What are the prospects now for buy to let property investment in the UK?

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

Like, ever…

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.

Tax changes

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.

Comment

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,

 

 

 

 

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29 thoughts on “What are the prospects now for buy to let property investment in the UK?

  1. I believe that one of the biggest drivers behind buy to let is the poor returns on savings that are the alternative. I know two investors who decided to go down this route as their bank and building society accounts were earning next to nothing and they felt safer with brick and mortar than with stocks and shares. Unfortunately I was not one of them as I did not believe that ’emergency interest rates’ would go on as long as they have! My friends are feeling very happy with themselves and, in a rising market, would probably not have been deterred by the extra 3%. They are cash buyers rather than borrowers who may look at the economics differently.

    • Cash buyers aren’t really a problem though,aside from the social/political considerations of families being priced out.

      They don’t pose a threat to the banking system in the way BTLers with IO 75% LTV mortgages and a rental cover of 125% do.Therein lies the problem for the BoE in that once these marginal buyers become forced sellers,there could be vicious circle down until the average price approaches the average salary.

      • Poor returns on savings have caused others to take cash off deposit and use it as a deposit on one or more properties to improve their return. It works providing no one takes the punch bowl away.

        • ‘It works providing no one takes the punch bowl away.’

          Absolutely.I think one of the fundamental problems here is that ‘bricks and mortar’ as an asset has always maintained a strong political support as successive generations of chancellors have sought to maintain the goodwill of floating voters.

          This has engendered an understandable investment bias which creates the sort of stability that Minsky argued inevitably created instability….eventually.

          As ever,those last into the Ponzi get wiped out first.

  2. hello shaun,

    Looking at the HMG own figures we have pushed people from council house rented sccomodation to private landlord ones.

    I cant imagine that has reduced the UK economy housing costs, it certainly has pushed up the cost locally

    Also I do know of people who have already purchased houses to rent because the returns are better than in bonds/isas / whatever.

    I have also posited that if house prices corrected to historical norms then the Banks will be bust again – no one will do that these days , this leaves the IR question moot , no one will in their right mind increase interest rates , until a black swan appears of course

    So I see the next few years as more of the same , 0% or MIRP and with houses taken off the market and thus pushing up prices again – how far that will go is anybodies guess . My WAG is that actually theres little to gain here , might get another 5-10% above inflation

    We shall see

    Forbin

    PS: 400K of houses , we should be building that a year !

  3. The reality is that BTL-as in the post 2002 model- only works whilst asset values are rising.Returns are single digit at best,loss making at worst.

    As ever with our leaders,they like rising house prices as it placates middle class swing voters in the key 150 seats that have a vague chance of swapping hands at election time.Generally,voting turnout is higher in home owners than renters which in turn reinforced the willingness of the poltical class to turn a blind eye to the looming iceberg both in 2007 and now.

    Indeed their response to 2007 wasn’t to let asset prices reset where traditionally they did ie at 3 times average salary,but to reignite another boom this time blown up by buy to letters,risking their own homes on interest only mortgages on properties with single digit returns.

    Truly,the blind leading the blind.

    Many of these BTLers aren’t even aware of the looming tax changes.I know a good few and many don’t even realsie their own home is at risk if they default on their BTL portfolio.

    Osborne and the Tories have made a clear political decision to let these BTL ‘out to dry’.It makes a great deal of sense for them given the result in 2015.

    Also,though,it does make life fairer for residential buyers and I personally think it’s gives family stability if they can buy their own home.Why should it be the preserve of the equity rich,the retired or the well off.

    • Hi Dutch

      in essence the “rescue” model applied by central banks has involved pumping up asset prices and telling everybody that wealth is created rather than inflation. Of course as we often discuss on here the truth is that whilst some wealth is created we also inflict inflation on first time buyers and those trading up in the property market. If we had not figured this out we could have done so by the battle the establishment has put up to avoid having house prices in the official consumer inflation data.

      The problem is that not only does it create a junkie culture and potentially trap us into even lower interest-rates (paging the ECB next week) it has side-effects as you point out. In the UK the buy to let growth is a bad side effect.

