Buy-to-let landlords face a ticking timebomb as policy and regulatory changes combine with mortgage lending and tax issues, which will force many to exit the market, according to analysis from Maskells Estate Agents.

Maskell’s Principal, Charles Curran says, “We reviewed the forthcoming tax and regulatory changes that will affect the leveraged buy-to-let market in London and conclude that these are serious enough to trigger a sell-off. There is a desperate need for housing and a sentiment that buy-to-let landlords have pushed house prices up as they were not constrained by the Mortgage Market Review regulations.

Buy-to-let landlords are standing on a train track playing a high-risk game of chicken with regulatory locomotives. Charles Curran, Maskells Estate Agents.

In tinkering with the buy-to-let market, regulatory authorities are likely to create forced sellers from leveraged landlords, creating more supply to the housing market and, dependent on the volume of that supply, pushing prices down. This may be good over the long term for housing needs, however in the short to medium term, many tenants in rented accommodation may be forced out and, with the natural reduction in rental stock, be subject to increased rents as they seek alternative accommodation.

THE CURRENT MARKET

The National Landlords Association (NLA) says that there are over 860,000 private rented sector properties in the capital representing more than 1 in 4 households (6th May 2016). In the run up to the increase in Stamp Duty on buy-to-let and second homes, buy-to-let landlords took advantage of cheap debt helping to push overall lending up by 59 per cent year on year and 43 per cent more than in February according to the Council of Mortgage Lenders.

The effect of the removal of interest rate relief will become more pronounced, even if underwriting criteria and mortgage rates remain constant – which they will not.

CML data on new buy-to-let mortgages shows total advances for buy-to-let house purchases at £7.1bn for March 2016; up 162 per cent from the March 2015 (£2.7bn) representing 28,700 loans vs 8,800 in the same period a year earlier.

There are, as at March 2016, 1,839,800 outstanding buy-to-let mortgages representing £222,800,000,000 in loan balances (Source CML, MM17M). This is expected to grow further: the Prudential Regulation Authority in their Draft Supervisory Statement on buy-to-let underwriting standards, maintains that, “Firms plan to grow their gross buy-to-let lending by, on average, almost 20 per cent per annum over the next two years.”

Notwithstanding the sector’s popularity, the buy-to-let mortgage is typified by short term fixed periods and interest only repayments, always very susceptible to short term interest rate movements.

In mid-2015, the Bank of England noted, “The actions of buy-tolet 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. In a downswing, investors selling buyto- 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.”

FINANCIAL STABILITY REPORT, ISSUE 37, JULY 2015 – PART A, UK HOUSING MARKET.

The Bank’s very clear stance on the buy-to-let market has been enhanced by regulatory and political winds which have continued to push against the sector through 2016.

BOE’s two main concerns are based on the nature of the buy-to-let mortgage market and the effect of the buy-to-let investor on house prices; both of these are now being addressed. The timing of these changes is as important as the changes themselves which are detailed below:

ADDITIONAL STAMP DUTY

This rise has been well documented but note that the seasonally adjusted number of residential property transactions increased by 41.5 per cent between February and March 2016 (74.8 per cent non-adjusted) and 69.7 per cent higher in March 16 than March 15 (77.1 per cent un-adjusted) (HMRC). A slowdown is now expected and we expect the year-on-year decrease in transaction volumes to be significant in March 2017.

MORTGAGE INTEREST RATE RELIEF

The removal of this deduction will be one of the largest factors in determining whether buy-to-let landlords exit the market. Certainly the higher value properties owned by landlords who pay the Higher or Additional Rate of Income tax may well see an initial small reduction in their income if they hold a mortgage but they will become more pronounced over time as the reduction of the Relief becomes greater – and that is assuming that mortgage rates and underwriting criteria remain constant – which they will not.

