Buy-to-let profitability improves as property prices rise

Our latest buy-to-let profitability index shows that returns on investments are improving, with a five year geared investor almost breaking even. Investors may even begin to see a profit in the next quarter, claims Brian Hall, founder of The Model Works. Our index uses Bank of England, Nationwide and Association of Residential Letting Agents data to calculate the historic returns over 25, 20, 15, 10, and 5 year periods, for a cash buyer or a geared investor, with a repayment or an interest only mortgage, selling today. What a difference a year makes! Our previous four quarterly indices showed losses over five year investment periods. This was primarily due to falling property prices. A year ago our five year index was based on a purchase in Q3 2007, when an average first time buyer property was 156,634. Five years later its value had fallen to 138,561, a 18,073 loss, which is an awfully large hit to be recovered over a short period. Our latest index assumes a purchase in Q3 2008, when the average value was 140,387. Five years later the value has risen to 142,930, a capital gain of 2,543. If we look a year ahead, the value of this property bought in Q3 2009 was 133,611. Four years later its value has already risen by 9,319. And property prices are still rising. Investing in Q3 1007 versus Q3 2008 resulted in a 20,616 difference in capital gain. Clearly, understanding the market and timing are critical in maximising buy-to-let profitability. Those investing today really need to be aware of this marketplace volatility. We have done a lot of work in this area and it is one of the factors that really jumps out from the data, particularly on shorter investment periods, with highly geared investments. We have a dynamic bubble chart on our website that illustrates this behaviour. The issue is made more relevant given ARLAs recent observation that the buy-to-let market has shifted from long-term investors to novice landlords who view property as a short-term investment. The red flags here are short-term and novice. Interest driving interest Returning to the index, other factors are contributing to improving profitability. Generally rates are falling. We use a Bank of England, monthly, combined bank and building society rate and this has dropped by a full one percent over five years. Over the same period, rental yields have increased leading to improved margins Over the same five years, the Bank of England deposit rates we use have halved and are now at 1.72%. This reduces the opportunity costs (the comparative returns from investing the funds elsewhere) and this further increases buy-to-let profitability. Obviously, with savings rates at a nine-year low, many investors are looking to buy-to-let. Note to editors: For further information and to receive the new index, contact Brian Hall on 07785 954040 or brian.hall@themodelworks.com. Additional background on research into first time buyer exclusion and buy-to-let is available from www.themodelworks.com.

Buy-to-let profitability improves as property prices rise

Predicting future profitability What will happen to property prices and interest rates over the next five years? We have been working on regional indices. These may be helpful, for example in better understanding the hyper-valued London market in relation to the regions. London Central Portfolio say prices would have to fall by 54% to match price-to-income ratios elsewhere, while Knight Frank say that three quarters of new builds in the capital are sold overseas, off-plan, before they have even been advertised in the UK. So London prices are less dependent on London incomes, at least on new builds. Taking the UK as a whole, the Money Advice Service say that nine million more adults are struggling with money compared to seven years ago and the Chartered Institute of Housing say that overpriced property is choking economic recovery. However, many pundits say that the funding for lending and help to buy schemes may cause another property price bubble. And this is against a backdrop of builders, lenders and estate agents all reporting that business is booming at the moment. It is very difficult to reconcile the conflicting realities of optimistic providers (including buyto-let investors) and over-extended consumers to predict the future. Instead, The Model Works has published a downloadable beta model on its website to allow investors to enter their own projections and read off the results.

Note to editors: For further information and to receive the new index, contact Brian Hall on 07785 954040 or brian.hall@themodelworks.com. Additional background on research into first time buyer exclusion and buy-to-let is available from www.themodelworks.com.

Buy-to-Let Index Q2 2013

Repayment Geared Investor 5 Years Purchase Price Opening Balance Closing Balance Selling Price Redemption Amount Closing Equity Final Balance Return (100% = Break Even) Compound Rate of Interest 140,387 -37,202 -48,479 142,930 -94,700 48,230 36,953 99.33% -0.13% 10 Years 103,862 -27,524 -37,178 142,930 -60,021 82,909 73,255 266% 10.28% 15 Years 52,495 -13,386 2,676 142,930 -23,392 119,538 135,601 1013% 16.69% 20 Years 39,467 -10,064 11,133 142,930 -10,583 132,347 153,543 1526% 14.60% 25 Years 42,068 -10,727 -8,740 142,930 -662 142,268 144,255 1345% 10.95%

Interest Only Geared Investor 5 Years Purchase Price Opening Balance Closing Balance Selling Price Redemption Amount Closing Equity Final Balance Return (100% = Break Even) Compound Rate of Interest 140,387 -37,202 -36,300 142,930 -107,396 35,534 36,437 97.94% -0.41% 10 Years 103,862 -27,524 -20,198 142,930 -77,897 35,534 72,359 263% 10.15% 15 Years 52,495 -13,386 14,630 142,930 -40,159 102,771 130,788 977% 16.41% 20 Years 39,467 -10,064 23,120 142,930 -30,192 112,738 145,922 1450% 14.31% 25 Years 42,068 -10,727 8,580 142,930 -32,182 110,748 130,055 1212% 10.50%

