The best laid plans… In the financial world you can do all the research, all the forecasting and all the forward planning you like, but invariably some event, some dramatic change comes out of left-field to spoil the party.
Buy to Let has enjoyed many years of sustained growth, helping small-scale landlords build substantial property holdings. This is on the back of low interest rates, and relatively easily obtained interest only mortgages, which could be piggy-backed one on another. Couple this with steadily rising property prices, caused by a severe housing shortage, and a growing population creating healthy demand from tenants, and you have the ideal formulae for rapid expansion of a BTL market.
Some landlords have really pushed the boat out; they have built-up large property portfolios highly dependent on credit – many are so highly geared as to be vulnerable if things change.
This high level of debt across the piece worries the Bank of England (BoE), especially when other financial worries loom around the world. So much so the Bank of England (BoE) Governor Mark Carney has warned that buy-to-let could be a threat to the UK’s financial stability.
The BoE quarterly report sees China’s economic slowdown as a threat to Britain’s banks and the wider economy as turmoil in the world financial markets threaten to spread from Asia
China’s economy has driven global growth for many years, but is now going through a structural change with uncertain consequences for the UK and its financial stability. British asset managers have large investments in China and emerging markets, which would put serious pressure on the banks should another crash occur.
UK landlords would be particularly vulnerable to rapidly falling property values during a bust, the Bank of England warns. The Financial Policy Committee (FPC) says landlords are more sensitive to booms and busts, buying rapidly when prices rise but also selling properties quickly during a downturn:
“The buy-to-let mortgage market has continued to grow rapidly. In the year to 2015 Q1, the stock of buy-to-let lending expanded by 8%. Buy-to-let lending now accounts for 15% of the stock of outstanding mortgages, and 18% of the total flow of new mortgage lending. This strength is consistent with a structural trend towards a larger private rental sector, driven by demographic changes and higher house prices relative to incomes. The private rental sector accounted for 19% of households in 2013, compared with 11% in 2003.”
Also the BoE and the Government has worries about the effect Buy-to-Let is having on the rest of the housing market:
“Buy-to-let lending could pose a risk to financial stability. The actions of buy-to-let investors affect the broader housing and mortgage markets as individuals compete to buy the same pool of properties. Looser lending standards in the buy-to-let sector could contribute to general house price increases and a broader increase in household indebtedness. And in a downswing, investors selling buy-to-let properties into an illiquid market could amplify falls in house prices, potentially raising losses given default for all mortgages. This could be a particular concern in a rising interest rate environment, if properties become unprofitable given higher debt-servicing costs. 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.”
Although the committee had said that the risks from buy-to-let were likely to be “contained” if house price falls were moderate, the bulk of buy-to-let lending might be vulnerable to very large falls.
If the market were allowed to continue to grow at its current rate, driven by competition between lenders, loosening of underwriting standards, and Britain’s ageing population, as well as the new pension freedoms boosting demand, this would push up buy-to-let lending even further in the future.
Therefore Mark Carney is said to be in talks with Chancellor George Osborne about giving the Bank greater powers to police the buy-to-let market, with a view to tightening affordability criteria “by the end of the year.”
Last year the FPC introduced regulations to prevent the overall housing market from overheating. Banks cannot approve more than 15pc of residential mortgages to people borrowing more than 4.5 times their income. They are also required to “stress test” borrowers’ ability to repay loans. However, these rules did not apply to buy-to-let mortgages, which now account for a sixth of the market. At a recent meeting the FPC has decided not to impose further controls for now.
In his Summer Budget 2015 Chancellor George Osborne has taken his own steps to cool the booming buy-to-let market, albeit gradually over an extended period, using taxation measures coming in next April.
But contrary to Mr Osborne’s claim that the changes would affect only around one-fifth of private residential landlords, it seems that this figure is more likely to be around 60% and for many they will result in swingeing tax increases.
It is only now that the severity of these proposed changes are beginning to dawn, and the quite drastic effect they will have on the private rented sector (PRS) – “game changing” is the description being bandied around. Landlords are feeling angry about the way they have been misled and the deceptiveness in the way this was introduced.
