Buy-to-let hysteria in the media?

Buy-to-let hysteria in the media

Is the media hysteria about the UK’s buy-to-let industry justified, and is it on the brink of collapse? Let's have a look at the facts and figures.

Are the UK headlines warning about buy-to-let profits “disappearing before landlords’ eyes” true?

A note of calm, to start. It is unlikely there’ll be a house price crash, because property markets only take a dive when very high unemployment combines with high interest rates.

However, watch out for a dip in the buy-to-let sector, as gross rental yields reached a record low of 4.38%, thanks to house prices rising faster than rents.

Buy-to-let yields

Capital Economics predicts yields will hit a new low of 4.26% by the end of this year, with landlords facing higher costs due to climbing interest rates, leading to the biggest squeeze on rental income and mortgage costs since the financial crisis.

But to put that into context, we’ve had 40 years of increasing house prices and we’re focusing on a current, short-term period.

Hamptons estate agents predicted a 15% drop in the average net profit for a new buy-to-let property for landlords paying the higher-rate tax, after the Bank of England raised interest rates to 1.25%.

The London market

That means a London investor in the higher tax bracket could see net annual profits per property drop by ￡840 or 29%. Taken in isolation, they are quite damning figures.

Should the base rate reach 2%, profits for the average landlord on a higher tax rate could be cut by half, Hamptons said, while Capital Economics said the rate could reach 3%, taking annual losses to ￡403, rising to ￡2,180 for a London landlord. 

The government’s phasing out of a mechanism that allowed landlords to deduct mortgage costs from their tax bill has amplified current rising costs - though investors buying buy-to-let properties via a special purpose vehicle or offshore still benefit from the deduction.

Spooked investors?

Some analysts think investors will take their money elsewhere: “This is another good reason to think house prices will decline until rental yields look more attractive,” said Andrew Wishart of Capital Economics.

While fixed-rate mortgages are protecting 79% of landlords from interest rate hikes, according to a Zoopla report, everyone across the country will be affected.

 A rate of 2% would lead to a 37% drop in profits for a higher-rate taxpayer in the North East of England, rising to 67% for someone in the North West.

The upside

Capital Economics said the cost of servicing a mortgage would be ￡1,094 at a 3% interest rate for a median income-earning household with an 80% loan-to-value mortgage for a property costing the UK average.

 Whether that servicing cost is high enough to prompt a spike in forced sales and a housing market crash is unlikely because of one particularly British reason: UK homeowners will do everything they can to pay their mortgages.

It’s a trend pointed out by former Bank of England governor Mark Carney and it’s why British banks prefer the safety of mortgage lending. Even at the height of the financial crisis, very few homeowners defaulted on their mortgages.

Tighter regulations and an influx of investors

The aftermath of the financial crisis was more regulation making it harder to secure a mortgage. Higher borrowing costs at the moment are more likely to prompt would-be homeowners to sit tight and wait it out, rather than rush in.

Taking their place are overseas investors, with an anticipated 100,000 people from Hong Kong expected to hit the UK market, buying UK properties as bolt-holes.

Shifting the buy-to-let balance

As well as facing higher interest rates, UK landlords are also grappling with government changes that are tilting the balance increasingly in favour of tenants, whether it’s allowing pets by default, or enforced environmental improvements.

Although they may be too much for smaller landlords to cope with, there seems to be no shortage of corporate and institutional investors, with the economies of scale needed to absorb these costs, willing to step into the breach.

While some have suggested a steep increase in interest rates may not be a bad thing, potentially prompting a crash that would broaden access to homes for first-time buyers, we don’t think it’s the way to go.

The end of the world is not nigh

Neither Threadneedle Street nor Whitehall want a recession or a house price crash - they’re not in their interest.

We believe they will avoid both, the market will not tank, and the end of the world is not night. The hysterics in the marketplace are just that: designed to sell newspapers and ad space.

Thanks for reading, please send any comments and feedback.

Thanks,

Callum