened for long, given that it has generated significant profits for thousands of investors in the UK over the past few years. The market has expanded rapidly: it now accounts for 6 per cent of all lending secured on residential property, compared with 0.5 per cent in 1998, according to CML figures.

The attraction of property as an investment is that it provides both income and capital appreciation. Research from Paragon Mortgages, the third-largest lender in the buy-to-let sector, underlines this: total returns generated on a £119,587 property to the year ending July 2004 were almost 25 per cent - £9,055 in rental income and £21,073 in capital appreciation.

The advantage of this combination of growth and income is that if one slows - as growth is doing at the moment - then landlords often continue to benefit from the other: in this instance, income.

Rents, meanwhile, are holding their own. The latest residential letting survey from the Royal Institution of Chartered Surveyors (RICS) says rent is "rising at the strongest pace for three years", driven by firm demand. RICS believes the rental market will be underpinned by a shortage of property and first-time buyers delaying getting on to the first step of the property ladder. So the balance of surveyors expecting rents to rise rather than fall over the next three months is firmly above the average for the past five years.

While the outlook for buy-to-let is far from bleak, the CML warns that investors should do their research carefully and settle in for the long haul. The buy-to-let sector is not the place to make a quick profit.

"With the market gradually beginning to soften in some areas, it is now more important than ever that investors take a long-term approach to purchasing buy-to-let property," says UCB Home Loans' Mr Reed. "They need to undertake thorough research before making a decision and to take at least a 10-year outlook, rather than try to make a quick gain through capital appreciation alone."

Research from the Association of Residential Letting Agents (Arla) indicates that most landlords have the right idea. It says the typical investor with a handful of properties is more interested in capital growth than income and is prepared to stay in for the long run. With this approach, short-term fluctuations in interest rates or rental income present few problems.

"Small-scale landlords, with one to five properties in their portfolio, are not so much in it for rental yield as long-term financial gain. They aren't rushing to sell at the moment because they expect to make money in the long run," says Malcolm Harrison, a spokesman for Arla.

Having said that, there are regional differences. The strongest demand from tenants in three years has been reported in the North, while the marked slowdown in demand in London continues.

Landlords with family homes to rent are also faring better, with a relatively short supply of such properties leading to strong demand.

For a free copy of the CML/Arla buy-to-let guide 2004/2005 - with information on making a return on your investment, trouble-free letting and knowing your local market - contact your nearest Arla-registered letting agent.

Details of Arla members can be found at www.arla.co.uk or call 0845 345 5752.

'Landlords need a long-term view'

Thomas Quinlivan, 39, owns nine buy-to-let properties in north London. He remains "relaxed" about the prospects for the market.

"I am not sure that there is much capital growth in property at the moment, but there has been a rise in demand for rentals from tenants," he says.

"A lot of landlords sold out early in the year because last year was quite slow for renting. But it has picked up this year because fewer properties are available to rent. To generate profits, landlords need to take a long-term view."

Mr Quinlivan, a property developer, puts his success down to staying invested for the long term (he bought his first property in 1988, just before the crash, and still owns it today).

He also maintains high standards in his properties so tenants are happy to stay put rather than move on after a few months.

"I don't have a lot of churning between tenants," he says. "So when the downturn came [last year], I didn't have to reduce rents to attract new tenants as mine all stayed."

While Mr Quinlivan has made a success of buy-to-let, he wouldn't advise anyone to move into the bricks-and-mortar market just now.

"There are few property bargains out there at the moment. This time next year is when I will start buying again."