Buy-to-Let Investment: Strategies, Benefits, and Risks
Buy-to-let (BTL) investors are people or businesses that buy residential properties, primarily renting them to renters rather than living in them themselves. With this investment approach, income is produced through leasing fees, with the possibility of long-term gains from property improvement. To diversify investment portfolios and create passive income, buy-to-let investing has grown in popularity. Investors in BTL often look for homes in locations with high rental demand and development potential. The investment portfolio covers various properties, including commercial real estate, apartments, condos, and houses (Leyshon & French, 2009, pp.438-460).
The primary goal of buy-to-let entrepreneurs is to produce a consistent flow of rental revenue. This money can be used to pay the mortgage, maintenance expenditures, property management fees, and other related obligations. The ideal situation would be for the rental income to be higher than these costs, resulting in a positive cash flow and potential profitability.
Investors in BTL may gain from capital growth alongside rental revenue. Property values could rise as time passes, enabling owners to sell the home for more money than they originally paid. Capital gains and maybe substantial returns on investment may emerge from this.
Nevertheless, it is crucial to remember that buying rental property has dangers and difficulties. These include changes in the rental market, unforeseen costs, vacancies, potential issues with renters, and modifications to laws or taxation policies that affect the industry. Before making any investments, savvy buy-to-let investors frequently perform extensive research and due diligence. The local rental market, home prices, rental yields, and potential demand are thoroughly examined. They might also think about collaborating with property management firms to handle tenant-related issues and property maintenance.
Reasons for Renting Houses
Individuals rent houses for various reasons, depending on their financial capabilities and needs. According to McMullan et al. (2021), pensions and investments are the most influential factors for renting properties. This implies that BTL investors primarily acquire properties to raise their pension contributions.
Leyshon and French (2009, pp.438-460) also observed that 70% of all rented houses were meant for investments by their owners. In other cases, individuals could rent properties as homes for their friends and relatives or employees. The properties could also house needy people, such as low-income people, orphans, and widows. The figure below summarizes the factors behind property renting.
Distribution of BTL Investors and Investments in the UK
BTL investors target areas with the best possible returns, particularly urban ones. According to McMullan et al.(2021), London is the most lucrative BTL investment hub due to the proliferated demand for rental housing and the assured market appreciation. Buy-to-let investors have predominantly concentrated on Tower Hamlets, Chelsea, and Westminster.
In Southeast England, BTL activities are mainly concentrated in Cambridge, Oxford, and Brighton due to the presence of universities. Students and university staff present high rental demand and increased prices. Manchester has seen increased job opportunities, translating to a rise in BTL investments.
Birmingham is undergoing a controlled regeneration of projects, expanding the job and affordable housing markets. As a result, it has attracted investors, rejuvenating BTL activities. Liverpool has a strong rental demand from students and young professionals, attracting investors and triggering market growth. Edinburgh and Glasgow have a vibrant market and presence of universities, resulting in steady demand for BTL properties. In other parts of the country, such as Newcastle, Bristol, Leeds, and Nottingham, rental demand, affordable property prices, and emerging economic activities have increased BTL activities.
The UK has become a significant Asian investment hub, particularly from China, Hong Kong, Singapore, and Malaysia. Investors have paid key attention to the property market, with interest in new developments, student accommodation, and luxury properties (Mulheirn, 2019). Asians purchase properties as long-term investments for their students in the country (Mulheirn, 2019).
They also lease their properties to tenants to generate revenue (Mulheirn, 2019). Middle East investors from Saudi Arabia, Qatar, and the United Arab Emirates have focused on London, Manchester, and Birmingham properties. European investors from France, Germany, and the Netherlands have focused on cities with strong rental markets and investment potential.
Property price hikes, particularly in London, have been attributed to foreign BTL investments, particularly in upscale districts. Due to price pressure brought on by demand from foreign investors, it is now more difficult for locals, including first-time purchasers, to afford properties in these locations. The UK government has recently introduced several regulatory measures to address concerns regarding foreign investment inflows and their effects on the housing market. These measures include tighter lending standards, higher stamp duty rates for foreign buyers, and proposed changes to the legislation governing leasehold property.
Foreign BTL investment activity has been impacted by the UK’s decision to leave the European Union (Brexit) and the ensuing currency volatility. Currency exchange rates may affect the availability and appeal of UK real estate to overseas buyers. Although governments may implement measures to control currency exchange rates, the attractiveness of investment opportunities in the UK provides a self-healing environment for stabilizing the rates. Foreign currencies may lose value against the Sterling Pound in cases of uncontrolled trade deficits.
Factors Affecting Affordability in Housing Markets
Economic growth is affected by several factors in most nations around the world. The housing market plays a significant role in the growth of a country as it affects all residents of any country (Mulheirn, 2019). The growth of the housing market sector is subject to numerous factors and primarily depends on affordability.
