Research by the Financial Services Authority (FSA) has revealed the extent of buy-to-let repossessions, prompting issues of repayment, regulation and lending...

This is body-blow for the buy-to-let lobby and a wake-up call for intermediaries, as It looks like buy-to-let chickens are finally coming home to roost. More investors who bought new properties from developers at over-inflated prices are unable to cover mortgage payments with the rental income, have seen little or no capital appreciation, and are simply walking away.

Research into repossessed properties sold at auction, carried out by the FSA, shows that in February 2006, 8% of properties offered for sale at auction were repossessions by the mortgage lender. By December 2006, only nine months later, the figure had risen to 25% – a big jump.

The FSA also found that almost 80% of repossession lots at auction were in postcodes dominated by buy-to-let properties – areas where home ownership with a mortgage is not the predominant form of tenure. ‘We estimate that 50% of repossessions are buy-to-let properties,’ says Robin Gordon Walker of the FSA.

Low rates of capital appreciation

‘Repossession in buy-to-let properties reflects the negative net rental returns and the low rates of capital appreciation on newly-built properties in the last couple of years,’ says the FSA report.

The average price of a new flat – which make up 45% of the repossession sample, but only 8% of the mortgaged housing stock – increased by just 0.8% between the second quarter of 2004 and the first quarter of 2006, according to Land Registry figures.

Over the past five years the average price of older flats has soared in value by 59% while the average price of a new build flats rose by just 15%.

‘Although mortgage repossessions are at historically very low levels some buy-to-let investors are failing to achieve the kind of rents needed to cover their costs,’ explains Stephen Ludlow of London letting agent, Ludlow Thompson.

Landlords competing with each other

Ludlow points out that newly built flats generally command a premium of 10% over ‘second hand’ properties. They are often built in huge blocks with other identical flats. Developers, keen to get rid of units, offer supposed ‘discounts’ to bulk buyers or guaranteed rental returns for a year. But with so many units flooding the market at the same time, landlords compete with each other and have to lower rents to attract tenants.

‘We often find that developers forecast unrealistically high rents when they are marketing new builds. It pays to get a second opinion on a forecast rent from a lettings agent unconnected to a development. Buy-to-let investors often find that when a guaranteed rent period ends the actual market rent they receive may turn out to be lower than during the guarantee period,’ Ludlow warns.

The buy-to-let lobby is reluctant to admit there is a problem. In November 2006 the market was up in arms at what was generally dismissed as an ‘irresponsible’ piece in the Financial Times, which reported that repossessions on investment properties were rising. But the FSA has revealed that a high proportion of repossessions are indeed on buy-to-let properties.

Disguised buy-to-let

FSA research concluded that a significant chunk of lenders’ mortgage losses came from ‘disguised’ buy-to-let properties. This has thrown the regulatory spotlight on both lenders and intermediaries involved in advising these clients. The FSA found evidence that some brokers were advising borrowers to take mainstream mortgages on buy-to-let properties.

Unsurprisingly, many of the repossessed properties were new flats, many purchased direct from the developer with supposed discounts or rental guarantee periods. Curiously, many borrowers had disguised their buy-to-let property as an ordinary owner-occupier loan – presumably to obtain a larger loan-to-value.

This poses a problem for the regulator. Buy-to-let mortgages are unregulated. But if the borrower claimed that they were owner-occupiers, does this make it a regulated transaction? ‘I suppose it does, if the applicant had hidden the fact that it was a buy-to-let property,’ is the reaction from Sue Anderson of the Council of Mortgage Lenders (CML).

False transactions can open a huge ‘can of worms’

Robin Gordon Walker does not agree. ‘We would look through a false transaction and if the real purpose of the loan was to finance a buy-to-let property, rather than the owner-occupier mortgage claimed by the applicant, we would treat it as an unregulated mortgage.’

This is important for both intermediaries and lenders if the client is looking around for someone to blame after having lost their property. ‘This is an issue for the regulator,’ says Chris Cummings, director general of the Association of Mortgage Intermediaries. ‘If there are advice issues, at some point somebody will ask whether the consumer has an enforceable mortgage. It is a can of worms.’

Cummings goes on to say, ‘one of the things that concerns me is the downward drift in lending criteria generally – not just in buy-to-let. Lenders chasing business are relaxing their lending criteria just as mortgage rates are rising. When a major mortgage lender says it is ignoring county court judgement s on its prime mortgage lending I think we should be concerned.’

Repossessions on the rise

The FSA is clearly worried too.

‘Given the recent increases in interest rates there is a risk that the number of properties taken into possession will rise sharply in the coming months,’ it warns.

Referring to the ‘disguised’ buy-to-let mortgage applications, the regulator says, ‘there is a significant risk that mortgage lenders do not know the true quality of their lending book and therefore any stress testing that they have carried out may not be reliable.’

One thing that is beyond dispute is that repossessions overall are rising. Latest figures from the Department for Constitutional Affairs show that during the first quarter of 2007 33,715 mortgage possession claims were issued – 1% higher than in the first quarter of 2006. Some 21,931 mortgage possession orders were granted – again, 1% higher than in the first quarter of 2006.

Deserting the market

But there has been a significant drop in the number of possession orders that were suspended to allow the borrower to clear arrears and avoid repossession – down from 50% to 46%. This indicates that a larger number of borrowers are unable, or unwilling, to clear the arrears, and are simply walking away from the property. This is not something that owner-occupiers are likely to do except in extreme situations.

CML figures show a similar trend. Of the 850,000 outstanding buy-to-let mortgages, 0.69% are three months or more in arrears, up from 0.39% in the first half of 2003, indicating that some 5,865 investors are in difficulties.

Some lenders admit that arrears are rising. Bradford & Bingley (B&B) says 1.06% of its entire buy-to-let book is in arrears, up from 0.52% in 2004. B&B also reports a sharp rise in self-certificated buy-to-let loans – where proof of income is not required. These leapt to 46% last year, although B&B says the increase partly reflected more people in flexible working and self-employment.

In the lending market, CML figures show that average maximum loan-to-value has gone up from 80% in 2003 to 85% today with some B2L lenders offering 90% loans. Similarly, rental cover has come down from 130% of mortgage interest payments in 2003 to 125%

Lenders and mortgage intermediaries should remind themselves what is happening in the US where lenders all but abandoned all reasonable lending criteria – with disastrous results.