Streetwise property investors eye solid rental yields

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In a time of depressed economic growth, stagnant property prices and ongoing troubles in the eurozone, it's a surprise that any sector can be described as thriving.

However, the buy-to-let market, while nowhere near its pre-credit crunch high, is making a steady comeback.

This is evidenced by figures from IFA search engine, which show that 25% of searches on the website last year related to buy-to-let. Meanwhile, a report from specialist lender Paragon Group reveals that landlords expect tenant demand to remain robust in 2012.

"We have seen positive growth in the buy-to-let sector," says Brian Murphy, head of lending at Mortgage Advice Bureau. "Amateur landlords are coming back into the market as more lenders reintroduce competitive buy-to-let mortgages to the market. Buy-to-let is an area where lenders have increasing confidence, due to the low level of arrears and good margins."

According to Robin King, director at property specialist Move With Us, the buy-to-let sector is at the bottom of the growth curve. "People cannot afford to buy and nobody can afford a deposit on a property. In the next four to five years, I predict rental supply will increase by about 50%."

Last year, the National Housing Federation described the housing market as "in crisis" as more people were "locked out" of buying property. "There's a lack of money in social housing, and it's much, much harder to get a mortgage now. It's a complete shift towards a renting population - for a chunk of people, renting is the only option," says Ben Thompson, managing director at Legal & General Mortgage Club.

In response to this dearth of buyers, several buy-to-let lenders, including Abbey, Woolwich, Paragon and Aldermore, have crept back into the market with competitive deals. This competition, according to Thompson, is set to increase in the next five years, and this will help bring mortgage interest rates down.

In addition, the availability of buy-to-let mortgages has risen recently, according to data provider Moneyfacts. Some 486 mortgages are now available, compared with just 386 last February. The average interest rate has dropped to just 4.79%, from 5% in February 2011.

While the north-south house price divide looks set to continue - house prices in London are now double those in the north, according to data provider Acadametrics - the buy-to-let market is not as divergent, and there are massive regional differences.

"It's highly regional, even local," says Thompson.

Manchester is a significant hub, according to William Jordan, managing director at letting agency Jordan's. "There is a significant shortage of properties to let because of little 'churn' in the property market. The costs of moving are so high that it's cheaper just to stay put," he says. Jordan finds opportunity in big social housing hubs such as Warrington, as the council will guarantee the rent.

Steve Olejnik, head of sales at Mortgages for Business, prefers house price outperformers London and the south-east. "Rents are increasing and property values continue to hold up," he says.

Attractive yields

As if low savings interest rates and a turbulent stockmarket weren't enough to fuel the buy-to-let market, buy-to-let yields (rental income) are making the sector look increasingly attractive. King reports average yields across the country of about 6%, although yields are higher in places where property values are lower, and vice versa.

Central London and central Cambridge properties outperform property in the rest of the country, but yields there are lower - by around 4 or 5%, says King. Compare this with yields in northern cities, where property values are lower but yields are higher to compensate for the higher risk of unemployment and void periods there - where a property is empty for a time.

Look for towns and cities with new infrastructure as a potential investment, King says. "Canterbury on the new Southeastern high-speed line or anywhere on the new high-speed train route to Birmingham is good. Alternatively, look 10 miles outside expensive areas - market town Saffron Walden just outside Cambridge, for instance."

There are several fundamentals to adhere to, says Stuart Law, chief executive at property investment specialist Assetz. "Pick a good-quality location where employment is strong. City centres are a good bet - there's a dearth of properties, so there's no risk of being unable to rent it out."

The student accommodation market has long been a lucrative one: it has seen investors earning "phenomenal rates", says Jordan, but this could change when student tuition fees go up this September. Recent data from the Universities and Colleges Admissions Service shows a 9% drop in applications for this year - a figure that will undoubtedly affect the student buy-to-let market. Jordan admits it might force more students to live at home, but he believes the drop will "hit the fringe, rather than the majority".

King says there continues to be "reasonably strong demand" in university towns.

However, Murphy says he would be more cautious about buy-to-let demand in student towns in future. He comments: "This is a market in its own right and the demands on landlords are different from those with other lets. Landlords need to research which areas are likely to experience less demand."

The pros and cons of management agencies

Those considering buy-to-let as a potential investment should weigh up the pros and cons of employing a management agency. Some agencies come in on the lettings side, leaving the landlord in full control of the property when it is let, while others offer a full management service. Expect to pay around 10 to 15% of the full rental yield each year for the latter.

A management agency will collect rent each month, find and vet new tenants and organise any repairs needed.

For an amateur landlord, a management agency is typically the best route, as the agency takes responsibility for the day-to-day needs of the property as well as the legal side of things.

Murphy urges new investors to think about the profile of the tenant they are targeting. "Do they want to target small families looking to rent a house, young professionals who might prefer a flat or students who want to live together? These targets will present landlords with different issues to consider, not least wear and tear and the likely cost of repairs," he adds.

However, the lack of regulation in the property management market can pose problems for potential investors. In theory, any management agency can register itself as a letting agent.

"Ensure the agency is registered with the Association of Residential Lettings Agents, which offers protection to landlords and management agencies," says Jordan. "The line between landlord and management agency can get a bit murky. There's an ombudsman scheme, which is a free service for landlords."

There are several downsides to the buy-to-let market though. While tenant demand has undoubtedly increased, unemployment has risen with it, and there could be pressure on landlords if tenants become unable to pay the rent.

Landlords also run the risk of suffering a void period, which can swiftly drag rental returns down. If the rent is £1,000 per month, or £12,000 a year, two void months will bring the annual income down to £10,000 - wiping out 16% of an investor's annual profit.

However, if these pitfalls are avoided, investors should benefit from a strong source of income. And with annuity and gilt rates hitting rock bottom, property could provide a decent alternative or supplement to pension income. "People feel comfortable buying a property. They see where the money is coming from," says Law. "It's something tangible, something you can measure. The income stream is equivalent to an annuity, and you don't have to give any money to an insurance company for it."

One last piece of advice comes from Olejnik, who says it's important to go into the buy-to-let market with your eyes open. "Do your research. What type of property do you want? What type of tenant do you want? Find out what you want from the portfolio."

And remember, an Englishman's home is indeed his castle, but don't buy a buy-to-let property as a homeowner - buy as an investor.

Are you looking for an all-round guide to property investment? Get in-depth analysis of prospects at home and abroad, as well as tips on how and where to invest, in Interactive Investor's property special.