The landlord associations are lobbying hard over the proposed changes in Clause 24 of the Finance Bill
The upshot is that the change removes what was an integral component of the growth of buy-to-let and a long held principle that businesses can claim interest paid for financing against profits. By gradually reducing the amount of mortgage interest relief that landlords are able to claim against the cost of finance over the next 4 years, until it reaches a maximum set at the basic rate of tax, it will hit hardest those with highly geared portfolios who already pay high rate tax.
The double whammy is that the tax calculation is going to be on turnover rather than a profit, which means many basic rate tax payers will be pushed into the higher rate tax band, and quite a lot more tax to pay. This will be exacerbated if and when interest rates rise, potentially pushing some landlords into a cash-flow crisis.
With all the adverse media attention that buy-to-let landlords have received over the last couple of years, triggering a surge in legislation which continues to strengthen the regulation aimed at landlords, it does not take a genius to see that operating profitably as a responsible landlord in England is about to become a damned site harder. If you happen to live or have properties in Scotland or Wales, where even more tenant friendly laws are about to be introduced, you will probably find it harder still.
It would appear that Government policy in future will favour an approach to the rental market (Private Rented Sector – PRS) that mirrors what you have in America and parts of Europe: a much larger corporate sector, building large complexes of rental accommodation all professionally managed.
Compared to these other countries, 98% of UK rental property is owned by private individuals most owning less than 4 rental properties. These landlords are operating small businesses alongside their regular day-job or profession. Just like the corner shop when Tesco came along, the small-scale landlords are coming under attack.
The British Property Federation (BPF) has said there is £30bn of private institutional finance ready to enter the rental market to provide long-term private sector rentals and create:
“…an American-style rental market where single companies own large portfolios of homes…And most importantly, for renters, it will revolutionise the sector, providing greater choice of tenure length, rent certainty and high levels of customer service.” – Melanie Leech, chief executive, British Property Federation.
The Group Chief Executive of Legal and General goes even further by calling for: “an end to the cottage industry ownership of private rented housing in the UK.”
As Ranjan Bhattacharya says in his report on the Summer Budget 2015 “The Property Investors’ Survival Guide” – the problem for these big guys is the small-scale landlords with between 1 and 5 properties owned by people who have salaried day-jobs. “These people are not necessarily relying on their rental income to live on and therefore the big corporates find it difficult to compete.”
The large institutions it would seem have the ear of the Chancellor and have been very successful in lobbying for tax incentives and loan guarantees in stark contrast to the way the traditional landlords is now being treated. They are building new properties which the Government desperately need to fill the void of a shortage of housing, whereas buy-to-let investors tend to buy existing stock, though they do an excellent job of refurbishing and bringing old stock into new use.
My view is that the buy-to-let PRS, run predominately by small-scale landlords, is far too important, and too competitively run (with the exception of a minority of rogues), to be seriously challenged in the short-term. It will no doubt become tougher to manage successfully than it’s been, but let’s face it, BTL has had a very good run. Managed sensibly and with not too high a borrowing burden, private landlords can still make good money despite the tax changes.
The taxation issue is by far the biggest and most immediate threat to the BTL landlord; though the chancellor has given them time, a 4 to 5 year phase-in, which allows for a change of strategy if this is needed, there are limited options.
One option for those with high borrowings is selling down and paying off debt, paying down your mortgage debt by selling off selected assets. However, some of these landlords with highly leveraged portfolios, built from regular refinancing, could be in a bind. With capital appreciation over a number of years, capital gains tax, loan repayments and selling costs, these may mean there is insufficient equity to cover all of these costs. They will need to put more money in to pull it off.
Another option, which is being bandied about by the experts, is incorporation. For investors of any size, owning properties through limited companies has always been a preferred method, and is probably the way to go in the future. The tax treatment is more generous, certainly in the short-term, and of course companies escape the new tax measures the Chancellor is bringing in.
The difficulty here is transferring the assets from personal ownership into a company. This process triggers a sale, capital gains tax and stamp duty liability. There may be a possibility of deferring capital gains tax until the property is eventually sold, through a process known as Incorporation Relief (see Elizabeth Moyne Ramsey v HMRC), but there’s no guarantee of this.
Expert advice should be sought when considering any of these strategies after the new legislation is passed and the full implications become apparent. Fortunately, time is on your side.
Tom Entwistle, October 2015