Reports about the health and prospects of the buy-to-let sector are somewhat contradictory at present. On the one hand, you have the commentators who claim that buy-to-let is as strong as it has ever been. On the other hand, you have the doomsayers; those who say that buy-to-let has had its day, and that it’s time to move on.
The chief argument of the latter camp seems to centre on short-term gains. Buy-to-let provides return in the form of both income and asset appreciation, but the proliferation of short-term investors in recent times has cultivated a focus on working yields.
With house prices rising, the entry cost to a buy-to-let investment is likewise creeping upwards; the restriction of tenants’ incomes mean that rents in some areas seem close to reaching a natural roof; and the imminent rise of interest rates have many speculating that landlords’ costs will become unserviceable in one or two years’ time.
Interest rates and buy-to-let mortgages
Under Mark Carney, forward guidance from the Bank of England has been a little more concrete than markets are used to. The current steer is that interest rates will start to rise in small increments of 0.5% by the end of 2015, peaking in 2017 at around 3.0%.
Swap rates are edging upwards in response to this news, with the most pronounced increases seen in swaps of five years or longer. The residential mortgage market has felt the effects, with fixed rates increasing or simply disappearing; however, the buy-to-let market has – conspicuously – thus far been spared.
One explanation is the forthcoming Mortgage Market Review, due to hit on 26 April. The new regulatory framework for mortgage advice will include strict new affordability rules, from which most commercial business will be exempt. With the promise of longer processing times and fewer approvals on the residential side of things, lenders are ramping up their unregulated business to balance their books.
In the last week, we have seen the intermediary-only lender Santander launch a new five-year fixed rate and cut selected buy-to-let rates from their existing range. We have also seen Aldermore announce its intention to double its maximum portfolio size from 5 to 10. This month, the Mortgage Works axed the upper age limit on its mortgage range, replacing it with a maximum application age of 70. And within the last two months, Saffron for Intermediaries removed its minimum income restrictions for buy-to-let applicants.
These are just a few of many examples, and there is a clear trend of buy-to-let lenders loosening their criteria in order to attract more business. And whilst lenders’ rates will eventually begin to rise, there is no guarantee that it will be in perfect tandem with the base rate.
Consider that, at the base rate’s pre-recession peak, the fixed differentials that lenders used to calculate their own variable rates were a fraction of what they are now. It is reasonable to assume that lenders will simply readjust these differentials as the base rate begins to rise again, so as to remain competitive and not undermine the integrity of the rental sector.
As of February 2014, the average annual salary in the UK (excluding bonuses) was around £23,430 1, which translates to an after-tax income (in the 2013–14 tax year) of £1,562 per month.
By the standard definition of ‘affordable’ (no more than 30% of a tenant’s take-home income), the average rent should be no higher than £470 per person; and this is failing to take into account that many individuals in the rental sector are likely earning a below-average income when compared to owner-occupiers. It is well documented that many tenants, particularly in London, are spending close to and sometimes more than half of their take-home pay on rent.
For years, wage growth has been outpaced by both inflation and rents. This is clearly unsustainable, and if this trend continued, tenants’ incomes will place a cap on the rents that a landlord may realistically charge.
However, in its spring 2014 forecast, economic auditor the EY ITEM Club predicted that average incomes could begin to overtake inflation as early as April 2 as a “long, low-inflation recovery” gets underway. Meanwhile, LSL Property Services have reported an improvement in tenant affordability, with a 35% drop in the number of tenants in severe arrears between Q1 2013 and Q1 2014 3. This is despite an 11.1% increase between Q4 2013 and Q1 2014, which can be attributed to seasonality.
As the economy improves, wages will begin to rise in real terms, allowing rents to continue to rise in line with local market forces.
The EY ITEM Club expects house prices to rise by 7.4% in 2014 and 7.2% in 2015, slowing to 4.2% in 2016 when government support, in the form of the Help to Buy mortgage guarantee scheme, is withdrawn.
With average rents rising by just 0.9% in the 12 months to March 2014, it seems likely that yields are going to constrict in the near future. Those investing in rental property for short-term gains will be turning increasingly to areas such as the North East and Yorkshire, where house prices have risen more slowly.
The government has promised additional construction to meet demand, and the Bank of England’s Monetary Policy Committee has committed itself to “spotting risks” in the UK housing market in order to avoid future property bubbles. If successful, these measures will restrict future capital gains from buy-to-let property, but they will also have a stabilising effect on the rising entry cost.
The 200,000 new homes promised in the 2014 Budget 4 still fall short of the required supply, however, and prices will continue to trend upwards. This is good news for long-term borrowers.
It may be that the coming months will see a fundamental change in the buy-to-let market, with an increasing number of investors entering the market for growth rather than yields, but it is not a foregone conclusion that income from buy-to-let investments is destined to flatline. It is true that the property market in some areas is better placed to achieve an income from rental property, and it may be the case that achieving a workable income from rent alone will become more difficult than it was following the recession – but buy-to-let remains both an important part of the UK housing market and a viable prospect for the capable, professional landlord, and its time in the spotlight is far from over.
1) – http://www.ons.gov.uk/ons/rel/lms/labour-market-statistics/april-2014/sty-earnings.html
2) – http://www.bbc.co.uk/news/business-27010326
3) – http://www.lslps.co.uk/documents/tenant_arrears_tracker_apr14.pdf
4) – http://www.theguardian.com/housing-network/2014/mar/19/uk-housing-need-to-know-budget-2014