Buy-to-let expansion set to continue - as lending to first-time buyers also improves
Published: 17 July 2013 | Author: Bernard Clarke
The last decade has seen the first significant decline in owner-occupation in the UK since the First World War. Since 2000, the number of owner-occupiers has continued to grow in absolute terms – increasing by half a million to 17.9 million. But during that time the number of UK households has grown by 2.3 million to 27.6 million, so the proportion of home-owners has fallen back from 69% to 65%.
In recent years, the private rented sector has played an increasingly important role in housing those who are unable to realise their aspirations to home-ownership in the short term. The emergence of buy-to-let lending over the last 15 years or so has had a positive impact on the private rented sector, helping to provide tenants with flexibility, quality and choice. And early next month, we will be publishing new data on lending in the buy-to-let sector, which has continued to grow strongly in recent years.
Over a similar period, pressures on the funding of social housing have reinforced a longer-term decline in accommodation in that sector. Since 2000, the number of social tenants has decreased from 5.5 million to five million (or from 22% to 18% of the population).
The decline in provision of social housing and in owner-occupation since 2000 means there has been a strong increase in the numbers living in the private rented sector. Over that period, the number of households renting privately has almost doubled, from 2.4 million to 4.7 million (an increase from 9% to 17% of the population).
Despite significant changes in the balance of tenure in recent years, the fundamental problem for the UK housing sector continues to be a shortage of stock. Current rates of construction are at their lowest since immediately after the Second World War. Despite projected annual growth in the number of households of 221,000 in the period up to 2021, only 98,000 new homes were started in England last year – down 11% on 2011.
The shortage of housing has contributed to affordability problems for tenants, as well as for would-be owner-occupiers. But, despite the rising cost of home-ownership, it remains overwhelmingly the tenure of choice. Our surveys have continued to show that around 80% of British adults would like to own their home in the long term.
The contribution of buy-to-let
Crucial reforms on the supply side of the mortgage market have enabled the buy-to-let sector to respond to growing demand from tenants and landlords over the last decade or more:
- Although buy-to-let rates are generally a little higher than those in the residential mortgage market – reflecting the higher risk – the emergence of a competitive buy-to-let sector has produced a range of attractively priced loans for borrowers.
- Landlords have also been able to continue to borrow on an interest-only basis, enabling them to keep their costs in check. Interest-only borrowing became the norm for residential borrowers during the 1980s, although its popularity has declined sharply in recent years. Regulators have confirmed, however, that their concerns about new interest-only mortgages for residential borrowers do not extend to the buy-to-let sector.
- Finally, de-regulation has made it easier not only for people to take out buy-to-let mortgages, but also to rent out their own property as an alternative to selling.
Our figures show that CML members have helped fund an expansion of the private rented sector, while continuing to lend on conservative criteria to buy-to-let investors. The weighted average rental cover of buy-to-let loans advanced last year stood at 178%, having risen from 165% in 2010, when we first collected this data. Such a comfortable level of rental cover reduces the exposure of landlords to loss of income during "void" periods, when they do not have a tenant in the property. This partly explains why mortgage arrears in the buy-to-let sector are even lower than in the residential sector – where mortgage arrears have also been kept in check.
Our figures also show that, since 2009 (when we began collecting this data), lenders have been advancing buy-to-let mortgages for an average of around 65% of the value of the property. Lending at this conservative average loan-to-value ratio provides an ample cushion of equity for most landlords, helping to protect both the borrower and the lender in the event of mortgage payment problems.
Buy-to-let lenders continue to assess affordability for the borrower very carefully, although – unlike the residential market – the income of the customer is not generally a key factor. Instead, most lenders make a robust assessment of affordability based on projected rental income.
Regulation of the rented sector
The private rented sector in the UK is heavily regulated, with more than 50 acts of parliament and 70 other pieces of legislation affecting the relationship between landlords and tenants. Regulation of the market is multi-layered and somewhat unclear, with local requirements adding to complexity.
