I appeared on BBC Breakfast last week with a buy to let investor who was convinced he was very rich. He had, he said, made £8m out of the buy to let boom. Further chat revealed that he had properties valued at £8m but £5.5m worth of debt. So he is on paper ‘worth’ £2.5m. You might think that sounds like a reasonable margin of error but I’m not sure its enough: property can turn nasty fast. Many of the reasons not to invest now (the main one being the fact that yields are lower than interest rates) have been widely discussed but here’s one more reason to steer clear. Buy to let mortgages deals tend to contain little read covenants regarding the loan-to-value ratio of the mortgage. In a rising market this isn’t the kind of thing borrowers take notice of but in a falling market they may find that it is the ruin of them.
It works like this. The loans allow lenders to periodically revalue properties (at the borrowers expense naturally). If the value has fallen and the loan to value ratio has, as a result, risen above the level required by the mortgage (say from 80% to 85%) the lender can then ask the borrower to come up with more cash to get it back down. The result, says my lawyer friend, will be that as capital values drop, buy-to-let investors will start to receive letters from the lenders along the lines of ‘Dear Mr Bloggs, I should be grateful if you would restore your loan to value ratio by sending us a cheque for £25,000’.
This, most mortgaged-up-to-hilt investors will be utterly unable to do. The result? Panic selling and not just from the market’s new entrants. People who have been in the market for more than a few years are keen to suggest that they will be immune from any drop in prices thanks to the equity they have built up. But most of them – the man I met on the BBC sofa included – have also bought new properties in the last year. If margin calls – for this is what they are – start coming in on these how are they going to come up with the cash? No one’s immune.