Despite the government’s insistence that it wants to “create a bigger, better and safer private rented sector”, it would seem pretty obvious to any casual observer that things are going to get a lot more difficult for the small-scale buy-to-let landlord in the future.
With a whole host of new regulations affecting safety and tenant evictions in England, punitive tax changes and restrictions on mortgage approvals, you would be forgiven for concluding that the aim is to discourage investment in rental housing, not the reverse
Despite this, in the run-up to the end of the tax-year, buy-to-let has seen investors confound expectation by rushing in to snap-up rental homes before April’s buy-to-let stamp duty changes – the 3% surcharge the Chancellor has placed on all buy-to-let and second home purchases.
Estate agents across the country have been reporting a huge appetite among buy-to-let investors to buy-up property before the new surcharge comes into force on the 1st of April, and this has been the case throughout an unusually buoyant December and January market. The Council of Mortgage Lenders (CML) figures show a significant increase in the number of buy-to-let mortgage loan applications.
The British Bankers’ Association (BBA) Chief Economist Richard Woolhouse has said that the volume of mortgages approvals is up 27 per cent year-on-year.
“The start of the year has seen a significant rise in mortgage borrowing. It seems that this has been driven, in part, by borrowers wanting to get ahead of the increases in stamp duty for buy-to-let and second home buyers scheduled to come into effect in April”
Reflecting the government and the Bank of England’s concern about the volumes of buy-to-let lending amid fears over a new UK property crash, a new report from the Bank will assess ways to rein-in this booming landlord lending market.
The Bank has been watching and reporting on the buy-to-let market for some time as it is increasingly concerned about the amount of money being pumped into the market and its effect on the lending banks’ vulnerability should there be even a small increase in borrowing costs.
Threadneedle Street’s regulatory arm, the Prudential Regulation Authority (PRA), has published a report on underwriting standards for buy-to-let mortgage lenders alongside scenarios for testing the financial strength of Britain’s banks.
The Bank is concerned that lenders have relaxed their standards for landlords, creating conditions for a property crash. Potential measures to rein in the market include limiting the percentage of buy-to-let mortgages for each lender, tightening the terms of such mortgages or forcing lenders to use more capital for their loans.
The Financial Policy Committee (FPC) reporting this week said:
“The FPC remains alert to potential threats to financial stability from rapid growth in buy-to-let mortgage lending. The outstanding stock of buy-to-let mortgages has risen by 11.5% in the year to 2015 Q4. The macroprudential risks centre on the possibility that buy-to-let investors could behave pro-cyclically, amplifying cycles in the housing market, as well as affecting the resilience of the banking system and its capacity to sustain lending to the wider real economy in a stress. The FPC welcomes and supports the Supervisory Statement issued by the Board of the PRA to clarify its expectations for underwriting standards in this market, including guidelines for testing the affordability of interest payments”
Although the FPC thinks “growth of buy-to-let mortgage lending is likely to slow in Q2 as changes to stamp duty take effect”, future restrictions are likely to include a loan-to-value (LTV) cap (most are in the region of 60% though up to 90% has been recorded), debt-to-income limits, where landlords could face tougher assessments of their own finances (income) before being granted a buy-to-let mortgage, rather than just on the property value, and rental income covering 125 per cent of interest payments, and a restriction on overall lending limits – the total amount of buy-to-let mortgages the lending banks are allowed to hold on their balance sheets.
The bank will want to make sure that lenders do not become too exposed to the rental market, given that it believes landlords are more likely to face financial distress and sell their properties than owner-occupiers in the event of economic instability, and it would want to make sure that landlords can still make their repayments should interests rise to a theoretical norm of 5.5%
From a slow start twenty years ago, buy-to-let grew to provide double-digit returns for investors, when in a low interest environment alternatives were sparse – it outperformed all major asset classes over the past couple of years, with average total annual returns from buy-to-let around 12 per cent in 2015.
But, as the saying goes, what goes up must come down: clouds on the horizon point to the growth phase of buy-to-let investing coming to an end, at least for the time being.
