Mortgages that helped fuel speculation during the U.K.’s housing boom by turning homeowners into aspiring property moguls are making a comeback.
Investor demand for bonds backed by so-called buy-to-let mortgages surged last week by the most in almost two years, according to JPMorgan Chase & Co. New lending to rental property investors rose 40 percent last year to 14.1 billion pounds ($22 billion), the Council of Mortgage Lenders said today. That outpaced a 3.9 percent gain for all new residential lending.
While Britain’s economy may slide into recession in the first quarter and unemployment is at a 16-year high, buy-to-let mortgages are gaining as tighter credit keeps potential first-time buyers renting. Low interest rates and rising rents are encouraging investors to put savings into the properties, and falling late payments and lower repossessions have lured back lenders including Yorkshire Building Society and Banco Santander SA that exited the market during the slump.
“It’s the only growth story in the broader market at the moment,” said Jeremy Law, head of buy-to-let lending at Yorkshire Building Society, the customer-owned lender that began offering loans across all of England and Wales Jan. 23.
The extra yield investors demand above benchmark rates to hold 3-year senior bonds backed by U.K. buy-to-let mortgages contracted 20 basis points last week to 330 basis points, or 3.3 percentage points, JPMorgan data show. That’s narrowed from 11 percentage points in June 2009 and is the least since August.
Relative yields on five-year bonds backed by prime mortgages to U.K. homeowners fell 3 basis points to 155 in the week ended Feb. 3.
“There’s a realization that buy to let is a prime credit-quality risk,” said John Heron, director of mortgages at Paragon Group of Companies Plc, which lends mainly to landlords with more than 10 properties.
Paragon raised 163.8 million pounds in November by selling bonds backed by buy-to-let loans, its first issue since July 2007. The mortgage provider has climbed almost six-fold in London trading since November 2008 after losing 97 percent of its market value during the previous 32 months. Today, the shares rose 2.3 percent to close at the highest in six months.
Buy-to-let mortgages differ from loans to owner-occupiers because borrowers generally don’t repay the principal and use rental income to pay the interest. Most lenders require that rent equals 125 percent of interest, giving them a buffer in case the building isn’t fully occupied.
Landlord financing became easier to obtain starting in the 1990s, when the government allowed more companies to provide mortgages. That fueled a 19-fold increase in buy-to-let lending in the decade ending Dec. 31, 2007, during which U.K. home values tripled, Savills Plc estimates.
TV shows promoted rental property as a way to diversify savings. In the final years of the investment boom, buy to let developed a reputation for get-rich-quick schemes as property investment clubs offered seminars to persuade novice investors to put savings in new residential development projects.
Homebuilders responded by constructing more apartment blocks, particularly in former industrial cities in northern England, tailored for investors. Many still stand empty, blighting neighborhoods, a testimony to the unrealistic rental projections of borrowers who paid too much for them.
“A small minority gave buy-to-let a bad name,” said Law. “People didn’t use it to fund a landlord business, but as a speculative way of making lots of money.”
The boom ended with the freeze in global credit markets triggered by the U.S. subprime mortgage crisis. Companies scaled back or withdrew from the market after a 15 percent slide in U.K. property values in the 18 months through March 2009.
Yorkshire Building Society, based in the English city of Bradford, bought unprofitable Chelsea Building Society in April 2010. Eight months before the purchase, Chelsea disclosed 41 million pounds of suspected or proven cases of mortgage fraud, mainly buy-to-let loans.
Bradford & Bingley Plc was the U.K.’s largest buy-to-let lender, according to Council of Mortgage Lenders data, until its takeover by the state in 2008. The government sold the branch network and savings deposits to Madrid-based Santander. Repossessed homes or late payments of more than three months affected 1.26 billion pounds of loans as of the first half of 2011, or 3.56 percent of the loan book of the “bad bank” now managed by a unit of the U.K. Treasury.
The delinquency rate for the 36.6 billion-pound market of securitized buy-to-let loans has dropped to 1.68 percent in the three months to November from 1.79 percent in August 2011, according to Moody’s Investors Service. The measure rose to 3.95 percent in the second quarter of 2009.
