With historically low interest rates the attractiveness of the property market, and more specifically the “Buy to Let” sector has increased significantly, and this for a number of reasons:

• Low interest rates means low yielding alternative fixed income investments such as bonds and the various types of bank accounts;
• Low interest rates means that it is cheaper to finance the purchase of the property through a bank loan (even though technically these should be considered as business loans rather than home loans);
• There seems to be no form of regulation on the property market with estate agencies advertising buy-to-let rates as investment products, without any form of warnings;
• The inherent historical obsession of the local investor with the property market and the attitude that “land always appreciates” – I guess they have not heard of the 2007/09 financial crisis in which the property market was the key source of all the turmoil?!
• The influx of foreign workers who re-locate to Malta as the demand for certain jobs that might not be fully catered for by the local work force has increased significantly. Such workers would typically be specialised IT developers who would more likely be looking to rent, at least in the first few years.
• The increase in marital separations and divorce has also led to a demand for rental properties as proceedings can take a while to be concluded and it would involve some form of division of assets that would make it more affordable to rent a property as opposed to buying one.

What are the risks?

Although buying a property for rental income is not a bad thing in itself, there still are risks involved in such an investment. First of all, I am always sceptical of “investments” that are not regulated. Since property investing does not fall under the definition of a financial instrument it is not regulated by the very investor-centric regulations that financial instruments are. What this means is that as an investor you are not protected and the person selling the property to you has no obligation to explain the risks involved in investing into the property market. He/she doesn’t even need to know about the risks

Another risk of buying to let is that property investing typically takes up a large portion of one’s portfolio of assets. We all know how the advice is always to spread your risk by diversifying into different investments. If a person has for example €150,000 invested into a property for rental purposes and then has €20,000 in other investments, such an investor has a high concentration risk whereby 88% of his investments are in one single investment. In the same logic that one should never buy into one single investment when considering financial instruments, one should not have such a high concentration into property.

By its very nature, property is an illiquid asset, meaning it cannot easily be converted into cash. Even if one is lucky and manages to sell his property in say 3 months, there typically will only be a promise of sale first and then 6 months to a year later the contract will be done which could be subject to other things such as development approval, approval of a bank loan and so forth. If on the other hand an investor has a Malta Government Stock (MGS) and wants to sell €1mln in one day he will get his money in 3 working days.

The hidden costs are also a major factor to keep in mind. Since property as an investment is not regulated there is no obligation to mention all the costs from beforehand:

• The initial costs in buying a property are typically a commission if a property dealer is used (not an agency, those are normally paid by the seller). There is then a tax to be paid on purchase of a  property. There are the notary fees to be paid for research and drafting of the contract. There are then the bank fees if a loan is being taken out to finance the project.
• The on going costs – if an agency is going to be used in order to find tenants (which is the most convenient option), then the agency would take its commission for doing its work. If you are renting out a furnished property which is typically the case you not only need insurance on the property but also insurance on the content (furniture, fixtures and fittings). If your property is an apartment part of a block you also have the annual maintenance fee to be paid (for maintenance and upkeep of the common areas). There is of course the ongoing typical maintenance costs involved in keeping any property in good form such as painting and plastering from time to time and so on.

So when you add all the costs together you quickly realise that the advertised 4-6% rental income is just a gross figure and not the real net return. This is besides the fact that like other investment income the income from renting is subject to 15% withholding tax as well.

Another risk is the interest rate risk that exists. Here we have two factors in play.

1. One factor is the current cheap  mortgages attributable to the current low interest rates. Some “investors” who are buying property with the aim or renting it out are not factoring in the event that interest rates could start rising and with them the cost of maintaining their bank loan. As interest rates rise the monthly payment needed to pay the mortgage on the property goes up and it might very well go up to the point were many would not consider it viable to keep renting out the property. In such a situation there will be a rush to sell properties. 
2. The other factor is when you consider the income of renting out a property (with all the hassle that brings along with it) compared to the income from a regular bond or bank deposit.  As interest rates start to rise the difference starts to narrow and could even end up reversed whereby one could get a better interest on financial instruments as opposed to rental income. This scenario would also lead to a rush to sell property and hence a fall in the price of such property.

A final risk to consider is the dependence on foreign occupants for certain sectors of the rental market. Many rental properties around the Sliema, St. Julians, Gzira and Ta’ Xbiex area are occupied by foreigners form the IT, Gaming or Financial Services sectors. These tend to be employed by foreign companies that have been attracted to Malta mainly for the advantageous tax setup for non-resident shareholders. Imagine what would happen if the EU had to pressure Malta to change such tax setups and a number of these foreign companies had to relocate elsewhere!

Are we witnessing a bubble in the making?

When you have a situation that a lot of investors are switching to buying property in order to rent them, you quickly start to build up more supply of rental properties. This, coupled with all the reasons listed above as to why the demand for buy-to-let is going up, could end up creating a situation where property values go up in value too high, too fast. At the end, you end up with a situation where prices have to be corrected and you have a fall in the asset value.

Although I do not think that we have entered this phase yet, history teaches us that we are slowly heading in this direction. I am not talking about 20 years ago history, I am talking about a few years ago when there was a big drive for many people to knock down their house and build a number of apartments. All of a sudden ever Tom Dick and Harry became a contractor – at first it was quite a lucrative venture, eventually however the demand reached its limits and the supply outweighed it.

The Bottom Line

Like any other investment, investing into a buy-to-let property has to be taken in the context of one’s total portfolio. One should not over expose him/herself just to get into this market. On the other hand, if it is affordable, an investment into the property market is considered a good addition as it will not move in the exact same direction as other investments and can lead to more diversification.

Just like not all bonds are the same, not all shares are the same and so no, not all property is the same. Location, property size and other factors will have an effect on the rent-ability and potential saleability of any property one might consider. So advice from a professional is always recommended.

Furthermore, one should note that there are other ways of entering this market without actually buying property. There are many investments issued by property renting firms which one could invest indirectly into this market. One could also add different investments from different geographical locations and different sectors of the rental market. This could be done much cheaper and provide for much better diversification of one’s risk than actually buying property directly.

KD