Die-to-let: Will the Chancellor’s B2L policies have unintended consequences?

The Chancellor’s housing policy is one-dimensional, antagonistic and likely to have unintended consequences for the buy-to-let sector, say experts

There is arguably no part of the market more in the spotlight than buy-to-let. The sector’s rapid growth – from a low of £8.6bn in 2009 to £27.4bn in 2014 – caused concern among policymakers, leading to an unparalleled level of intervention. In last year’s Summer Budget, Chancellor George Osborne announced a radical shift in buy-to-let taxation by slashing the amount of tax relief landlords receive on mortgage interest payments. Presently, higher-rate taxpayers can claim up to 45 per cent tax relief, but from 2017 this will be gradually reduced to 20 per cent.

The Chancellor was not finished there. In last year’s Autumn Statement, he announced a stamp duty surcharge of 3 percentage points for those purchasing a second home or a property to let. A consultation on the proposal suggests there could be a carve-out for incorporated landlords with 15 properties or those bulk-purchasing homes, but a decision has not yet been taken.

Moreover, the Bank of England’s Financial Policy Committee will this year be given powers of direction over the buy-to-let market, most likely in the form of LTV and affordability caps.

While talk of the death of the buy-to-let market is well wide of the mark, the cumulative effect of the Government’s actions will be significant. But how exactly will the market change?

Mortgage Strategy met with four leading buy-to-let experts to find out, and to discuss – at Paragon’s City-based office – whether the Government is taking the right approach.

What do the tax changes say about the Government’s attitude to landlords?

Heron: I think what we have seen from the Government is really quite a radical shift in policy approach to housing.

To put that into context, for the best part of the past 30 years we have seen successive governments follow what is broadly regarded as tenure-neutral housing policies. That is, there is no particular bias in housing policy towards owner-occupiers, private renters or indeed the social rented sector. The housing market has been allowed to find its own level.

What has clearly happened over that 30 years is that we have seen really significant changes in society, in demographics, in the economy and in the economics of housing. And as part of the market response, of course, we have seen a very significant increase in bias in the population towards renting privately.

Ying Tan, Managing director, The Buy to Let Business

We have seen that more or less double in scale over the past 10 years, with nearly 5 million homes in the private rented sector. So it’s a much bigger proportion now than the social rented sector. And because of those social and demographic changes, most housing analysts believe it will continue to grow and could well represent 25 per cent of households within the next five years.

It is quite radical, therefore, for a new government to come in and pursue what is effectively a one-dimensional housing policy. And it is also quite radical for that housing policy to be led by the Chancellor rather than the housing minister. But very clearly the Chancellor has made a personal priority of homeownership and is willing to promote this over both social renting and the private rented sector. You can see that in his message about “levelling the playing field” between homebuyers and landlords.

Should the Chancellor be promoting the owner-occupied sector over buy-to-let?

Moloney: To a certain degree we should promote homeownership – and there have been various schemes for first-time buyers – but actually a certain proportion of the population just don’t qualify for homeownership. The demographics have changed and a number of people have come to the UK to live and work; without the private rented sector, where would these people live? The private rental sector is embedded in society now and in the way homeownership is made up.

Heron: The key is balance – and the concern when you have such a strong bias in policy is that it lacks balance.

Tan: Not everybody who rents wants to buy. There is a real misconception out there that every body wants to be a homeowner. We have come across many people, young people in their twenties, who want the flexibility of renting and do not want to be burdened with huge amounts of debt. I, for one, see this shift in Government policy as a real attack on landlords. The Chancellor is starting to break the equilibrium and we mustn’t underestimate the requirement for the PRS in the coming five or 10 years.

Whittaker: Nor, equally, should we forget the social housing element. John and I went on record last February when the figures were released that showed the social housing element had dropped below the 20 per cent threshold. This is not desirable in the long term.

Then, extraordinarily, Cameron at the general election did an open attack on the housing association sector with his giveaway promise to tenants of housing associations, which clearly shows we have a government that has no real interest in articulating a social housing policy, let alone being able to afford one.

The Labour government 10 years ago had a social housing policy but couldn’t afford it. I think there is a worry that Osborne needs to get the balance better and that, almost, this is short term opportunism for his own aspirations. It needs to be toned down because this isn’t a binary equation and the dynamics are changing.