Cash Buyer 5 Years Purchase Price Opening Balance Closing Balance Selling Price Redemption Amount Closing Equity Final Balance Return Compound Rate of Interest 140,387 -144,598 -120,570 142,930 142,930 166,959 115.46% 2.92% 10 Years 103,862 -106,978 -57,065 142,930 142,930 192,844 180.26% 6.07% 15 Years 52,495 -53,545 9,936 142,930 142,930 206,411 385.49% 9.41% 20 Years 39,467 -40,256 31,445 142,930 142,930 214,631 533.16% 8.73% 25 Years 42,068 -42,910 37,309 142,930 142,930 223,148 520.04% 6.82%

Gearing 75% LTV, arrangement: 2% of mortgage, provisions for arrears, voids and management, maintenance and insurances: 2.5%, 5.75% and 15% of rent, interest at B0E rates, property prices from Nationwide, yields from ARLA

The Model Works 31 July 2013

Buy-to-Let Index Q2 2013

Methodology The Model Works Buy-to-Let Profitability Index provides a simple, quantitative assessment of the returns on investment in the private rental sector over time. The index provides profitability data for: 5, 10, 15, 20 and 25 year investment periods Cash buyers and geared investors with: A range loan to value ratios Mortgage types: o o Repayment Interest only

The index is published quarterly and provides profitability data back to 1983. Future releases will include mortgage interest tax relief and capital gains tax calculations and produce data on a regional basis. In addition to the index, which provides historic data, a model based on systems thinking principles will be published to project future outcomes. This paper documents where the data is sourced and how the index is calculated. Overview The index is founded on the following source data: House prices from the Nationwide Building Societyi Mortgage rates from the Bank of Englandii Deposit rates from the Bank of Englandiii Rent and void levels from ARLAiv Stamp Duty rates from HMRCv

Mortgage repayment and balance calculations are from Mortgages Exposed.vi The index incorporates additional allowances for: Mortgage arrangement fees set to 2% of loan Provisions for arrears set to 2.5% of rental Management fees set to 15% of rent

The Model Works 31 July 2013

Buy-to-Let Index Q2 2013

Structure The index is based on two linked sets of calculations: Capital Gain Cashflow

The Index works back from the selling date. For example, if the selling date is Q2 2012 and the index is calculating a five-year investment, the period under review will commence at Q2 2007. The calculation will take the average property price at this purchase date and any stamp duty and acquisition costs that apply at that time. This will create a negative balance on the buy-to-let investors account. Rental income and deductions, including mortgage repayments, are calculated quarterly and applied to the buy-to-let investors account, before the appropriate interest rate is applied to the resulting debit or credit balance. Finally the index identifies the property price as well as any selling costs, including the cost of redeeming any mortgage, at the selling date and calculates the resulting closing balance. If the closing balance is greater than the opening balance, this signifies a profit and the compound rate of return over the period is then calculated. If the return is negative, then the word Negative is entered.

Comparisons The Model Works Index differs from other buy-to-let indices in several ways. Most indices concentrate on the net rental yield. A typical calculation will simply divide the annual rental income by the initial property price to produce a yield figure, but this is inadequate on several counts and the calculation excludes: Mortgage repayments and the opportunity costs of using funds that could be invested productively elsewhere are not incorporated A raft of other acquisition, maintenance and management costs, voids and arrears costs and selling costs are not taken into account

Generally other indices are far more optimistic and less volatile than that of The Model Works, which takes more factors into account and applies true historic data rather than assumed values.

Regional quarterly series by buyer type - First Time Buyers (Post 1983) Post 1995 IUMTLMV, Bank of England, monthly, combined bank and building society (from 1983 to 1995 BSA Yearbook 2011-2012 New Mortgage %) iii Post 2009 BoE IUMB6RH, Monthly interest rate of UK resident banks (excl. Central Bank) and building societies' sterling fixed rate bond deposits from households (in percent) not seasonally adjusted - 2 year (1996-2009 - BoE IUMWTFA, Monthly interest rate of UK monetary financial institutions (excl. Central Bank) sterling fixed rate bond deposits from households (in percent) not seasonally adjusted, 1995 - UMWTTA, Bank of England, monthly, sterling time deposits rates, from 1983 to 1995 BSA Yearbook 2011-2012 Ordinary Share %) iv Association of Residential Letting Agents - Buy to Let Review v www.hmrc.gov.uk/stats/stamp_duty/00ap_a9.htm vi www.mortgagesexposed.com/Book_Contents/Other_Formula.htm
ii

The Model Works 31 July 2013