As we all know, buy to let is somewhat challenging at present. Buy-to-let lending year to date is down year-on-year by 56.7 per cent on purchase and 51.6 per cent on remortgage (UK Finance) and an astonishing one in 10 properties for sale currently were formerly rented out (Zoopla).
So not only are new landlords entering the market in ever decreasing numbers, but landlords are also deserting the market in record numbers. To add salt to the wounds, many landlords will not look to sell until their cheap fixed rate deals end, many in 2024 and beyond – resulting in a turbulent next three years (assuming rates do not fall back substantially).
How did we get here?
In short, cheap finance, and rising house prices, a pretty much win/win for most aspiring landlords over the last decade or so. For those who timed it right and had the golden characteristics of quality property and location, the return on IRR (Internal Rate of Return) if you sold today would be substantial. Even with net rent after tax and probable costs, your property increase would likely be in excess of 12%, and in many cases nearer 14%. The problem is a lot of landlords have been late to the party.
The growth of buy to let
Buy to let was fueled by cheap interest rates from 2010 to 2021 with typical mortgage rates just over two per cent during this period. There was, however, a dip in BTL that started in 2017 as tax relief for mortgage payments was phased out. From new originations of £15bn in 2016 (UK Finance), originations dropped to just £10.2bn by 2019. While the termination of tax relief was painful for landlords, rates still stood at/around two per cent. Crunching the numbers still, by-and-large, added up, especially for new landlords opting to put properties into company schemes and pay lower corporation tax.
By 2021, new originations had shot up to an all-time high of £18.2bn and by 2022, the year interest rates exploded, new BTL originations were still over £17bn. This is in stark contrast to 2023, where analysts are suggesting originations may end at just over £8bn, a more than 50 per cent reduction.
The good news is that for originations post-2019, most would most likely have been on five-year fixed rates.
The formula is looking challenged
While most landlords are looking at a buy-and-hold strategy, this approach leaves many concerned about the outlook for property prices over the medium-to-longer term. Buy to let as an investor clearly remains focused on the combined rental yield plus long-term capital appreciation.
The steep rise in interest rates is putting a huge strain on affordability and the borrowing ability for mortgage borrowers, which in turn, is driving house prices downwards. Looking at average income to average loan sizes data indicates that from 2012, to 2022, the average multiple increased from 7.03X to 8.84X (UK Finance). Without low interest rates to support increased borrowing, the outlook for house prices outside of anything than a local or specific opportunity level would not appear that promising.
But by far the biggest impact on BTL investors, is of course interest rates. Nearly all buy-to-let mortgages are interest only, which simply means that if the mortgage rate triples from two per cent to six per cent, the monthly payment does the same. Landlords are unable to pass this level of increases onto tenants, and will more often than not find themselves unable to offset the mortgage payment against tax (see above).
Lenders are also in a tricky spot. For affordability purposes, lenders are working off Interest Coverage Ratios (ICRs), and in broad terms, are looking for the rental payment to cover typically 145% of the mortgage payment (sometimes at an interest rate higher than the borrower will be paying) for a higher rate taxpayer. In the past, loan to values (LTV) of 80 per cent to 85 per cent were common. In the current climate, it can be a struggle to get an ICR to function at much past 50 per cent LTV. This means that not only is it problematic purchasing a new property, but it also incredibly difficult for all the landlords reaching the end of their existing fixed rate deal and finding their mortgage payments, in many cases, tripling.
The future of BTL – modelling the yields
Reading the above, you’d be forgiven for thinking BTL has no viable future. However, it does. The reality is it’s going to look quite a bit different going forward from what it once was.
The process of BTL has moved from an ‘easy win’, that was often the domain of amateur landlords buying locally to manage, to a professional business decision with calculated long-term risk. The types of property and locations are now much more thought through, and with time the sector will become much more professional as the smaller landlords sell up.
Rates are continuing to drop at present, albeit nowhere near as fast to make the sector realistic again for most. The reality is rates need to come down to sub 4.5 per cent for the rental yields to start making sense for amateur landlords again. Whilst that may be some time away, the BTL market will revive. This will undoubtedly offer opportunities for new landlords, and relief for those who have held their properties during an inflated rates period.
In the short term, we can expect a continuation of what we are seeing. A raft of smaller landlords looking to exit the party.