    • “Also,though,it does make life fairer for residential buyers and I personally think it’s gives family stability if they can buy their own home.Why should it be the preserve of the equity rich,the retired or the well off.”

      Well that rather depends on if there’s a significant price correction in housing. If there is, then lots of owner occupiers who were unlucky enough to buy at the ‘wrong’ time will be left with negative equity, and quite possibly a massive load of debt to go with it.

  4. Another factor coming into the mix could be the realisation that not only are most of the mortgages for BTL on an IO basis but often “investors” become “professional landlords” and to finance their houses they take the capital gain from their existing properties as a remortgage and then buy a new property . This “business model” works in a rising market and with low interest rates but is a seriously risky strategy as it only takes a change in interest rates/taxation or a fall in house prices to bankrupt them. Meanwhile they have hoovered up many of the FTB properties so leaving many families at their mercy in rented accommodation.

    • This used to be my thinking Jan and it was/is the model my brother stateside (a btl landlord) follows.

      I warned him many times about the situation you describe but when exactly this circumstance impacted in the US in 2008/2009 he found that as prices crashed because people could no longer afford the IR payments and were repossessed with the houses being sold off cheap, those same sub prime people, recently made homeless still required somewhere to live.

      This is where my brother stepped in with his rental properties, renting them out to these homeless people.

      It’s still high risk and he has had many bad experiences with people doing moonlight flits owing a couple months rent and the house trashed, but he keeps managing to rent them back out (following repairs) thus keeping his cash flow going to meet the mortgage interest. He is still in a precarious position as I I believe that if he has a couple of properties empty (a void period) for more than a couple of months his (imo) house of cards will come crashing down.

      His business model is completely reliant on continuing capital gains to borrow against and to eventually realise as a long term profit if he ever divests himself of the business, but so far (20 years) he’s made it work although he has had no income from it and has had to regularly subsidise it from his salary.

      I think if it was his only source of income it would have folded years ago but there may many other buy to let landlords like him who keep propping up their failing business with private savings and income.

    • They’re also open to a downturn in rents.

      It makes me laugh when you read journalists arguing that these recent changes will lead to landlords raising rents.They’re rather missing the elephant in the room in that rents are paid out of wages and that even if they manage to extract a higher rent,the economic repercussions through lower aggregate demand will cancel that out.

  5. Hi Shaun

    I think the government are targeting BTL as a proxy because I think their target is not BTL but the housing market generally. I think they are aware of the dangers of a housing bust from the electoral point of view and are looking to dampen down BTL demand to constrain the market generally – by reducing demand at the margin. To me the recent change to make mortgage interest a non allowable expense was a strong indication of this.

    In some ways this is a clever strategy because the main way to restrain prices would of course be interest rates but, as this is such a blunt tool, it has many collateral effects, mostly negative, so chipping away at a marginal source of demand may be “wrong” in one sense but, nevertheless, sensible.

      • Hi Noo2

        Which bit the boom or the bust or both? More seriously we have seen the boundaries increasingly blurred between monetary and fiscal policy in the credit crunch era. The FLS was an example of this because although it is a Bank of England policy I note this.

        “The Bank has therefore sought and received an assurance from the Government that the objectives of the Scheme lie within its remit (as noted in the exchange of letters between the Governor and Chancellor on 13 July). And
        the Funding for Lending Scheme itself will be overseen by a joint Bank/HM Treasury Oversight Board, which will meet on a quarterly basis. ”

        Of course the official view is that the Bank of England (like the OBR which discovered all that tax money down the back of its economic modeling sofa yesterday) is independent. Otherwise the trick starts to fail…

  6. In the words of Ice-T, “I’ll never go broke I got property”.

    How do you know if someone is actually a home owner already when buying a second property?
    I can see so many ways of gaming this as the property register isn’t tied to national insurance numbers.

    If I have bought a house with my spouse as a joint owner, what if we both buy a house in our own name. Does that count as me buying a second property or is it my first? What if I bought one and my spouse the other both from the common bank account we have? Continue this for all offspring.