David Whittaker, Managing director, Mortgages for Business

Heron: The politics of this are actually quite worrying because the messages around it do not help us develop a sensible debate around housing policy. It’s very antagonistic, confrontational: it’s homeownership good, private renting bad. Homeowners are favoured above landlords, who are getting a very bad press. That is preventing a really sensible assessment about the housing we require going forward.

If we’re not investing in social housing, we need a strong and vibrant private rented sector for housing provision for those who either don’t want to or can’t afford to buy. That is not getting discussed anywhere in housing policy at the moment.

What effect will the new stamp duty rates have on the market?

Heron: The stamp duty change is at least clear; we know when it is going to happen and that’s it. It is clearly an additional cost as far as landlords are concerned and it is far from welcome.

However, what we know about the landlord community is that they invest for the long term. The data we have is that the typical landlord has got a 15-year horizon. While the stamp duty change is not welcome, over a 15-year term it is significantly mitigated by house price appreciation. Indeed, if you’re in the London market, six months’ house price appreciation would balance it out.

Landlords are used to weighing things up with care and consideration. They don’t rush into things; it is not a ‘get rich quick’ scheme. It would add to a landlord’s consideration but I don’t think the stamp duty change itself will radically reduce the level of investment in the sector.

Tan: The stamp duty change is an irritation at best but it is certainly one I think landlords can overcome.

Why has the Chancellor decided to cut tax relief and what effect will it have on the market?

Heron: What has been said is that property investors have an advantage over home purchasers because of the tax relief they receive.

Going back in time, landlords were broadly regarded as running a business and were able to offset allowable expenses, like any other business, against their tax bill. What I think has happened here is that smaller-scale landlords in particular, holding properties in their personal name, have become regarded as investors rather than as people who are engaged in the business of owning and managing a property. As a result of that, a different view has been taken in that tax relief is an advantage not allowed or easily accessible to other investors in other classes of asset. Therefore, on that analysis, the Treasury in the Summer Budget stripped that back to 20 per cent rather than achieving relief at one’s marginal rate.

They have also changed the process by which it happens, which is fairly complicated but basically means that a landlord currently on a basic rate is unaffected but a landlord on the highest rate is impacted in perhaps the way intended. There are possibly surprising consequences for landlords between those two bands because they may find themselves moving from one tax band to another where previously they might not have expected to. That could have a broader impact on their personal finances that may be more excessive than was the original policy intent.

There has been no real debate that I’m aware of about what makes a landlord an investor or in the business of being a landlord. There has been some sort of allowance because the Treasury has talked about taking a different approach to incorporated landlords, and there has been a discussion around the market about lending to incorporated landlords. But there isn’t a great degree of clarity over that and these things have not been well defined.

…And the effect?

Tan: Buy-to-let is a business and if you are going to run a business you want a certain amount of return. As your costs go up – be it stamp duty or the tax relief changes – something has to give. Is that the purchase price of the property, or could it be rents? This means less disposable income for tenants and therefore less money for a deposit.

I wonder whether some of the Government’s proposals have been thought through fully and if they truly understand the impact it is going to have on landlords and, in turn, tenants.

Heron: There is clearly a lot more going on with the cut to tax relief than with stamp duty and it is less clear as a result of the long period over which it is going to be introduced. Don’t get me wrong – that is very welcome as it gives the industry and landlords time to develop their understanding and adjust their strategies.

There is a risk there as well, of course, as some people may get complacent and not get there quickly enough. But it doesn’t start to get phased in until April 2017 so that means it doesn’t impact customer budgets until 2018, which means it is not done and dusted until 2022.

I think it is positive that this is being phased in over an extended period but, as an industry, we have got a responsibility to our customers to make sure there is no complacency around it. We’ve certainly got a responsibility to inform, educate and signpost where people can get more information and, in particular, more advice.

I think it is inevitable that there will be more investment through limited companies – particularly for landlords with larger holdings. I can’t foresee the medium-scale landlord persisting in investing in their own name.

Will you see a surge in lenders moving into limited company buy-to-let?