Soon and Tan (2019) argue that income levels determine the ability of people to buy or rent houses in the UK. A significant determinant is people’s average income or earning potential in a property market. Affordability becomes a problem when salaries are low in comparison to housing costs.
Better affordability is typically correlated with higher income levels. House developers’ and owners’ asking prices have a direct impact on their prices. As a result, this influences the number of people who can afford the properties for residence, renting, or rewarding employees and relatives (Soon and Tan, 2019). The effects of BTL investors on house affordability are discussed in the following sections.
Income Levels
The affordability of houses in the UK is affected by individual and income levels. A decline or stagnation in incomes accompanied by increasing house prices implies difficulties in affordability. As a result, fewer investors will be willing to buy homes during such times.
Forde et al. (2020, p 114) noted that a 1% in income levels resulted in a 4% decline in the housing market. Consequently, most people will seek to rent cheap and affordable houses. Such trends could include high income, paying in cash, securing mortgages, and increasing the number of houses bought in a given period.
Housing Prices
The affordability of houses is directly proportional to the corresponding house prices. The rates are associated with several factors, such as rental incomes and construction costs. The local market conditions, as well as demand and supply, determine housing prices.
According to Forde et al. (2020, p 114), a 1% increase in house prices led to a 7% decline in demand. This implies that the prices tend to be higher in areas and instances of higher supply and demand. On the contrary, the prices decline with demand, the cost of raw materials, and other associated costs.
The overall impact of fluctuations in housing prices affects the ability of individuals to own homes. This creates an opportunity for profit-minded investors to fill the market void. Individuals who cannot afford to own homes end up renting. However, if the housing prices are high, the rental rates also increase significantly.
Interest Rates
Housing affordability is substantially impacted by the mortgage interest rates currently in effect. Low interest rates result in lower monthly mortgage payments, which increase housing affordability. On the other hand, high interest rates raise the cost of borrowing and may limit the number of people who can afford to become homeowners. As a result, investors may choose to acquire property at times when the rates are most favorable.
However, the periodic adjustments of interest rates could deter investors’ willingness to access mortgages and own homes, opting to rent. In this regard, BTL investors could charge premiums for their properties. Fingleton et al. (2019, pp. 25-35) studied the relationship between interest rates and house prices for ownership and renting purposes. The authors observed that house prices would drop by 2% if interest rates dropped by 1%. Such variation significantly impacted the overall affordability in the housing market nationwide.
Availability of Credit
Housing affordability is greatly influenced by how easy it is to get credit and the requirements of financial institutions. If financing is easily accessible and lenders offer favorable terms, more people can qualify for mortgages and buy homes. On the other hand, rigid lending requirements and restricted credit availability may make housing less affordable. It would be hard for individuals to afford houses when credit rates are high. As a result, many may opt to rent properties for residential purposes, boosting the revenue of BTL and other investors.
Housing Supply
The supply of housing units determines whether investors will buy or rent apartments. Housing becomes less accessible in areas with a shortage of available homes due to rising prices. In this case, financially stable individuals may rent their apartments to raise revenue. It also ensures that those who cannot afford to acquire such properties live within their means.
Land availability, zoning laws, building prices, and development strategies affect housing supply. Fingleton et al. (2019, pp. 30-41) observed a relationship between the increase in the number of households and the corresponding prices. A 1% increase in households translated to 2% in house prices.
Demographics and Household Composition
The demographic profile of a region, such as population growth, household size, and family composition, can affect housing affordability. For example, suppose there is a high demand for housing due to population growth or an increase in single-person households. In that case, it can put upward pressure on prices and reduce affordability. Consequently, BTL investors may exploit this situation and rent their properties to generate revenue or fund other projects.
Government Policies and Regulations
Another critical factor affecting property values is government policies and regulations. Governments may put influential measures such as zoning regulations, subsidies, taxation, and housing programs in place. Policies to increase the housing supply, provide financial assistance, or promote affordable housing initiatives can improve affordability.
On the other hand, policies that restrict development or impose high taxes can contribute to housing unaffordability. If the measures put in place by the government favor home ownership, the need for BTL internments will decline significantly. For example, policies that favor higher education and job creation will translate to an increased demand for BTL properties.
Regional and Local Economic Factors
A given region’s economic performance and well-being could determine the flow and availability of properties for sale or rent. Factors such as renting, employment opportunities, and cost of living contribute immensely to the overall health of the housing sector. Areas with robust job markets and higher wages generally have higher housing costs, which may make housing less affordable for some individuals.
In inner London, for example, the average monthly rental rate is three thousand pounds. On the contrary, the value averages eight hundred pounds in Wales. The difference in the rates is attributed to the regional and economic performances of the specified regions.
Infrastructure and Transportation
The availability and quality of infrastructure, including transportation networks, determine housing affordability. Access to affordable and efficient transportation options can expand housing choices for individuals, allowing them to live in more affordable areas outside of city centers. Developed urban areas with clean water, stable power supply, and well-maintained sewer systems attract investors and dwellers. While there is stiff competition between homeowners and BTL investors, such regions generally provide a conducive residential and business environment.