The silver lining for landlords perhaps is that demand for renting still keeps on rising as it’s still almost impossible for a large proportion of the younger population to buy. The Association of Residential Letting Agents (ARLA) report that “In February, demand for rental properties grew to an average 37 per letting agent branch – the highest since February 2015, as supply increased marginally… Over half of UK letting agents believe the new buy-to-let stamp duty reforms will push up rent costs”
Some of the other changes which will affect the profitability of buy-to-let in the future include:
- Tax relief on mortgage interest allowable will no longer be treated as an expense item of the property but as a reduction on tax liability, reducing over four years to a maximum of 20% of the interest payable. The effect of this will be that landlords will be trying to keep their income including rent and other sources within a tax threshold boundary.
- The 10 per cent Wear and Tear tax relief for landlords who rent out furnished homes will be abolished from 1st April, which means landlords will no longer have the annual 10% reduction but will claim for the amount that they have actually spent.
- A change to Capital Gains Tax (CGT) rules means buy-to-let landlords will, from April 2019, have to pay CGT due on a sale within 30 days, rather than waiting until the end of the tax year, as they do at present, and the reduced rates of CGT (10% on the 18% & 28% rates) announced in the March 2016 budget will not apply to rental property sales.
Add to all this the tougher rules on health and safety; smoke and carbon monoxide alarms, legionella risk assessments, the new Right to Rent, and the new Section 21 regulations, plus the “retaliatory eviction” legislation for buy-to-let, and it becomes a less attractive proposition than it was.
However, given the continuing healthy demand for renting and returns likely in rental property for the foreseeable future, changes will not necessarily spell the death knell for buy-to-let; they will however demand a methodical approach to managing buy-to-lets profitably. But higher and additional rate taxpayers who acquired highly geared portfolios of buy-to-lets will as a consequence of the tax changes have to pay quite a bit more tax.
The overall effect could be to cool the market as the government appears to want; it could benefit the smaller investor in buy-to-let as more properties come onto the market and letting agents may feel the effects as more landlords decide to save by managing their own properties.
As with all changes in the economy, longer terms effects are hard to predict. But if the changes prompt a proportion of landlords decide to exit the market, and/or deter others from entering it, then fewer buy-to-let properties will be available to meet the demand. The inevitable result is an increase in rents as the supply / demand situation reaches a new equilibrium.
The changes outlined above will undoubtedly change the structure of the market, particularly in the short-term, but many experts are predicting that it will return to normal in short order as landlords adjust to the changes; this is especially if investment returns continue to look attractive relative to other asset classes.
The prospects of higher rents and continuing house price growth, with a resulting supply-demand imbalance in the market, should mean that capital returns will remain attractive. Even with a significant rise in interest rates it is expected that buy-to-let returns will still look attractive and could easily outperform ISA savings accounts.
There will still be opportunities in this market if investments are made using sound investment criteria: although many landlords have found themselves in something of a bind, claiming they will lose vast sums of money, perhaps one might question their approach placing so much on trust and taking on risk, and it leaves open to question the true viability of their investment strategy.
The projected increasing tax allowances will help those in the lower rate tax band, but it is clear that individual landlords in the 40% and 45% bands will pay more tax as a result of this change. Some in this situation may consider setting-up a company for their property investments, and indeed it has been reported that a growing number of landlords are doing so.
Such a move could potentially halve a higher rate taxpayer’s tax bill as they will then pay corporation tax, rather than income tax, which is to be 19 per cent from 2017, and falling to 18 per cent by 2020. Income can also be taken out flexibility as a wage or via dividends, and this may suit some taxpayers allowing them to protect their personal allowances.
There are of course other implications to transferring existing properties into a corporate structure such as stamp duty and CGT liabilities and tax on dividends. Incorporation is not going to be the right choice for everyone, but for some it will be a good solution. Seek professional advice before making any decision on this.
There are estimated to be around two million landlords in Britain own something like 4.6 million rental properties worth just short of £1 trillion. This represents 20% of the country’s private housing wealth and rivals major industries in size.
The government and the Bank of England want to cool the market yes, but rental property is too important to the economy for them to want to “kill it” as a viable enterprise; ultimately, bricks and mortar will remain a safe long-term investment, even if these changes bring about a short-term up-set in the market.
Tom Entwistle©LandlordZONE® – legal content applies primarily to England and is not a definitive statement of the law, always seek professional advice.