One of the features of the UK property price boom which was triggered by the Bank of England in July 2012 has been a shift from people buying to own to buying to rent. The changes were highlighted on the 10th of this month in a speech given by Jon Cunliffe of the Bank of England.
And it is growing quickly now, by around 9% a year. Buy to let now represents 16% of the overall mortgage stock and accounted for 80% of net lending over the past year.
The attraction was two-fold but came from this development driven by the start of the Funding for (Mortgage) Lending Scheme (FLS) which drove this.
But over the past three years, as banks’ funding costs have reduced and as competition in the mortgage market has intensified, on average mortgage interest rates have fallen by 2 percentage points.
So the opening attraction was lower mortgage rates which began to turn the mortgage market around and this led to the second factor which was the expectation of higher house prices. So costs were cheaper and expected returns were higher especially if you figured that the Bank of England was really determined to fire the market up again. After all FLS followed some £375 billion of Quantitative Easing and the slashing of Bank Rate to 0.5%. This all looks bit like the “whatever it takes” expressed back that same summer of 2012 by Mario Draghi of the European Central Bank.
Buy To Let had been on the march anyway
The longer-term situation had been as shown below.
The private rental sector in the UK has been growing rapidly over the past 15 years partly due to structural reasons. The stock of mortgage lending for buy to let has increased from £65bn to £200bn over the last decade. And it is growing quickly now, by around 9% a year.
Thus we see that an existing trend was given a shove by the Bank of England and it was not alone. Back in July another policy change was highlighted by the Financial Stability Report.
The buy-to-let market could receive an additional stimulus from recent pension reforms, which give retirees more flexibility over how they use their defined contribution (DC) pension pots.
We simply do not know the longer-term impact of the change to pension rules. Perhaps the strongest impact may well be the perception that a type of “Greenspan/Bernanke/Yellen Put” is being applied, as measure after measure boosts house prices. For those unfamiliar which the concept then listen to “The only way is up,baby” from Yazz for a musical theme. In this arena “down” is definitely a four-letter word.
Why did buy to let boom relative to house purchases?
There are several factors at play here and the most obvious was tucked away in the Bank of England FSR.
higher house prices relative to incomes.
Whilst the reductions in mortgage-rates have improved affordability of course real incomes have fallen whilst house prices have risen. There are different measures of this but house prices are up by around 18% and real wages are down by around 6% in the credit crunch era. It would be an irony if it is the continual hints and promises of interest-rate increases from Bank of England Governor Mark Carney that have deterred people but whatever the reason prospective mortgagees who face ever longer terms may wonder how long low interest-rates will last for?
Also there is something else which seems to have encouraged a change and it is also something which the Bank of England may want to lock away in a dark cupboard.
But there are signs of growing risk appetite spreading to underwriting standards. …….the number of advertised buy-to-let mortgage products at LTV ratios of 75% and above has increased since mid-2013………Looser lending standards in the buy-to-let sector.
Criteria for buy-to-let mortgage lending are different to ordinary mortgage lending but we are left with the view that its rise has been partly due to the fact that it has been easier to borrow.
How much of a problem is this?
Let me use the words of the Bank of England to describe it.
Buy-to-let borrowers are potentially more vulnerable to rising interest rates because loans are more likely to be interest only and extended on floating-rate terms, and affordability tends to be tested at lower stressed interest rates than owner-occupied lending.
You may be surprised by the “interest-only” bit as one only has to recall around 2009 when our political class were telling us that these were not far off evil and would not be a feature of the UK system going forwards in the words of Taylor Swift
In reality we find that they have simply metamophosed, changed form and been expanding in another area. Still don’t be afraid as our valiant “great and the good” are on the case.
HM Treasury will consult on tools for the FPC related to buy-to-let lending later in 2015, with a view to building an in-depth evidence base on how the operation of the UK buy-to-let housing market may carry risks to financial stability. The FPC will continue to monitor this sector closely.
A bit like the sheriff in the film Smokey and the Bandit I think.
If you have a boom then governments and establishments immediately see scope to tax it. This is now in process for the buy-to let boom. Back in the summer Budget there were plans laid for the future.
Currently, individual landlords can deduct their costs – including mortgage interest – from their profits before they pay tax, giving them an advantage over other home buyers. Wealthier landlords receive tax relief at 40% and 45%. This tax relief will be restricted to 20% for all individuals by April 2020.
A trim for some although the obvious critique is that it is “So Far Away” (Carole King).
Yesterday we saw a change in that the tax raising became more immediate.
From 1 April 2016 people purchasing additional properties such as buy to let properties and second homes will pay an extra 3% in stamp duty.
So we have a classic establishment move which was estimated to raise around £1 billion a year in an area where the tax take has risen a lot in recent times. It was a bit over £6 billion in 2011/12 rising to £10.8 billion in 2014/15. Thus the UK Treasury has been very grateful for the house price boom and no doubt gives an appreciative nod to the “independent” Bank of England which triggered it.
Firstly let me make it clear that I have no beef with individual’s making a choice to buy and let a property. It is the collective issue and the way that the UK economy has been twisted towards it which has meant that money and effort has flowed to it as opposed to other others such as manufacturing. The consensus for house prices that “The only way is up” has twisted our expectations and has consequences for the flow of funds and entrepreneurial effort elsewhere. It is a factor in us moving towards a rentier society. Also by driving house prices higher it makes them ever more unaffordable for first time buyers which means that more are pushed towards renting and the cycle becomes more like a fly-trap than an economic choice.
What happens next? In the short-term (until April 2016) we may see a flurry of purchases ahead of the tax change. After then I am not so sure. If we look at the gains from buy to let then I have been looking at a few yields around London and the gross yield seems to be of the order of 5%. I know that there are costs and void periods but they may not be far off covering a mortgage. Should that be so then the Stamp Duty needs to be compared to the prospect of a capital gain which have been?
UK house prices increased by 6.1% in the year to September 2015
Ah so six months worth of capital gain? We need to look back longer for a better perspective. The UK ONS has a mixed-adjusted measure for pre owned house prices which started at 100 in February 2002 and as of September was at 220.9. So if we add 3% to the 100 we are left mulling the words of Newt in the film Aliens.
It won’t make any difference.
So whilst a couple of tax nudges to the buy-to-let market are welcome and indeed likely to be popular there are clear and present dangers. The first is that they look good but in reality change things only at the margin. The second is that they are all about tax or as Steve Winwood put it.
While you see a chance take it,