The buy-to-let (BTL) market has always proved resilient during market swings, with investors ready to adapt to whatever challenges are thrown their way.
The recent escalation in mortgage costs has added a fresh set of obstacles for landlords at a time when many are already seeing their margins squeezed. Nevertheless, with large areas of the UK suffering from a chronic undersupply of rental properties, demand remains as strong as ever.
BTL is predominately a numbers game and the key will be making sure those numbers add up for landlords. Increasingly, they will turn to brokers for guidance on this.
The market must remain viable
Given the barrage of challenges facing the private rented sector (PRS), it is not surprising some of the recent media coverage has implied landlords are cutting their losses and exiting the market. But is this actually the case?
Diversifying portfolios
“Landlords are certainly reassessing their portfolios,” says Impact Specialist Finance managing director Dale Jannels.
“They are not necessarily leaving the market but are working out the best way to maximise yields and returns. They’re maybe moving towards houses in multiple occupation [HMOs] rather than single lets, for example, or renovating to create a bigger rental opportunity.”
He adds: “Yields further up the country are higher than in the South, with properties generally less expensive. Therefore, landlords may seek to relocate their property focus.”
Landlords may seek to relocate their focus
Recent research (among 70,000 landlords) from agent comparison site Rentround found that, contrary to some reports, only 7% of landlords were planning to exit the market completely. Instead, 43% were looking to remain as they were, 24% intended to grow their portfolio and 26% either planned to reduce it or were unsure about their next move.
Stonebridge appointed representative and Home of Mortgages managing director Michael O’Brien says, while landlords looking to expand their portfolio will find it more difficult due to rising rates, there are still deals to be had.
“Many landlords use equity gained in existing portfolios as a deposit for onward purchases,” he explains.
“Given the increased stress rates imposed by lenders – some as high as 8.49% – the ability to leverage existing property is limited. These stress rates dictate that new BTL purchase deposits are increasing to 40% or 50% in London and the Southeast.”
We urge the government to introduce viable pro-growth policies that encourage long-term, sustained market growth
Since 2017, changes introduced by the Prudential Regulation Authority (PRA) have meant that, when measuring affordability, most lenders applied an interest cover ratio (ICR) of at least 125%, stressed against a minimum rate of 5.5% for all fixed rates under five years.
“I expect to see landlords picking up good refurbishment projects using bridging finance – where ICRs don’t apply – and then refinancing to BTL mortgages once the value has been added. We have also seen an increase in landlords enquiring about second charges to raise additional finance,” says O’Brien.
He predicts the increased stress tests will lead to a greater appetite for HMOs and student lets.
The offsetting of mortgage interest for tax relief would be a huge help if it returned
“With rising rents, these investments are still attractive,” he adds.
Holiday lets
Alexander Hall director of partnerships Stephanie Daley is also seeing landlords look towards HMOs, student lets and holiday lets in search of higher rental yields.
“Following the pandemic we saw an increase in enquiries for holiday lets and we expect this to be a growing area,” says Daley.
This also seems to be a focus area for lenders, with recent analysis from Moneyfacts showing there are now more than 300 deals available for holiday lets – a rise of 72% since September 2021.
As well as diversified portfolios, Daley says Alexander Hall is seeing increased demand for incorporation of portfolios and limited company BTLs.
We have seen an increase in landlords enquiring about second charges to raise additional finance
“It would be great to see more limited company options from high-street providers,” she adds.
In the 12 months to September 2022, a total of 50,445 new companies were set up to hold BTL property – more than double the 24,456 in September 2017, according to the Hamptons Monthly Lettings Index. It predicts even more landlords will follow this trend in a bid to offset rising mortgage interest against their tax bill, and to increase profits.
Hamptons estimates around 40% of new BTL purchases are made via a company structure – up from around 10% in 2016, before the Section 24 tax changes were tapered in.
Challenges ahead
Even for landlords who are moving to a limited company structure, there are some notable challenges ahead.
“There is a big problem for landlords whose initial BTL rate ends in the next 12 months,” says Vincent Burch Mortgage Services mortgage director Vincent Burch.
This is a real challenge for landlords in deciding if an investment property is still worth keeping hold of when having to pay to keep it
He explains that, since the PRA introduced its new underwriting rules, most landlords have taken out five-year fixed rates due to the more generous affordability measures around long-term fixes. However, in 2017 a typical five-year fixed rate for a limited company was around 3% to 4 %, compared to around 6% today.
Given that lenders are still applying an ICR of at least 125%, this is creating problems.
“The loan amounts just do not work on the ICR calculations, considering the higher interest rates,” says Burch.
“This is causing mortgage prisoners for the majority of landlords who are coming up for their remortgage review. The situation might not be as bad for landlords whose current lender offers product transfers, but it could be devastating for those who don’t.
It’s crucial that lawmakers don’t exacerbate what is already a significant problem for the market
“Something needs to change,” suggests Burch. “Either lenders need to get more creative with the ICRs or the PRA needs to change them.”