While property values fall, investor demand for buy-to-let loans has increased because of the attractive income rental properties generate compared with other financial assets.
“Now’s a good time to invest,” said Richard Blanco, 45, who plans to buy a property a year to add to the 10 rental homes he already owns in East London and Nottingham. “Prices are depressed and people are struggling to get finance so there’s less competition.”
Low interest rates mean money left on deposit earns nothing after inflation, while Bloomberg data show that an investment in the FTSE 100 index of leading shares returned an average 2.5 percent during the past five years.
Gross income returns rose to 5.2 percent last year from 5 percent in 2010 as rent rose, broker LSL Property Services Plc said. That figure excludes debt, the impact of vacancies, late rent payments and property management costs.
An investor with a standard buy-to-let mortgage would get a net pretax annual return by 2017 of almost 22 percent, if current conditions prevail and home prices appreciate at the average rate of the past two decades, the Association of Residential Letting Agents projected.
About 25 lenders are offering the mortgages compared with 19 a year ago, according to Mortgages for Business, a broker based in Sevenoaks, England.
“Given the flat residential market, a quality buy-to-let offering, aimed at non-professional landlords, poses a good growth opportunity,” said Phil Cliff, director of mortgages at Santander UK Plc, explaining why the unit of Madrid-based Banco Santander SA resumed buy-to-let lending in December after withdrawing in 2008.
Borrowers typically pay as much as 1.5 percentage points more interest on a buy-to-let mortgage than for owner-occupied loans, said Ray Boulger, a senior technical manager at mortgage broker John Charcol.
Increased competition has led some lenders, including Clydesdale Bank, to start offering mortgages with only a 20 percent down payment requirement for borrowers instead of the 25 percent deposit prevalent since 2008.
The number of loans available is still a fraction of the 3,305 products available at the peak of the market in August 2007. The 14 billion pounds of advances that may have been loaned this year compares with 45.7 billion pounds loaned in 2007 at the height of the last property investment boom.
“The tests are still to come for buy-to-let, when interest rates start to rise,” said Jonathan Livingstone, a senior analyst at Moody’s, who covers U.K. residential mortgage-backed securities.
Lenders have learned the lessons from the recent bust and are more rigorous in underwriting new loans, said Nigel Stockton, head of financial services at Countrywide Plc, the U.K.’s largest mortgage and real estate broker.
They’re limiting the number of loans secured by properties in any one development after being left with multiple bad loans in new apartment blocks when the market collapsed, he said. Advances to any one landlord are also restricted, he added.
Lenders are reluctant to deal with novice landlords, said Ian Potter, operations manager of the Association of Residential Letting Agents industry group. They impose penalties on early repayments to deter property speculators and verify loan applicants’ rental assumptions independently, he said.
Giving them more comfort are current conditions in the housing market, which appear unlikely to change any time soon. High property prices and large down payments required by mortgage-lenders are forcing more Britons to rent.
A shortage of properties to lease lifted rents by 4 percent last year, LSL estimates, based on a survey of more than 18,000 homes in England and Wales. Countrywide estimates that 3.3 people competed for each rental property on its books in the final quarter of last year and it took less than two weeks on average to lease a home.
U.K. households in private rented accommodation increased by 1.45 million in the five years to the end of 2011 to 4.9 million, real estate adviser Savills estimates. By the start of 2015, the private rented sector will represent 20 percent of Britain’s housing stock, Savills estimates, compared with 17.4 percent now. That would be the highest in about 40 years.
With the exception of the spike in arrears and foreclosures in 2008, CML data from 1999 to 2010 show late-payment rates for owner-occupiers exceeded buy-to-let mortgages each year.
Arrears of more than 90 days represented 1.38 percent of the 1.4 million of outstanding buy-to-let mortgages in the fourth quarter, CML data show. That compares with a 1.98 percent late-payment rate for the 9.8 million of owner-occupier loans.
“Buy-to-let came through the recession showing it was much more resilient that many thought,” Charcol’s Boulger said. “What appeals to lenders is the higher margin for less risk.”