Times have changed in buy-to-let market, writes Laura Slattery, but the sector is likely to grow

Unrealistic expectations have heralded many a short sharp shock, as tech-obsessed stock market investors found out to their cost as the dotcom bubble evaporated. So are fledgling property investors next in line?

Growth in the housing market has hardly stalled, but it did slow down to 1 per cent over the first three months of 2005, the lowest quarterly rate of increase in nine years.

For property investors who started their portfolios years ago, the figures are of little concern: they have already made their money.

But equity-rich homeowners exploring the delights of buying to let for the first time will be depending on a healthy, sustained increase in house prices to give them a positive return on their investment - especially as an overcrowded rental market means they can't rely on tenants to pay their mortgage.

The Irish population's emotional attachment to practically arranged bricks, concrete and timber is oft talked about but, from a strictly hard-hearted investment point of view, the main enduring advantage of property is the ability to borrow to fund its purchase.

People who would never go near something as ephemeral as the stock markets, quite happily borrow hundreds of thousands of euro, sometimes using their family home as security, in the assumption that property prices will continue to soar.

But heavy borrowing increases the risks and costs involved, warns Tice O'Sullivan, a financial adviser at Primafinance.ie.

"If property values fall, the investors' equity will disappear fast as their debt still has to be repaid. In addition, rising interest rates can turn the cashflow on an investment property from positive to negative," he says.

Unless they have very low borrowings, new investors are unlikely to earn enough rental income to cover their mortgage repayment. In other words, they already have a negative cashflow.

In Dublin, rental yields can be less than 3 per cent, O'Sullivan notes.

"With buy-to-let interest rates at 3.5 per cent or higher, you know you are going to have to go into your own pocket every month, unless you do an interest-only mortgage."

Some investors may be happy to fork out small differences between rents and debt repayments, as long as capital appreciation in the value of the property eventually secures them their profit. But the problem could be exacerbated if the European Central Bank (ECB) base interest rate to which the mortgage interest rates are linked creeps up off its current floor of 2 per cent. This would push up investors' monthly expenses.

They may then find it impossible to compensate by charging more rent.

A report by sales and lettings website Daft.ie shows that average rents stabilised in 2004, following drops of 6-8 per cent each year since the highs of 2001. But the vastly increased supply of properties means many investors may have to take what they get.

"You can't make any money on the rent anymore," according to Emma Webb, director and co-founder of Blake Webb, a residential lettings and management company.

To attract tenants in the first place, buy-to-let investors have to try harder than ever.

"Investors need to avoid areas where there is an oversupply of properties because competition for tenants is very high," says Webb.

Properties that are close to amenities and good transport links like the Dart and Luas lines remain the safest bets, she adds.

But buying in the right location is not enough. "If they are fitting out their property, they really do need to make sure it is finished to a high standard. Tenants are more discerning now because they have so much choice. It's not good enough to put in flat-pack furniture."

According to Webb, tenants are demanding that landlords include facilities such as dishwashers and microwaves when the time comes to renew their lease. If landlords don't cough up, they could easily lose their tenants to the apartment next door, down the road or anywhere that the tenant can move to with white goods.

Even if landlords do everything they can to make sure their tenants are happy, they must still be prepared for vacant letting periods. In any case, lenders won't allow for the full estimated rental income when calculating buy-to-let borrowers' ability to repay.

At Bank of Scotland Ireland, for example, only 80 per cent of the rental income is taken into account when assessing investors' repayment capacity, while at First Active this figure is 70 per cent. At EBS, it is assumed that there will be no rental income for two months of the year.

Lenders are also required by the Irish Financial Services Regulatory Authority to "stress test" all borrowers' ability to repay a loan at an interest rate that is 2 per cent higher than current rates, i.e. at roughly 5.5 per cent.

Stress testing is important because new investors frequently borrow up to 90 per cent of the purchase price of their investment property, with many taking out top-up loans on their existing properties or using a combination of their savings and released equity to fund a deposit.

It might not seem like the end of the world if investors suddenly find that they can no longer afford to maintain their second property. Can't they just sell it?

Well, yes, but the freedom to put up a "for sale" sign and escape unscathed disappears if property prices sink and negative equity means investors can't get out without realising a loss.

Whether they have considered quite such a gloomy scenario or not, new entrants to the buy-to-let market are at least aware that the capital appreciation surges and buoyant, easy-come rents of the past are unlikely to be repeated, according to Dara Deering, head of residential mortgages at EBS.

"People are looking at the long-term forecast and they're happy enough to supplement their rental income to cover the repayments by a couple of hundred euro a month," she says.

EBS research indicates that three-quarters of property investors get involved in buy-to-let in order to fund their pension. Others view it as a nest egg for their children.

The long-term focus is healthy for the market, Deering believes.

No longer are opportunistic, carefree property investors buying indiscriminately off plans and making a quiet killing by the time the wooden floors have been put in and the last of the construction prefabs have moved on to a new site.

Today's breed of buy-to-let investors are required to be more patient, more astute and more cash-rich if they want to make the market work for them. And it seems there is no shortage of willing investors.

"Our forecast for 2005 is that there will be €5.3 billion in new lending in the buy-to-let market, up from €4.9 billion last year, so it's still a very strong market," says Deering.

According to Brendan O'Hora, head of marketing at First Active, investors now account for 15 per cent of lending, down from peaks of more than 20 per cent reached following beneficial taxation changes in 2002.

But maturing Special Savings Incentive Accounts (SSIAs) could provide renewed impetus to the market from May 2006, O'Hora says.

Couples who have both paid the maximum €254 into their SSIAs over the five-year term will have access to a nice, deposit-sized €40,000 at maturity.

The end of the SSIA scheme will also free up €508 in their monthly household expenditure, which they can then divert into repaying a buy-to-let mortgage.

So expect fresh clusters of "to let" signs to decorate roadsides this time next year - and sales of wooden floors to go through the roof.