Buy-to-let: a happy new year for landlords?
Published: 6 January 2016 | Author: Bob Pannell
New survey data from YouGov points to considerable financial resilience on the part of buy-to-let landlords as they face the prospect of future rises in interest rates.
The findings may bring some new year solace to the sector, which faced a challenging end to 2015. In the final weeks of the year, the IMF added its voice to those favouring controls over buy-to-let lending, the Bank of England governor Mark Carney reiterated his concerns about activity in the sector, and HM Treasury published a consultation on powers of direction for the Financial Policy Committee (FPC) in the buy-to-let market.
The writing has been on the wall for some time and may partly explain a recent Residential Landlords Association survey showing that 10% of landlords plan to leave the market over the next five years.
But, given that buy-to-let accounts for nearly a fifth of all lending currently, the granting of directive powers over buy-to-let represents a logical backstop for the macro-prudential regulator.
However, backstop is the critical word here, as the FPC has always had the ability to exercise powers of recommendation (as indeed it has done for lending to owner-occupiers). If the FPC makes appropriate recommendations during the upward leg of the economic cycle, then the need to apply an emergency brake – in the form of directive housing measures – should seldom, if ever, arise.
What matters, then, is the dexterity with which the FPC seeks to apply speed limits for the housing market.
Macro-prudential decisions will always be a matter of careful judgement, and this is particularly true for buy-to-let, where business models often favour landlords expanding their portfolios and re-leveraging borrowing on a regular basis.
Although the FPC continues to signal its watchfulness with respect to buy-to-let, it has to date refrained from announcing any specific interventions in the sector.
This feels like a sensible holding position for the time being, not least because it has prompted lenders to nudge their underwriting criteria firmly in a more conservative direction.
Tightening lending criteria
According to the transactional data we collect from lenders accounting for about 90% of new lending, the typical stressed mortgage rate being used by the industry has increased by 50 basis points to between 5.6 and 5.7% over the past year.
While this is still some way from the rates implied for lending to home-owners, a more forced pace of adjustment would risk destabilising the buy-to-let sector.
In its December Financial Stability Report, the FPC recognised the possibility of sector disruption, when it expressed concern about what might happen if mortgage rates were considerably higher than today’s prevailing rates.
As it happens, the scenario it chose to focus on – the likelihood of landlords’ selling their rental properties in the event of their investments turning sour – appears a little contrived.
The latest buy-to-let survey of nearly 1,000 landlords by YouGov highlights the resilience of these investors to interest rates increases.
Respondents were asked how they would cope with a 1.5% rise in mortgage rates over the next three years. This represents a highly plausible scenario, and is, in fact, slightly more adverse than all the paths for interest rates featured in the Bank of England Inflation Reports in 2015.
Chart 1: Coping with higher mortgage rates
According to the YouGov survey, three-quarters of landlords foresee no problems in servicing their mortgage payments.
Landlords identify a range of strategies for coping with higher mortgage costs, including the positive cash flow that rental payments currently provide and ready access to contingency funds.
Reassuringly, even though the most likely context for higher rates would be a strong jobs market and incomes growth, only 13% of landlords appeared to rely on raising rents.
This feels like a long way from the pro-cyclical “cut and run” behaviour described in December’s Financial Stability Report.
None of which is to say that landlords are in a comfortable position.
The impact of tax changes
A number of tax measures have been announced in recent months, and these are likely to have a dampening effect on future growth prospects for buy-to-let and the private rented sector.
The reduction of tax reliefs available to private landlords from 2017-18 onwards, announced by the chancellor in the summer 2015 Budget, will adversely affect the future cash flows for affected landlords.
Chart 2: Likely impact of tax relief changes on portfolios
Landlords should be able to mitigate the direct financial impact in a number of ways. Indeed, the latest YouGov research corroborates our view that the overall impact will be to lift rents higher and to narrow the availability of homes in the private rented sector.
The direct effects appear modest, but are likely to be reinforced by the stamp duty changes, announced in the chancellor’s autumn statement. The rapid succession of recent tax changes also risks having a significant indirect effect on investor sentiment, altering the direction of travel for buy-to-let lending and the further expansion of the private rented sector.
Activity easing back
The CML’s latest market forecasts envisage house purchase activity by buy-to-let landlords falling away over 2016 and 2017.
Given the significant lags in government housing initiatives stimulating additional housing supply, this raises a question about the future availability of rental accommodation in the face of ongoing demographic pressures.
In this context, macro-prudential intervention, if or when it is applied to buy-to-let lending, carries a significant risk of unintended consequences for the wider housing market. We will continue to work closely with the Bank of England, to reinforce its understanding of the sector, and to ensure very careful calibration of any forthcoming measures.