WHY LANDLORDS SHOULD SELL

Here at Property Hawk we maintain that a landlord should see property investing as a long term activity and not a way of making a fast buck. Therefore, our advice to landlords is to hold their residential investments for the long-term. Why? For a start trading property is expensive, figure on about 5% to buy and then sell a residential investment property, then there are also the tax implications.

From time to time however there are circumstances when a landlord needs to sell or where a sale of all or part of their residential investment holdings makes sense. For instance, if a landlord wants the funds for other purposes or they want to recapitalise their portfolio to reduce their gearing. If this applies to you, then here are five reasons why a landlord should sell NOW:

1. Affordability

Historically high house prices have stretched this to the limit. The fact remains that buy-to-let investing takes place in a market which is still dominated by homeowners. A residential investment is only “worth as much as someone is prepared to and is able to pay for it”.

Affordability can be measured in several ways. Traditionally, the key metric has been the multiple of average income to property value. Historically this has been about 3.5 times average household income; it now stands at over 6. Some economists argue that this measure is no longer relevant because of a paradigm shift downwards in interest rates making higher multiples more sustainable.

OK, point taken, in the 80s interest rates were for most part in or near double figures; in the 90s they probably averaged 6-7%. This is high by current levels; particularly when the fact that mortgage margins have reduced i.e. the differential a borrower pays above the prevailing base rate. In the 90s it ranged between 1-2%; before the recent credit crunch this had shrunk to in some cases to zero reducing the real costs of a mortgage even further.

What the housing ‘bulls’ (those that believe in a rising market) also argue is that what is more relevant in judging housing affordability is the proportion of household income paid out each month on servicing housing debt. After all they would argue, people don’t think of multiples or margins when judging whether they can afford a property, their first thoughts are how much it will cost per month and how much income they have got after tax and other vital household expenses. For an indication of this we can go to the statistics provided by the Council of Mortgage Lenders (CML). These stats make interesting reading. The good news for the bulls is that the latest figures for interest payments as a percentage of median household income was 17.7% in June which is well below the 27.1% reached in the first part of 1990 that heralded the house price crash of the early 90s.

However it should be remembered that this high rate was prompted by interest rates which reached 15%. More strikingly this rising figure is the highest since 1992 when the housing market was still in the depths of its last depression. Whilst not conclusive on its own; it shows that by any measure the costs of servicing a housing debt are becoming an increasing constraint.

2. Price rises have outstripped the long-term trend.

The Nationwide has generated a time series an analysis of house prices since 1975 that accounts for inflation. Using these figures they have produced a trend line that indicates an average price rise per annum of 2.7% above the rate of inflation for this period. This long run trend ‘suggests’ that the average house price today should be £133,751. The actual figure is £181,810. This analysis suggests that house prices are on average 36% over valued in respect to this projected long-term trend.

3. The credit crunch

One of the results of the ‘credit crunch’ is that landlords not on trackers or fixed rates will be facing increased mortgage costs even if interest rates don’t change. This is because of the increasing margin or ‘spread’ as lenders price in the added costs of lending from the wholesale market. The ‘shake out’ resulting from the sub prime problems in the US are likely to result in lenders re-pricing risks attributable to lending on property assets. This will make lending for landlords more restrictive and more costly over the next few years regardless of whether they are considered high risk or not. These costs will put further strain on landlord’s already relatively low net yields.

4. Falling yields

For landlords with a good memory, they may be able to recall when gross yields on some investment properties were in double figures. It was also up until relatively recently that many landlords could secure a reasonable level of income from their residential investment properties. However, for many residential landlords these days have gone. Small rental increases have not been sufficient to keep pace with rising capital values and rising interest rates. The result is that the last Association of Residential Letting Agents (ARLA) review indicated that gross yields were less than 5% as a UK average. This falls to 4.6% when taking into account rental voids. If management charges are also taken off, then the net yield is likely to fall below 4%. All this means that many landlords now face a cash outflow, which will remain for a number of years whilst rents increase and or interest rates fall.

5. What goes up must come down

There is a very basic investment principle that says assets that go up in price will at some stage eventually have to come down as well. Like the laws of gravity, prices cannot go up inexorably without some falls being sustained along the way. The general theory is that values that go up the sharpest tend to experience the most dramatic falls. The average house price according to the Nationwide Building Society prices is up by some 367% (August 07) since 1993.

The message is clear. For landlords that are thinking of selling, they should do it now. For those of us that are long-term investors; it’s a case of holding on to your hats and enjoy the ride!