Buy To Let Mortgages for off plan new build properties
In December 2005 The Mortgage Works announced that it would cease to provide buy-to-let mortgages on newly built properties. Portman has been lending in the buy-to-let market through its specialist lending subsidiary since 2001 and some industry commentators described this move as courageous.
There is an underlying shortage of housing stock in the UK and this was confirmed by the 2004 Barker review of housing supply.
Certain markets have been targeted by developers who have misjudged the level of untapped demand. The result of this has been areas of localised oversupply, most notably in two-bedroom, two-bathroom apartments located in certain provincial city centres.
Market forces dictate that where oversupply occurs you would expect to see prices fall, with some developers going bust. The stock of surplus property would then be gradually absorbed into the market and equilibrium would be restored after a number of years.
This is exactly what is starting to happen. Land Registry figures for the third quarter of 2005 show the price of new-build flats fell by 5.7%. Consequently, some developers found themselves in a quandary. They recognised the need to reduce prices but at the same time wanted to avoid undermining the value of their developments. As a result, a new dodge to deal with an old problem has been introduced, with developers and large buy-to-let investors - mainly property investment clubs – in an unholy alliance.
How does this work? The clubs buy in bulk from developers with a surplus of stock. They negotiate hefty price discounts that crucially do not appear in sale contracts -these show the full asking prices instead. The discount is then rebated to the buyers after completion as a so-called commission or cashback. The investment clubs then share this refund with their members. Investors are naturally attracted by the prospect of a big price reduction.
By arranging for the discount to be repaid outside the sale contract the true sale price is concealed from valuers, mortgage lenders and, worst of all, other bona fide buyers.
Off-contract discounts are risk damaging the market as a whole. After all, a valuer's opinion is based on prices recently achieved through the sale of similar properties. It is the price shown in the sale contract that is recorded at the Land Registry so off-contract discounts result in the overstatement of the true purchase prices achieved. Surveyors are much more likely to come up with valuations that are excessive, upon which lenders and other buyers subsequently rely.
Owner-occupiers in particular tend to place great weight on their valuer's professional opinion and, when buying new, naturally draw comfort from the fact that much of the relevant development seems to have already been sold at the price they are paying.
The crunch comes when lenders need to repossess or buyers want to resell. At this point, any seller will face the combined effect of the original over-valuation and the fact that the market may have been oversupplied further by more bulk selling in the interim.
Some lenders have argued that The Mortgage Works over-reacted, saying surely all that is required is a little more care in the valuation process. But this is more difficult than it sounds. Lenders still have to invest a high level of trust in the enquiries made by their valuers. In our experience, this is rather a hit and miss business. It is also said that we could ask more penetrating questions - for example about the involvement of investment clubs. But such awkward questions can be circumvented by the simple but effective device of not telling the truth.
Others have suggested that our decision is in some way anti-intermediary. This view is harder to fathom. In fact, our withdrawal from new-build buy-to-let followed discussions with some of our best and most trusted broker connections for whose frank input we remain indebted. Most intermediaries have no wish to get drawn into the dubious practices we have described and we condemn them unreservedly.
This off-contract pricing problem will gradually resolve itself over time as the imbalance of supply and demand is corrected through the operation of market forces.
The Council of Mortgage Lenders and the Royal Institution of Chartered Surveyors are working together to tackle the issues described in this article. We are monitoring the situation closely and when we are satisfied that the systemic risks have been addressed, we will be back in the new-build market.
A survey of buy-to-let landlords in 2005 showed that more than 77% had no new-build properties in their portfolios. Estimates from the CML, Datamonitor and Mintel indicate that new-build represents less than 10% of the buy-to-let market.
So there remains plenty for The Mortgage Works to do and our commitment to buy-to-let lending as a whole is as strong as ever. We intend to grow our market share significantly over the next three years. To do so, we are investing heavily in online functionality for brokers which is scheduled to go live at the end of this year.
The Barker review made it clear that buy-to-let should continue to do well in the UK given that it is the third most densely populated country in the EU, has a basic shortfall in housing stock and a continuing problem with affordability. Overall, buy-to-let represents an important and established market for lenders and investors.
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