Market Speculation and Investment
Speculative activities in the housing market can drive up prices, making housing less affordable for residents. As a result, fewer individuals will be willing to buy homes at such times. This creates an ideal opportunity for BTL to buy properties and rent them at affordable rates.
When investors purchase properties primarily for investment purposes or speculative gains, it can increase competition and inflate prices, limiting affordability for prospective homebuyers. Fingleton et al. (2019, pp. 45-50) noted that a 1% increase in stock resulted in a 2% decline in house prices. It implied that houses would be more affordable in cases of higher stocks. On the contrary, a drop in stock triggered inflation in the housing sector’s prices.
Effects of BTL Investments On the Affordability of Housing Markets
Buy-to-let investments can positively and negatively affect housing affordability, depending on various factors and market conditions. At times, BTL investors could present a competitive effect on the housing market, making properties more affordable to other buyers. However, they could also pose undue exploitation of prices, inhibiting affordability and driving up rental rates and prices. The following subsections provide a detailed discussion of BTL investments’ effects on the housing market’s affordability.
Increased Demand and Competition
Buy-to-let investments involve purchasing properties to rent them out to tenants. This increases the demand for rental housing, particularly in areas with high investor activity. As a result, increased demand can drive up rental prices, making it more challenging for renters to find affordable housing options. However, a decline in BTL investments reduces the demand for renting properties, prompting a drop in the corresponding rates.
Reduced Housing Supply
When bought for buy-to-let purposes, they are often taken off the market for potential owner-occupiers. This reduced available housing supply can contribute to higher home prices and decreased affordability for prospective homebuyers. As a result, it becomes challenging for individuals seeking to own homes to achieve their dreams in such areas. As a result, new investors may seek to buy properties in other regions, resulting in skewed economic and population growth.
Distortion of Market Dynamics
Concentrated buy-to-let investment activity in specific areas or neighborhoods can distort local market dynamics. Investors may target properties that offer higher rental returns, inflating prices in those areas. Consequently, the local population may find owning homes and other properties more challenging. Such distortions may take time to correct, affecting the overall market and economic growth in different parts of the UK.
Impact on First-Time Buyers
Buy-to-let investors competing for properties in the entry-level or affordable housing segment can pose challenges for first-time buyers. Usually, BTL investors are not seeking to acquire homes but investments that will generate revenue and profits for them. BTL investors have access to greater financial resources or are willing to pay higher prices, putting first-time buyers at a disadvantage. As a result, there is reduced affordability for those seeking to own homes for the first time.
Rental Market Stability
While buy-to-let investments might boost the supply of available rentals, they can also exacerbate the volatility of the rental market. Sudden changes in rental prices may affect renter affordability, especially if many investors enter or quit the market at once. Rent hikes that come out of nowhere can strain household finances and make it more difficult for renters to find affordable accommodation. Such processes could endanger economic growth, especially during unchecked inflation or fundamental economic changes.
Investment in Housing Stock
Positively, buy-to-let investors support the development and upkeep of the housing stock. By investing in rental homes, they raise the supply of available rental accommodation, which is advantageous for people or families who prefer or need renting options. The strain on the demand for owner-occupied housing may be indirectly reduced. Additionally, it enables low-income individuals to reside in respectable homes. Additionally, it suggests that those who relocate for work can find affordable housing.
Housing Market Liquidity
Buy-to-let investments can increase market liquidity by opening new real estate trade channels. As a result of this liquidity, people may be able to move across the housing market more easily and facilitate property sales. However, if buy-to-let investors take an undue majority, it can affect the market’s affordability and stability. A drop in BTL investments could also increase home ownership prices, affecting first-time owners and low-income earners.
Reference List
Fingleton, B., Fuerst, F. and Szumilo, N., 2019. Housing affordability: Is new local supply the key?. Environment and Planning A: Economy and Space, 51(1), pp.25-50. Web.
Forde, J., Hopfe, C.J., McLeod, R.S. and Evins, R. (2020) Temporal optimization for affordable and resilient Passivhaus dwellings in the social housing sector. Applied Energy, 261, p.114. Web.
Leyshon, A. and French, S. (2009) ‘We all live in a Robbie Fowler house’: The geographies of the buy-to-let market in the UK. The British Journal of Politics and International Relations, 11(3), pp.438-460. Web.
McMullan, L., Osborne, H., Blight, G., and Duncan, P. (2021) UK housing crisis: how did owning a home become unaffordable? Web.
Mulheirn, I. (2019) Tackling the UK housing crisis: is supply the answer. UK Collaborative Centre for Housing Evidence.
Soon, A. and Tan, C. (2019) An analysis of housing affordability in Malaysian housing markets and the home buyers’ preference. International Journal of Housing Markets and Analysis. Web.