Daley agrees that the rental stress tests are making it difficult for landlords to finance BTL loans, especially at higher loan-to-values.
“We need to see further innovation surrounding how overall affordability for BTLs is assessed. Those lenders that can take personal income into account will increase their market share in this space,” she believes.
Loss making
LDNfinance chief operating officer Greg Cunnington says the increase in rates means, even if the requested loan amount is possible, what were previously profitable or break-even investment properties often now look set to produce losses for landlords.
It would be great to see more limited company options from high-street providers
“This is a real challenge for landlords in deciding if an investment property is still worth keeping hold of when having to pay to keep it. This is where the offsetting of mortgage interest for tax relief would be a huge help if it returned,” says Cunnington.
“In a low-mortgage-rate environment, the recent removal of this saw most BTL properties remain profitable. But, if rates remain where they are now, that will no longer be the case.”
National Residential Landlords Association director of policy and campaigns Chris Norris would also like to see the government reconsider its stance around offsetting mortgage costs.
“With the supply-and-demand crisis growing rapidly across the UK’s PRS, it’s crucial that lawmakers don’t exacerbate what is already a significant problem for the market,” he says.
Many landlords use equity gained in existing portfolios as a deposit for onward purchases
“Much of this market turbulence is a consequence of the government’s move to prevent landlords from offsetting finance costs against income. As a direct result of this policy, many landlords have been forced, unwillingly, to raise rents to cover costs they have incurred.”
Norris adds: “As the Bank of England continues to raise the base rate – causing a significant spike in operating costs for landlords – steps must be taken to ensure the market remains viable for BTL investors. We urge the government to introduce viable pro-growth policies that encourage long-term, sustained market growth.”
Need for advice
While the maths around rental calculations and rising rates is causing a headache for landlords, this is just one of many challenges that lie ahead.
Waiting in the wings is proposed legislation that, if passed, would see landlords have to upgrade their properties to an energy performance certificate rating of C or above for new tenancies by 2025, potentially further adding to costs.
Either lenders need to get more creative with the ICRs or the PRA needs to change them
The Renters’ Reform Bill is also likely to see the abolition of Section 21 notices – no-fault evictions. While a positive step for renters, in certain circumstances it could create additional problems for landlords.
Given the current range of complexities around being a landlord, the need for professional advice is likely to grow significantly. Now, more than ever, landlords will be turning to brokers for guidance and help in navigating the ever-changing market.
Comment
Mark Harris, chief executive, SPF Private Clients
According to the National Residential Landlords Association, landlord confidence has dipped, with rising costs one of the factors leading some landlords to consider selling in the next 12 months.
Although this confidence varies depending on where they are invested in the country, landlords are reporting increases in tenant demand, and rents are on the rise.
The PRS is here to stay and landlords and lenders will find a way
Investors regard BTL as a long-term investment and those who offer a tenant-focused and responsible proposition will continue to do well.
However, rising finance costs, higher underwriting requirements and changing tax regimes could reduce the attractiveness of holding on to BTL properties. The level of borrowing has been impacted, so landlords looking to purchase or potentially capital raise may have to set their sights lower.
For example, if you are a higher-rate taxpayer holding a property in a personal name, with a yield of around 4%, the maximum gearing you could achieve would be around 40% to 50%. Changing the way in which you hold the property, or greater use of top-slicing for higher earners or those with portfolio rental profit, are just some tools landlords could consider.
The PRS has had to overcome several challenges, yet the sector has evolved and survived
Energy efficiency, whereby the government is proposing that all new tenancies from 2025 must have an EPC of C or above, with a potential penalty for non-compliance of £30,000, is another concern. Lenders are increasingly offering green mortgage products for landlords looking to take the leap and make those changes, while some landlords who are buying additional properties are considering new-builds because they are already compliant.
There are other challenges, such as: increased regulation and issues over evictions and possession; extra requirements for landlords to improve safety measures; tighter licensing; tax liabilities; the proposed Renters’ Reform Bill; the threat of a recession; and increased unemployment. All are increasingly a concern for landlords. Sadly, much of it is out of their control.
Investors regard BTL as a long-term investment and those who offer a tenant-focused and responsible proposition will continue to do well
Some areas of the market are doing well and, as consumers’ holidaying patterns have changed since the beginning of the pandemic, demand for holiday lets has grown significantly.
These were previously the domain of small regional building societies, but increasingly banks and specialist lenders are prepared to lend on them, so product availability has grown.
Also, changing trends, such as short-term AirBnB-style lets, are increasingly acceptable to lenders. Traditional hotspot yield areas remain true with large university towns still providing landlords with significant yields.
The level of borrowing has been impacted, so landlords looking to purchase or potentially capital raise may have to set their sights lower
The BTL sector has grown over several decades. During that time, the PRS has had to overcome several challenges, including changes to the tax regime, increased regulation and implementation of lender underwriting standards. Yet the sector has evolved and survived.
Even with the current challenges of higher borrowing costs and stress rates, the PRS is here to stay and landlords and lenders will find a way.