Heron: You may continue to see it through small-scale investors with one or two properties because, while the tax regime is not as beneficial as it was, a lot of them were primarily interested in capital growth over time. This is less attractive than it was but compared to, as they would see it, the extra work needed to hold it in a corporate structure, they may just persist in investing in their personal name anyway. You can see the nature of investment changing over time and the whole business moving to a more professional model – and that’s not a bad thing.

Whittaker: It’s two-fold. One issue is underwriting skills and, probably the bigger challenge, you need a technology platform in which to process it. We have all had experiences with trying to change technology in our own companies; it is always more expensive and takes longer than we thought. So even if a lender took the decision to enter limited company buy-to-let on 9 July, when Osborne first stood up, nobody is going to get to a lift point very quickly on this. If you are one of the major institutions with a legacy IT system, you don’t disturb those for fear of creating consequences. There is a desire for new lenders to join that space but I cannot see anybody rushing to get to the party because there are significant hurdles to get around.

As far as borrowers are concerned, we have seen a change in the numbers. We started tracking this after the July tax relief announcement, where we said about 18-20 per cent of our applications were limited company. This month [December] it has stepped up to 35 per cent, which is probably a trend at both Paragon and Kent Reliance.

John Heron, Managing director, Paragon Mortgages

Tan: Technology seems to be the biggest hurdle. I’m sure David is the same but we are having conversations with mainstream high-street lenders who want to move into that space but do not have the expertise. They see this as an opportunity and do not want to lose market share.

Moloney: The point about underwriting is quite right – we physically underwrite limited company buy-to-let. It is not something you can throw at a straight-through processing system; you do have to have the expertise. And one of the other challenges, of course, is they have all got to land their MCD changes first, in Q1 at the very latest.

Heron: The idea that a lender that has focused exclusively on lending to individuals can move very quickly to lending to corporates is entirely fanciful. There are significant system changes required: there is a shift in credit risk profile and for many lenders there will also be capital requirement implications. I would be particularly wary of lenders with limited experience in the sector making expansive claims about new offerings.

Whittaker: With the number of limited company products in the market at present – about 16 per cent of all products – that seems adequate for the time being. It might be a little stressful in Q1 and there might be a few people who move into it in the second half of the year, but this isn’t a seismic shift overnight.

What should brokers do and when?

Tan: We have a very small timeframe – let’s be under no illusion here. The [stamp duty] changes in April are for completions. If we are to speak to our clients and discuss a movement towards limited companies – because it is the best structure for them – then really we have got from now until the end of this month [to get the application in].

Moloney: On average it takes about 13 weeks to get from application to completion and there is a limited number of lenders operating in limited company buy-to-let. If a landlord hasn’t started the process [of switching to a limited company] and it is their aspiration to do so, they are leaving it very tight. Remember that lenders have got to implement their MCD changes and Easter is at the end of March. The clock is ticking for those who want to transfer into a limited company.

Heron: Certainly there are material advantages for a landlord who is looking to incorporate, if they can do so ahead of [the stamp duty changes], but it doesn’t necessarily invalidate considerations after that. I think we need to be a bit careful about rushing the market into responding. But the point is right: [landlords] need to have started the process already and they need to have taken mortgage advice and tax advice – they are going to need legal advice about incorporation. It is no simple process.

Adrian Moloney, Sales director, OneSavings Bank

How aware are people of the changes?

Tan: The challenge is that knowledge, even among professionals – accountants, lawyers, brokers – is still not there. Regarding the impact of these tax relief changes, and with the exception of a handful of people in our industry, they don’t fully understand the calculations and the financial impact. The stamp duty change was far clearer but, with the tax relief changes, people know it’s bad but they don’t know how bad.

Equally, the first change doesn’t come in until 2017 and the first tax bill doesn’t become liable until 2019. People are thinking: ‘I don’t have to think about that just yet.’

Moloney: Your ordinary, mainstream broker will not have dealt with limited company buy-to-lets over the past couple of years. Predominantly, that market has been dealt with by specialists who have access to specialist lenders that are perhaps not whole-of-market.

I guess with everything comes opportunity and I think there is an opportunity – for us as lenders operating in that space and for brokers who specialise in that space – to link up with accountants and tax advisers to provide that holistic approach to people.

