Alan Cleary, managing director at Precise Mortgages, casts a critical eye over the industry
Many column inches have been dedicated to buy-to-let of late, with some headlines predicting the end of the market.
I regard those headlines as provocative, lacking any strategic thinking and certainly not supported by basic facts.
We are all aware of the headwinds in the market in the form of: the Basel Committee on Banking Supervision consultation paper on the standardised approach for credit risk; changes to taxation for landlords; and the Financial Policy Committee’s powers of direction. Allow me to tackle them one by one.
The BCBS consultation paper potentially increases the amount of capital some lenders are required to hold for buy-to-let loans, therefore making them less profitable for the lender and less attractive as an asset class, despite the sector’s outstanding performance during the financial crisis. This could force prices up for consumers or see some lenders move away from buy-to-let.
The likelihood of this proposal coming in as it stands, however, is in question. It will need a lot of consultation before being finalised. In any event, it will not come into force until 2019 at the earliest and most likely only in stages over several years. Some lenders may consider moving to the internal ratings-based approach, which will mitigate the risks entirely.
Meanwhile, changes to buy-to-let taxation begin in the 2017/18 tax year, which means the first financial impact on landlords will be in January 2019. The size of the impact for the average landlord will be additional tax of £500-£600 a year, so not a deal-breaker. It certainly does not make the average buy-to-let look like a poor investment, especially when compared to alternatives. It is likely to be completely negated by increases to rents anyway.
Those most affected by the tax changes will be owners of low-yielding properties that are highly geared. Take, for example, a £1m property at 75 per cent LTV with a rental yield of 4 per cent. The change will reduce the landlord’s profit after tax by around £6,000 a year in the 2020/21 tax year. However, this type of property is typically in London and landlords who buy there have never got rich on rental yields. Indeed, they are more likely investing for house price inflation: at 2 per cent HPI, this landlord’s property will be appreciating by £21,000 per annum in the same tax year.
Many of these landlords will utilise limited company structures to take rental income into a corporate regime, thus avoiding the tax change entirely.
Powers of intervention
The final headwind is the FPC’s potential power to intervene in the buy-to-let market if it feels it is overheating and/or proving a threat to financial stability.
The two mooted areas of control are around LTV and interest coverage ratio limits, which, taking the controls it uses in the residential market as a proxy, may mean lending above a certain LTV or ICR will be limited to around 15 per cent of new business in any one quarter.
I am encouraged by the tone from the FPC in that it does not intend to use these powers until it has seen the effects of the taxation changes.
So what about the tailwinds? Well, there continues to be a significant supply gap when it comes to UK homes. Even if government initiatives deliver the new-builds planned, this gap will remain; in fact, it is more likely to continue to increase. With this in mind, house prices should continue to rise too.
The cost of buying will remain higher than the cost of renting, due to consumers having insufficient deposits or income, and this will drive continued growth in the private rental sector.
The Government’s primary policy objective is to increase homeownership, particularly for first-time buyers. A secondary objective is to ‘cool’ parts of the housing market, particularly the buy-to-let sector. We do not believe it is the Government’s intention to destroy buy-to-let because the private rental sector is a large part of the overall market and a critical source of housing.
Like many others, I encourage policymakers to consider the second-order consequences of intervention in the housing market (such as significantly increasing rents) and to ensure decisions are based on accurate data.
Alan Cleary is managing director at Precise Mortgages