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***Why the buy-to-let bubble is doomed to burst
***Stop press! Prices of flats are falling by up to 36% a year
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***RECOMMENDED ARTICLES: How the US can survive Peak Oil... What will Ben Bernanke mean for the US?...
Amateur landlords are the new tech investors. What on earth do I mean by that? Let me explain...
Buy-to-let borrowing is soaring. Buy-to-let mortgage specialist Paragon reports that lending activity is 60% higher than a year ago. The Council of Mortgage Lenders says buy-to-let lenders issued a record 130,400 loans in the second half of 2005. Investment property now accounts for 8% of the total outstanding mortgage market.
And with the Association of Residential Letting Agents claiming that rental property currently generates an annual return of 22.7%, it's no surprise people are flocking to buy.
You heard correctly - a 22.7% annual return. That sounds good. Almost too good to be true
And unfortunately, it is to good to be true. You can take my word for it, but looking at the maths is a good way of showing why you should never trust statistics from a partisan source. So here's how Arla composes that juicy double-digit return.
They assume that the landlord is buying a property priced around £285,315, with a 25% deposit. So the landlord pays £77,035 up front and takes on a mortgage of £213,986.
Assuming a gross annual rental yield of 4.99% - which is apparently the average yield achieved by Arla's members the landlord takes in annual rent of £14,233.
Of course, a property isn't let out all of the time, so Arla throws in a month-long void period, again based on the average reported by their members. That cuts the annual rent by £1,061 to £13,162.
But at 6.25%, mortgage interest repayments come in at £13,374. So that means in the course of a year (not including any repairs, broken boilers, or dodgy tenants), the landlord is actually making a grand loss of £212.
So where on earth does that 22% annual gain come from?
Well, here's the clever bit. After all those meticulously calculated numbers (right down to the last £1), Arla makes a whopping great leap of faith. It assumes that every year, for the next five years, property values will rise at 8.8% a year. That means that £285,000 property would be worth nearly £435,000 by the end of 2010.
So even though the landlord has lost money every year on the rental income, by the end of five years, the value of his initial deposit (£77,035 remember) has more than doubled. And that's how you get a 22% annual return on a flat that loses the owner money every year.
This is clearly fantasy. Arla says the 8.8% is based on the national average rise between 1984 and 2004. But if you invested in property at the start of 2005, you would have been lucky to see any house price growth at all. And even the most optimistic forecaster would be stunned if house price growth hits anywhere near 8% this year.
Worse still, the figure contradicts the group's own findings. In the introduction to the report, Arla reports that its members reckon the average "capital asset value" ie, the price - of rented homes fell 1.5% during the period. Meanwhile, the average value of rented flats "throughout the country" fell, by as much as 9% - in just three months. If you annualise that, that's a fall of 36%.
So there you have it. Don't fall for the hype buy-to-let is officially a loss-making investment. And remember to look carefully when vested interests wheel out their statistics.
And don't expect things to get any better. UK consumers can't afford to pay higher rents. They are already struggling with soaring energy prices and ever-increasing council tax bills - as the record number of UK bankruptcies demonstrates.
And it's not just consumers feeling the pain. Banking giant Barclays saw bad debt provisions surge 44% to £1.57bn during 2005, driven mainly by overstretched UK borrowers defaulting on their credit cards.
Let's think about that for a minute. That's £1.57bn that Barclays expects it will never see again. Annual turnover for the entire group came in at £18bn, so that's not peanuts by any manner of means.
That money doesn't just vanish into thin air. Someone must be benefiting from it - and subscribers can find out who, by reading MoneyWeek's recent debt cover story. Just click here: How to profit from bankruptcy
And if you're not yet a subscriber, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek.
Turning to the stock markets...
The FTSE 100 fell 5 points to 5,857. Utilities were among the main risers, as a $35bn offer from Germany's E.ON for Spanish group Endesa sparked hopes of more takeover activity in the sector. For a full market report, see: London market close.
Over in continental Europe, the Paris Cac 40 closed 12 points higher at 4,991, while the German Dax rose 7 to close at 5,801.
Across the Atlantic, markets closed lower as resurgent oil prices weighed on sentiment, and minutes from the last Federal Reserve meeting suggested that there will be at least two more US interest rate hikes to keep inflation in check. The Dow Jones closed down 46 points to 11,069, while the S&P 500 fell 4 to 1,283. The tech-heavy Nasdaq dropped 19 points to 2,262.
In Asian trading hours, oil edged lower, trading at around $62.40 a barrel in New York. Brent crude was trading at around $59.50. Meanwhile, spot gold was trading at around $554 an ounce.
In Asian stock markets, the Nikkei 225 fell 113 points to 15,781, on fears that US interest rate hikes may dampen consumer spending.
And in the UK later, we'll find out if any other members of the Bank of England's interest rate-setting committee joined Professor Stephen Nickell in voting for an interest rate cut here earlier this month. The key UK rate was left frozen at 4.5% and seems likely to stay there in the coming months.
And our two recommended articles for today...
How the US can survive Peak Oil
- The new George Clooney film, 'Syriana' exposes some of the murky geopolitical issues surrounding oil. But it won't help Americans to survive Peak Oil, says Jim Kunstler in The Daily Reckoning. To find out what the US needs to be doing to help prepare for a future without cheap oil, click here: How the US can survive Peak Oil
What will Ben Bernanke mean for the US?
- What will new Federal Reserve chief Ben Bernanke bring to the US economy? He seems to believe that the US is still in 'Goldilocks' mode, despite evidence of a crumbling housing market. But with previous interest rate hikes only just making themselves felt, Charles Stanley's Jeremy Batstone believes a downturn could come more quickly than expected. For more, click here: What will Ben Bernanke mean for the US?
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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