ARLA mis-selling or mis-leading?
Property Hawk would like to welcome the Property Bear (again no relation, as with the Property Snake) to its’ growing list of commentators. In many ways his dilemma is different to that of us landlords in that he is property light having sold his house in September 2006.
The Property Bear now agonises and ponders over the state of the UK housing market trying to judge when is the time if any to jump back in to the world of property ownership. In this article from his blog the Property Bear takes a look at some of the figures coming out of one of the founding organisations of the buy-to-let revolution, ARLA and concludes that their figures may be a little mis-leading.
ARLA – the background
According to its website, the Association of Residential Lettings Agents (ARLA) was formed in 1981 as the "professional and regulatory body for letting agents in the UK". ARLA takes credit for developing the first buy-to-let mortgages in 1996 when it approached a group of mortgage lenders to reduce interest rates for property investors wishing to purchase properties to let. This development of the buy-to-let mortgage market has been phenomenally successful – it now comprises about 10% of the entire UK mortgage market from a standing start in just over one decade.
What has made buy-to-let so successful? The two main factors are obviously the availability of cheap finance and house price rises. The one feeding off the other. Until now, that is.
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Historically the returns have been tremendous and nobody could argue about that. However, ARLA continue to trumpet stunning returns in its latest quarterly release from its March 2008 Review and Index of Returns on Buy to Let Investment. They project that property investors buying a house for cash can expect to make 10.9% a year over 5 years and for leveraged investors the returns are even better – some 21.7% a year!
These returns seem to contradict even ARLA’s own survey of the rental market of March 2008. Here they state: "average weighted rents for houses are down by 7% and for flats by 9%" and this "demolishes the myth of soaring rent levels".
So it must be capital returns right? Wrong. ARLA go on to say, "The average capital asset values of rented houses have fallen by 2.4% in Prime Central London, 1% in the rest of London and the South East and 5.1% in the rest of the UK. For flats, average values rose in the South East by 0.9% while falling 3% in Prime Central London and 8.1% in the rest of the UK."
Behind the figures
So how did ARLA achieve those returns? I for one never take any figures at face value and always rigorously challenge the assumptions. The full list of ARLA’s assumptions can be found in their quarterly returns document above.
The key items that stood out are as follows:
1. ARLA assume long run capital growth of 8.21% a year to continue.
2. Rents will rise by the rate of the Retail Price Index (RPI) every year.
3. No agents’ fees.
4. No annual running costs.
5. No Income Tax nor Capital Gains Taxes.
6. No accounting for general inflation to obtain ‘real’ returns.
So the figures that ARLA trumpets is essentially what they used to call in the dotcom bust "profit before the nasty stuff".
Let’s just look at their capital return assumptions. Admittedly, ARLA do show the impact on its figures of differences against the stated house price inflation of 8.21% pa on the projected returns – but only of 1% and 2% pa. So the smallest rise they give examples are for a 6.21% pa increase.
From their figures, a 1% change in expected hpi results in a change of about 0.9% pa for cash purchases and 2.3% pa for geared investments. Many commentators are expecting double digit nominal falls in house prices this year (before inflation). For house price declines of 10%, the hpi will be 18.21% lower than ARLA’s long run projection. Multiplying that 18.21% by those annual reduction in returns makes a big difference. Using that rule of thumb, you can take about 16% pa off the projected returns for cash purchases and some 42% pa for geared investments. Both would be solidly into losses right now. And that’s before the other nasty stuff. At least there may be no tax to pay.
ARLA’s Role in the World
Now I think that ARLA does potentially have a very important role in representing the nascent buy-to-let industry as a lobbying organisation and as a means of helping draft well thought through regulation. Unfortunately ARLA does not live by member subscription alone – it seems to promote a number of ancillary services to its members for which it probably earns fees. Unfortunately by doing this, ARLA opens itself up to accusations of having vested interests – its interest may lie more in encouraging more people to enter the buy-to-let market and to sell them things.
Whilst I would not go so far as to accuse ARLA of mis-selling, but certainly its quarterly index of returns used in its marketing material can be extraordinarily misleading in the current environment to many ‘investors’. Once people see those returns, I believe they simply don’t see or hear those legalistic words of advice to consult professional financial advisers and the like.
The buy-to-let industry as a whole is to my view woefully under-regulated as to the investment information it gives out. Any ‘advice’ in the legal sense seems to extend mainly to ensuring that no legal recourse can be made by the unsuspecting ‘investor’. In addition, apart from homes in multiple occupancy, there exists no licensing system for ensuring an appropriate level of training and competence as to an investor’s role and responsibilities in managing people’s homes. A situation that is intolerable to my mind. Unfortunately, ARLA tends to resist statutory regulation on behalf of its members – arguing as it does for self-regulation by ‘professional bodies’ such as theirs. Perhaps this is because of ill-thought through lines of argument or possibly because of its own income-generating vested interests.
A proper service to its members would be to ensure a stable market and a well run and regulated market. This ARLA can only do if it separates its functions. The one part being the core professional body and the other being the marketing offshoot that should compete on a level playing field with all other such service providers. The core professional body would then be in a position to ensure the market is substantially tightened up as it should be.
ARLA’s current approach in the long run may actually be damaging its market and thereby its members with over-supply and unfettered and unpredictable competition.
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