    If I set up a company and it buys it do I get around it?

    How do you check foreign cash buyers? What proof do you have of their uniqueness? We allow anyone to purchase property in the UK, you don’t have to be a resident. This is one thing I wish was changed as our housing stock should not be for rich people to hedge their home currency risk.

    Banks love lending buy to let as it is now very easy to evict renting tenants and the house can be sold with no input from them so if the buyer defaults it is easier to get money back. Much harder to evict person who has taken out a mortgage to actually buy a house.

    • just like the SORN for cars you have to declare which home is you main residence

      foriegn buyers will have to pay UK tax unless they can prove its their main residence here as well

      No declaration = fine

      easy peasy

      Forbin

      • You charge everybody the extra amount unless they can prove that it is their only property? How do you prove a negative?

        Does this go across marriage? If I own a house can my partner own another one and claim it is the only house they own?

        • A search at Land Registry will tell all. The more complex cases would be resolved by contacting the solicitors acting in the transactions of the other properties. This information is held by Land Registry.

    • Given the size of the potential tax take, I suspect they’ll be all over the various dodges.Although two partners buying two houses will likely get round it.You would need separate mortgages though.

      The tax change is the real dealbreaker though.I know some amateur landlords who have rental incomes that just about service their portfolios.When they start paying tax on the revenue,they’ll have to sell.I can’t see any other way out as several commenters have pointed out.

    • Hi bootsy

      I wonder what would happen if a married couple or civil partners complained under human rights and equality legislation? After all person taxation is pretty much individual these days when for a married couple it used to be joint.

  7. Shaun , what you think of this ?

    that the push to put penstion pots into housing has the effect of supporting the Banks , supporting the economy and it then allows the HMG to tax the extra income from the retired BTL and maybe stop all their state pension – and I mean all of it – makes a saving there

    Forbin

    • Hi Forbin

      It would be the same logic that is being applied to the buy to letters. It is not only the Vampire Squid that sniffs money as the taxman does too! It would also help with the public finances where the triple-lock promise (2.9% this year which most and maybe all will be a real increase) for the basic state pension is proving very expensive.

      So better off pensioners could be hit in the way that the extra personal allowance they used to receive was withdrawn if their income passed a certain threshold. After all these things usually start gently..

      As to your previous point about housebuilding I am reminded about the Ebbsfleet development in Kent that was first proclaimed by Ruth Kelly back in 2003/04 and has been proclaimed since by a litany of ministers as a new project since. The catch is that fewer houses are now planned than at first and less is indeed more apparently.

  8. To create affordable accomodation, pump up the supply.

    Create some social housing co-operatives to build tower blocks, which sold to local workers as primary residences. Sell before build and have the residents co-op decide on design and building contractor. The advantages are many, accomodation near where you work reduces transport costs, saves time, saves CO2 emissions and doesn’t burden the transport infrastructure. By providing affordable flats for all you’d remove the cost of subsidizing “overpriced part owned shoeboxes for essential workers”. Selling before provides reliable financing and bypasses the big house building firms cartel.

    I know that council towerblocks have a bad rep, use covenants which allow eviction for seriously antisocial/chav behaviour.

    • Hi ExpatInBG

      It is an interesting idea although I hope they manage better designs than the ones built in south west London in the past! Also I would add policing to your list as the Winstanley Estate not far from me was improved quite a bit some years back when the Met Police mounted a big operation to drive out the drug dealers.

      However it is not so new as my mother grew up mostly in the council blocks south of Tower Bridge in Bermondsey. These days though land there which used to be considered cheap is so expensive.

      The catch as Forbin has pointed out is that there seem to be many establishment and institutional barriers to increasing the rate of house building in the UK. After all there has been a need all this century.

      • Institutional barriers, AKA the landed gentry, the rent seeking classes. Feudal tradition leds to Dickensian poverty. Add in lobbying from the big housebuilding cartel and you get British housing gridlock.

        The facts are clear, British housing is smaller, of lower standard and more expensive compared to Britain’s OECD peers. Excessive housing costs reduces Brits purchasing power parity.

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