Buy-to-let landlords have been on the receiving end of several shake-ups in recent times, so can the market recover or is this the new normal?
It was once the sweetheart of the mortgage industry. Yet, after a slew of tax and regulatory changes in the past year – and with more on the horizon – the buy-to-let market appears to have lost its shine.
Transactions data shows that lending is dramatically down, even when taking into account the number of house purchases brought forward to beat the April 2016 stamp duty deadline.
Landlords are being taxed more than ever and the Prudential Regulation Authority is set to introduce further rule changes during 2017.
So where does BTL go from here?
Understanding the slump
The recent transformation of the market can be traced back to the door of former chancellor of the exchequer George Osborne. His decision to levy an extra 3 per cent stamp duty on people purchasing a second home meant that virtually all BTL properties would be subject to the extra tax from April 2016.
This announcement was hot on the heels of Osborne’s decision to treat all rental income as taxable income instead of profit – something that would also hit landlords hard. This tax relief policy was to be phased in over four years, starting its first phase in April 2017.
Huge numbers of landlords brought forward their purchases to beat the April 2016 stamp duty deadline, but this spike has been followed by a large and sustained decline in activity.
However, John Charcol senior technical director Ray Boulger says the new rules on tax relief have been the “real killer policy” and he expects this downturn to continue.
He says: “The economics of investing in the buy-to-let market have changed dramatically for those who can only do so with gearing.
“As this not only appears to be long-term government policy but also, because of the taper, worsens for several years, I see no reason to expect a significant bounceback in the level of buy-to-let investment by private landlords.”
Data from the Council of Mortgage Lenders shows that transactions for BTL house purchase peaked at 29,100 in March 2016 before slumping the following month. One year on and there are around 6,000 transactions per month, well below the trend of the past couple of years. BTL remortgage levels have remained relatively stable in this period.
Anderson Harris director Jonathan Harris believes the market has yet to fully adjust to the long-term impact of the tax relief changes.
“Buy-to-let is going through a period of adjustment with the changes to mortgage interest tax relief far more significant than the 3 per cent stamp duty surcharge on investment properties,” he says.
“Landlords have not yet felt the full impact of the changes because these are being phased in, and there is uncertainty as investors are not yet sure what it will mean for their bottom line. There is definitely more caution than previously.”
Has this shake-up of the sector simply masked underlying problems, however? According to Your Move, the returns seen by landlords have diminished massively in the past year. In April 2017 the average yield in England and Wales was 4.4 per cent, substantially down on the 5 per cent recorded the year before. The fast growth in house prices of recent years has also subsided, causing issues for landlords trying to gear their portfolios.
Harris says: “With yields falling and capital growth not likely to be what it was, investors have to be much more canny, expanding their portfolios only when it makes sense to do so.”
Landlords in London have been under particular pressure and have seen their yields shrink to 3.2 per cent – the smallest in the country. This could be prompting some smaller landlords to sell up – welcome news for first-time buyers but less so for choice in the rental market.
Data from the Association of Residential Letting Agents shows that the number of properties available for rent in the capital fell by around a third between March and April alone.
OneSavings Bank sales and marketing director John Eastgate believes the extra costs could drive a number of landlords out of the London market.
“Property investors in the capital already face the highest running costs in the country, at an average of £6,365 per property, and that’s before mortgages or rising taxes are factored in,” he says.
“With higher property prices, landlords in London have been hit hardest by last year’s stamp duty changes, and those with mortgages will see the biggest impact from the recent changes to mortgage tax relief.
“As these costs rise, many smaller-scale landlords are rethinking their investment plans. We will see accelerating professionalisation of the sector as amateur and accidental landlords leave the market and, arguably, that’s what we’ve seen in these figures.”
Boulger adds: “As the supply of new buy-to-let properties reduces, due to a combination of fewer purchases and some existing landlords selling, tenants will have less choice and rents will be higher than they otherwise would have been.
“This problem will be mitigated only if institutional investors increase the number of properties they own and, while this is happening, it is not on a sufficient scale to compensate for the reduction in supply from private landlords.”
If this situation was not challenging enough for landlords and lenders to cope with, they also face a wave of regulatory changes.
The PRA introduced tougher interest coverage ratio tests and interest rate stress tests in January 2017. Borrowers must be stress tested at an interest rate of 5.5 per cent for the first five years of a loan, unless the rate is fixed for longer than this. In addition, lenders are required to apply an interest coverage ratio test or an income affordability test that takes account of a borrower’s personal income.
Harris says: “While many lenders are adopting a rental stress test based on 145 per cent at a notional rate of 5.5 per cent, there are more bespoke solutions available, with some lenders assessing cover at more favourable levels for borrowers willing to fix for five years. Other lenders will allow 125 per cent for basic-rate taxpayers.
“It can make a big difference to the amount a landlord can borrow. With a rental stress test of 5 per cent at 125 per cent, you could get a mortgage of £192,000 on a property with a rental income of £12,000 per annum; but this would fall to £150,470 if the calculation increased to 5.5 per cent at 145 per cent. It means most landlords are able to borrow far less than they have been used to, which means they may find it harder to remortgage, particularly if they need to raise capital.”
Lenders are also required to delve deeper into an applicant’s financial history and tax status, while a further change means landlords with four or more mortgaged BTL properties are now classified as portfolio landlords and must meet specialist underwriting standards.
Boulger believes this is likely to reduce choice for many landlords.
He says: “Those with more than three mortgaged properties are likely to have less lender choice from 1 October and a big short-term risk is that, if not enough lenders are ready for the 1 October changes, service levels will seriously deteriorate.
“With less choice, the inevitable consequence is that the reduced competition will mean some increase in rates.”
However, Paragon managing director John Heron thinks that, although total BTL lending volumes are expected to reduce “a little” this year as a result of the fiscal and regulatory changes, there are positive aspects nonetheless.
“We expect lending to portfolio landlords to increase as a proportion of the whole, as landlords adjust their strategies to best position themselves for these changes,” he says, adding that Paragon’s approach is “already well aligned with the PRA’s requirements”.
He continues: “In 20 years of lending to professional landlords, we have always collected full information on all the properties that a landlord may own, whether individually or corporately, and on all of the applicant’s economic activity.”
While bridging loans, corporate finance, holiday lets and property investment lending are exempt from the new underwriting standards, the PRA says it will continue to monitor these markets. However, it has faced criticism for making too many changes to a market already dealing with wider economic factors, such as high inflation, the UK’s decision to leave the EU and the snap general election.
Many in the industry wanted the regulator to pause for breath between the rounds of regulation to allow time to understand the effects on the market. But the PRA insists it was “appropriate” to finalise standards in one fell swoop.
So how can we identify the new normal for the sector? Will the decline in BTL purchasing mean the market will retain its current shape?
In theory, first-time buyers need some welcome relief to help them get onto the housing ladder ahead of BTL landlords. But this may not be achieved if some property investors simply decide to maintain their existing portfolio.
Harris remains optimistic, however.
“All these changes and uncertainty have led to a fall in buy-to-let purchases but we don’t believe it is the end of the sector,” he says.
“People like investing in bricks and mortar and this is unlikely to change, with savings rates at record lows and equities remaining volatile. More landlords are enquiring about incorporating and lenders are offering more products to satisfy this market, so we expect demand to pick up again in the future.”