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Buy-To-Let Disaster In Waiting?
On the one hand we have buy-to-let P2P lending website Landbay* showing that buy-to-let returns have beaten all other assets over the 18 years to the end of 2014.
On the other, we have a This Is Money article calling buy-to-let a “£200 billion time bomb”.
Great past returns can mean poor future returns
Landbay has chosen a very convenient point to start from.
18 years ago it was 1996, which was right at the bottom of the last major property market crash. Even so, there's no question that buy-to-let has been a highly successful investment over the past two decades.
The thing is, past returns are a terrible way to estimate your future returns. Indeed, if anything, a very strong run in the past is more likely to lead to a bad run in the future.
Take the stock market in the late 90s (as just one example of many we could choose from). Shares had already had a great run for a couple of decades with huge double digit returns. This means that share prices had got very high.
Yet both amateurs and experts alike – with typically short-term memories for investors – believed that they would still get huge double digit returns for the following ten years. How wrong they were! In hindsight, it's easy to see that higher prices mean the risks of a fall are higher.
It's an irony that often contributes to bubbles and crashes: the longer and more powerful a good investment run has been, the more likely people are to think that it is now a good and solid investment, but, in reality, it is actually riskier and less likely to be a good investment.
This is because the price gets all out of proportion.
With P2P lending, the more people who believe it provides great, safe returns, the more they pile in to lend. This pushes down interest rates (which is a “higher price” for lenders) because all the lenders have to compete to lend their money to borrowers at lower rates.
Eventually, the rates can get too low for the risks involved – but because nothing has gone wrong previously, even more lenders now think that it is safe when it has actually become risky.
Buy-to-let is getting hot
According to This Is Money, the Bank of England fears that those lending to buy-to-let borrowers are taking on more risks than they used to. They can do that either by lending too much or by lending at interest rates that are too low for the risks involved.
The article also describes a buy-to-let explosion, as £200 billion is now borrowed to fund buy-to-let mortgages, up from very little a few decades ago.
Yes, as the article points out, buy-to-let landlords have tax advantages over homeowners in running their properties, which makes it more attractive for them to maintain homes than homeowners.
And yes, it's no surprise there's a big rise in private landlords, since successive governments have set up our property system so that there's less social housing and more private households.
Yet the article brings up some excellent warning points:
The buy-to-let dream has helped fuel a faster rise in house prices – and it could help them fall faster too. When interest rates rise, it won't take much for many landlords' low profit margins to be swallowed up. They – along with homeowners – might be forced to try to sell. This will see house prices plummet.
A property market disaster is far from inconceivable.
What should lenders like you and me do?
Landbay borrowers have something of a cushion against interest rate rises in that they receive much more rent than many newer landlords who borrow to buy.
On average, the rents they're receiving are around 1.65 times more than their monthly mortgage payments.
The average amount that Landbay lenders like you and me are lending to landlords is approximately 68% of the expected sale value of the property. This is not amazingly low, but it's pretty good.
Your money is also typically spread between ten mortgages and Landbay wants to push this up to 20 or more. This reduces the chance that one or two bad borrowers will destroy your investment.
Plus, Landbay* has a modest bad-debt provision fund worth 1% of the outstanding loans.
Finally, landlords all have ten-year mortgage deals with Landbay, so if lenders choose Landbay's fixed-interest deal they can be tied to landlords who are sensibly protected from rate rises.
(Note that lenders are just tied in for three years and you are allowed to sell your loans back if another lender is available to buy.)
Between all these protections, it could take bad luck combined with an incredibly severe financial or property crisis for you to lose money overall, after the interest you receive, over a five-year period.
Still, make sure you spread your money across several different lower-risk P2P lending websites and lots of loans, so that not all your lending is in buy-to-let.
We keep you up-to-date on warning signs that P2P lending generally or specific P2P lending websites are getting too risky. Sign up below to our newsletter for our alerts or visit Landbay*.
*Commission, fees and impartial research: our service is free to you. 4thWay shows dozens of P2P lending accounts in our accurate comparison tables and we add new ones as they make it through our listing process. We receive compensation from Landbay, and other P2P lending companies not mentioned above either when you click through from our website and open accounts with them, or to cover the costs of conducting our calculated stress tests and ratings assessments. We vigorously ensure that this doesn't affect our editorial independence. Read How we earn money fairly with your help.