Buy-to-let returns continue to improve, with a five year geared investor making a 6.52% annual return, according to The Model Works’ buy-to-let profitability index for the third quarter of 2013.
However, Brian Hall, founder of The Model Works, warned that rent arrears may rise in the future as housing benefit support for private rental sector tenants will effectively be reduced by £23.8 billion over the next five years.
The index uses Bank of England, Nationwide and Association of Residential Letting Agents data to calculate the historic returns over 25, 20, 15, 10, and five-year periods, for a cash buyer or a geared investor, with a repayment or an interest only mortgage, selling today.
Profitability is returning because the falls in property prices that dragged the index down in past years are working their way through the system, with poor quarters swapped for good ones. The recent gains have had a significant impact against a backdrop of rising yields, falling mortgage costs and low opportunity costs as deposit rates are very depressed.
These drivers are expected to continue for the next few quarters as the government’s Help to Buy scheme is allowing many prospective homeowners who were previously excluded to get on the property ladder. Hall said this is creating an upward pressure on property prices.
Hall added: “In the short to medium term there must be some concerns that the Bank of England may take action to stop a property price bubble occurring. Rising interest rates would obviously impact on buy-to-let profitability and in the longer term, interest rates must rise.
“The number of tenants in severe rental arrears has fallen sharply to the lowest level in two years say LSL Property Services. But the sector receives around £9.5 billion in housing benefits per annum which equates to £1,843 for every private rental sector property.
“According to Department of Communities and Local Government figures, the private rental sector has almost doubled in size over the past ten years to 4.7 million properties and at its current rate of growth it could double again within five to six years. However, figures from the Department of Work and Pensions suggest the payments of housing benefits within the sector are projected to flatline from this year onwards causing the level of support to halve.”
Hall said this combination of factors could take £23.8 billion out of the system over the next five years. Given that incomes are rapidly being overtaken by the highest cost of living increases in Europe and with rents at record levels, a significant increase in arrears seems likely, he explained.
He added: “The private rental sector appears to be buoyant at the moment but landlords must make informed decisions about what is likely to happen to property prices, interest rates and arrears over the coming years as these factors will have a significant affect on profitability. Landlords that are highly geared, with interest only mortgages, are obviously most at risk.
“Lenders must also take these factors into account as they consider their potential exposure.”