What about the powers the Financial Policy Committee has asked for?

Heron: We know what they’ve asked for: powers of direction over LTVs and interest coverage ratios: the affordability measure. It more or less mimics the controls they have already in the owner-occupied market.

As to how those powers would be exercised in due course, we don’t have a great deal of direction. But an initial reading of the consultation paper suggests they are considering using them in a similar way, which is to limit lenders’ lending more than X over a certain measure of affordability or a certain LTV. But there is a consultation under way and hopefully that is transparent.

Whittaker: There could be some unintended consequences as a result of the tax changes so it might make the FPC hold back from doing other things. We have three major things going on here so we have to see how they pan out.

Heron: The industry has persisted with a relatively crude assessment of affordability and a number of lenders have found it too much of a blunt instrument and effectively adopted much more complex assessment models under the surface – and we’re one of those. I think those who persist with these very simple affordability assessments based on just the ICR won’t be fit for purpose in a market where the tax status of the customer has a radical impact on affordability. You simply cannot use an ICR to accurately assess affordability unless you set it as a worst-case scenario – and the market isn’t showing much evidence of going down that route.

Frankly, whether the regulator is asking it of lenders or whether lenders are developing the response themselves, what you would expect to see is quite rapid development along that route where lenders are putting in a much more testing and sophisticated approach.

Tan: Do you think we’ll see 135 per cent [rental coverage] for higher-rate taxpayers and 125 per cent for lower-rate taxpayers?

Heron: I think you may find that some lenders abandon the ICR approach entirely or use it only as a backstop, because that will become less and less relevant to the individual assessment because it is too crude. That will make life more difficult for the intermediary community in many ways because, at the moment, you can compare lenders in a fairly straightforward fashion based on what you think the maximum available loan might be based on the ICR. I cannot see how that can possibly work the same way in future because lenders will have to have much smarter assessment tools and there will be complex algorithms.

Whittaker: The amount of information a lender will have to gather to make the more intelligent response will make the process of doing a residential mortgage post-MMR look like a walk in the park. It is then a case of whether borrowers, their intermediaries and their lenders will want to go down that route because it involves expense and time at all levels in the process. And that potentially drives behaviour towards the incorporated vehicle market, where, in general terms, the existing prognosis of underwriting will remain the same.

Tan: Is there a possibility that George Osborne and the Government will suddenly say: ‘Well, everyone is moving to corporation now so we’ll just change the goalposts for corporation’?

Whittaker: If they want to start messing with corporation tax rules, that has knock-on effects everywhere. And the feeling is that they might be minded to do it but, if you speak to the accountants, they’ll say it is a really big step with all sorts of implications.

And is the FPC right to be concerned about the buy-to-let sector?

Heron: Broadly, the Bank of England argues that buy-to-let could be a threat to financial stability because of credit standards in the sector – although they have been clear that they haven’t seen evidence that credit standards are particularly weak in the sector and, not so long ago, they said they saw no reason for intervention in the short term.

The second strand of their argument is a little more difficult. It is about landlords being a threat to financial stability because they will aggressively buy properties in an upswing and aggressively sell in a downswing. As a result of that, they would magnify movements and volatility in the housing market.

Now, while I can understand the argument, there was no evidence in previous economic cycles that that had been the case. In fact, what you see is that landlords have maintained their portfolios rather than sold to a weak market. Although you can see where the concern comes from, it is not supported by strong evidence.

Moloney: Over the past seven years, we have seen ups and downs in the mortgage market, but we have not seen landlords flood properties onto the market when it has crashed previously.

…And a final message to brokers?

Tan: They need to evolve. They need to really understand the implications of these changes because that needs to be articulated back to their customers. If they don’t do that, they will lose their buy-to-let business to brokers who do understand it and do articulate it and can help these landlords on what could be a choppy ride over the next couple of years.

Heron: It’s not simply a matter of ‘What is the best mortgage in this circumstance?’ Critically, the question is now ‘How do I structure my holdings going forward?’

And that requires a mix of financial advice, tax advice, accountancy and legal advice. We want to be sure our intermediaries are considering that.