The government’s localism agenda, and the system of partial administration and licensing by local authorities, can add to uncertainty for landlords and discourage investment in the private rented sector. This was confirmed in a survey, published earlier this month by Paragon, which found that almost three-quarters (74%) of landlords said that selective licensing would deter new investors in the sector. We are concerned that the government does not appear to be monitoring what individual local authorities are doing. Landlords, tenants, lenders and the government could all benefit from more consistent application of policy affecting the private rented sector.
We therefore urge that, before considering the introduction of any further regulation, the government should reflect on whether current requirements are being adequately enforced. Piecemeal regulation, with uneven enforcement, may simply frontload costs on to compliant landlords, tenants and other bodies. Most landlords are operating small businesses and we believe more should be done to simplify regulation, rather than add additional requirements.
Regulation for lenders should reflect the fact that the decision to invest in the private rented sector is a commercial transaction. Regulation intended to protect consumers is therefore not appropriate for the buy-to-let sector. But some aspects of lenders’ buy-to-let activity are regulated – as they should be – through, for example, rules governing financial promotion or unfair contract terms and consumer regulations.
Buy-to-let lending is also, of course, prudentially regulated, with firms required to set aside capital to reflect the risks associated with the loans they advance. So, a buy-to-let mortgage at a loan-to-value ratio of lower than, say, 75% does not equate to a 90% loan to a first-time buyer, with the lender generally having to hold more capital against the first-time buyer loan.
The strong increase in recent years in the number of people renting has exacerbated the problem of a shortage of accommodation – particularly in areas of high demand – and contributed to rising rents. We disagree strongly, however, with any assertion that intervention in the market to control rents would solve the problem. Attempts at rent control would discourage buy-to-let landlords and investment in both the supply and quality of rented accommodation. If the government wants to see lower rents – and lower housing costs more generally – it must look at what it can do to address the root cause of under-supply.
Buy-to-let lenders have typically required borrowers to offer assured shorthold tenancy agreements of up to 12 months. In many cases, a tenancy of that length balances acceptable security for the tenant with the need for the landlord or lender to obtain vacant possession of the property, if necessary.
Flexibility is one of the strong attractions of private renting for tenants, and many welcome the freedom to move at short notice or to re-consider their rental commitments on a regular basis. There is, however, demand from some tenants for the greater security that comes with a longer-term tenancy. So, earlier this summer, the Nationwide Building Society – through its buy-to-let outlet The Mortgage Works – launched a mortgage range enabling landlords to offer longer-term tenancies, if they wish to do so.
This new development shows the benefits of wider choice for consumers, delivered by a competitive, well funded mortgage market – and one that is clearly open for business. Although shorter-term tenancies are likely tor remain the most popular choice for most of those renting, we are continuing to work with lenders to understand the risks posed by longer-term tenancies – and how they can be overcome.
As we pointed out in reporting improved lending figures for May, increased buy-to-let lending does not necessarily displace activity in the residential market. May saw the largest number of first-time buyer mortgages advanced since 2007. But, as our press release announcing the data made clear, this occurred "in parallel with the strengthening buy-to-let market." The press release said:
"It is perfectly possible for the buy-to-let market and the first-time buyer market to improve at the same time, as the evidence clearly demonstrates. It is important that the supply of housing steps up, as increased housing supply is a crucial factor in ensuring that housing is affordable over the long term."
The private rented sector has grown rapidly in recent years, and buy-to-let lending has made a significant contribution to this expansion – and to tenant choice. But growth of lender funding of the sector has occurred alongside improved availability for residential borrowers – as our most recent data shows.
Improving conditions in funding markets – and competition between lenders – is delivering a wider choice for landlords and tenants. It is crucial, however, to ensure that regulatory requirements do not place unnecessary burdens on landlords. In particular, the government should be mindful of the risks associated with local variations in licensing and regulations, and the potential impact on the ability of lenders and landlords to meet growing demand from tenants.
The government should also consider whether tax incentives for landlords, or measures used successfully in other countries, could encourage greater provision of private rented accommodation to meet tenant demand. In Germany, France and the USA, for example, depreciation and rental losses can be offset by landlords against income. Elsewhere, the rate of capital gains tax declines the longer landlords hold on to their property. However, any proposed changes in taxation or regulation of the sector must be considered carefully to avoid unintended negative consequences for the private rented sector.