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Residential Buy to Let Funding and Financial Incest

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By - Friday 10 February 2012

Residential Buy to Let Funding and Financial Incest

It would seem no matter where you look at the moment – Buy to Let is hogging the news. Blooming, booming, flourishing and no end of adjectives adorn the headlines; all in a bid to flog the concept to the public that having someone else paying your mortgage is a good idea. On closer inspection of the bigger picture however – the furore being created around residential Buy to Let and the very fundaments that permit it's existence and ability to perpetuate as a viable concept in the UK are being destroyed from within by what can only be described as financial incest.

Rents are up, demand is up, rates are down, LTV ratios are increasing – all of which make for an ideal investment and will put some life back in the UK property market.

All of this sounds great initially – find a cheap property, scoop up an 80% LTV mortgage and watch the cash roll in. If house prices rise – bonus! Sounds so simple a 5 year old could do it.

If this is all you look at it does sound rather attractive – make money with no work, let's face it, we'd all like a piece of that if we could. However, as is often the case with such ideas – doom lurks around the corner.

Roll the clock back just a few years to when NINJA mortgages (No Income, No Job, no Assets), interest only and ridiculous LTV rates were all the rage. A jolly time, when one could hardly walk down the street without a banker hurling a mortgage product at you. Banks and lenders thought they new best – offering mortgages for more than the value of the property to "help you out" and backing it up with "house prices always rise don't they".

At the time it would seem nothing could go wrong – except it did. All the mortgages issued were repackaged and re-sold on the debt markets, conveniently turning high risk debt into something more attractive for the banks to trade, problem was, no one below management level really understood what it was all about – and those that did were unable to accurately work out what the assets backing the debts were worth – end result being crash, bail-outs and panic.

What’s Different Now?

If you only look at the "news" it would appear nothing is really very different apart from demand. First time buyers are struggling to find deposits, as a result they are being forced to rent instead. With demand rising, rental prices are going up – yields look great.

The problem is one of balance – or rather the lack of it, and the self-arresting nature of the economy with respect to the housing market.

There are several things to take into account at this point – all of which have an impact when it comes to an unbalanced world.

Interest Rates

Interest rates are low – so low in fact there is only direction they can go now – up. It might not be now, but at some point they have to go up. When they do – it means mortgage payments go up. For the traditional residential Buy to Let landlord this means one of two things.

  • The yield on the property comes down, or
  • You put the rent up

Unemployment and Income

Unemployment is on the rise and household incomes are showing no signs of being sustained or level for the foreseeable future. In essence – the public have less money.

Rental Arrears

Rent arrears are rising non-payment of rent means yields come down, and over a sustained period will leave many landlords no choice but to face repossession. End result – the banks end up with another property that likely has little, if any equity in it.

First Time Buyer Deposits

As rents and the cost of living rise and incomes fall – first time buyers are struggling to come up with deposits. The banks and the government have tried to counteract this by offering higher LTV's and creating things like the mortgage indemnity scheme – neither of which have had much impact on the ability to buy for first time buyers at all.

The Flaw

What appears to have been missed by the banks, mortgage providers and the press is - how exactly can the UK Buy to Let market continue to support itself?

There will come a point at which rents cannot rise any further – not only because the public or the benefits sector don't want to pay X hundred pounds a month for a flat, but simply because the money is not physically there to pay for it. As a result – more defaults occur, more toxic debt is loaded onto the banks ad-infinitum. The same applies to almost anything, high demand might sound like a great thing but it has its limits.

Supply and Demand

If the thing you supply can be created more cheaply by producing it in large quantities, all is good. Take the humble computer. These days the vast majority of the population in the civilised world has one in some form or another – wind the clock back 30 or 40 years and computers were reserved for the nerdy and the wealthy – mass production created the widespread availability. Look at Ford and the development of the car through mass production as another example. The traditional business methodology behind supply and demand works just find when it comes to physical products and services.

Wrong Tool for the Job

The problem is (albeit from perhaps a strange angle) that debt doesn't fair as well or become a better deal by producing more of it, taking more of it on or, creating higher risk versions of it. The lending world appears to have lost its way. Manipulating the mortgage market by creating supply solely to generate demand the in form of financial incest and hoping it can be covered up with low rates and quantitative easing is just passing the buck.

Sadly, the bowler-hatted bankers of old that were respected managers, guardians and even creators of capital have disappeared, only to be replaced by purveyors of snake-oil that extol a mythical light at the end of a very dark tunnel, a tunnel which has a full-width bottomless pit half-way along it as you stumble blindly toward the light with the promises of Buy to Let riches ringing in your ears…

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