BANK CAPITAL BUFFERS

The cost of buy-to-let mortgages for banks will increase in the future which will push the cost of buy-to-let mortgages up even without a rise in base interest rates. Under the current Basel III consultation, the standardised risk weighting for buy-to-let mortgages could increase from 35 per cent to 91 per cent and even up to 120 per cent for loans at 80 per cent loan to value or higher.

A £100,000 mortgage currently requires a £2,800 capital buffer (or reserve) – 8 per cent of the risk weighting – but may require £7,280 or even £9,600 if above 80 per cent LTV. If a bank is required to set aside 2.6 times (or 3.4 times for 80+ LTV loans) as much cash per loan, it may raise buy-to-let rates to take into account the loss of earnings on the reserved cash or it may just choose to exit the market, notwithstanding no potential move in base rates. (Source info: Fitch, calculations Maskells).

PRUDENTIAL REGULATORY AUTHORITY CONSULTATION ON BUY-TO-LET SECTOR

The PRA’s consultation paper calls for a minimum 5.5 per cent interest rate stress test on ALL buy-to-let mortgages even if the lender does not think rates which reach this level during the life of the mortgage (usually 2 year fixed).

The PRA would like to see landlords’ own income to be taken into account when assessing the viability of a mortgage rather than just looking at the minimum rental cover of 125 per cent of the rent received. Whilst many landlords may decide to use their personal income to supplement the rental income to qualify under the PRA’s terms, they will be subject to a more stringent underwriting criteria.

IMPLIED COMMERCIAL BANK FUNDING

Whilst buy-to-let mortgages may be very cheap, so is money in the financial markets. However, with the demise of the majority of the private label securitisation market where term funding was available, most banks now only seek to lock in liabilities for two years hence only offering two year fixed rate product which then revert to floating rate. A quick search of the net will produce buy-to-let offers of 2.18 per cent fixed for two years which then convert to SVR at over 4.5 per cent, prompting buy-to-let landlords to re-mortgage.

If bank rates reach anywhere near 1.33 per cent in 2020 from 0.65 per cent today, bank funding will be unable to provide a fixed two year rate of 2.18 per cent, implying an uptick in buy-to-let interest rates up to 2020. We can be sure though, that banks will not absorb unnecessary costs if they can be passed on to the mortgagee, particularly if the sentiment is to de-lever the buy-to-let market.

PERCENTAGE OF BUY-TO-LET MARKET AS REMORTGAGE

With landlords seeking cheap funding to maximise returns, most turn to an interest only two year fixed mortgage. This provides a two year reset for 100 per cent of the mortgages written in those 12 months but we do expect an increase in the re-mortgage market vs the new buy-to-let market.

Landlords may be beholden to one particular lender but if that lender is a bank seeking to reduce their exposure, and landlords do not qualify for other mortgage products, we may have forced sellers by 2020.

SELL OFF IN 2018/19?

Our analysis suggests that we might see buy-to-let property coming to the sales market between April 2018 and April 2019 – when the first and second tranches of the removal of interest rate relief come into effect, which, combined with an increase in capital charges for banks under Basel III, will push mortgage rates up.

Buy-to-let mortgages usually have a fixed rate of payment for two years and then if not refinanced convert to a tracker mortgage: As of 8th June 2016 and following the Court of Appeals ruling in favour of buy-to-let landlord clients of West Bromwich Building Society, we do expect the terms of buy-to-let mortgages to change.

CONCLUSION

We are always sceptical of government intervention in a market. The tinkering in the buy-to-let market, which has provided so much of the rental stock the country depends on, will lead to a sell-off. It will not be economically viable for many landlords to continue, if they try, they may find themselves trapped by not being able to renew their financing. This is great news for the government as there will be more properties on the market (If the 19 per cent of landlords in the NLA poll do sell, an additional 163,000 homes will go on the market – more than all new-builds in the UK last year) which will depress prices.

For those who can weather the storm, the upside is that with smaller rental stock, we expect rents to jump dramatically in 2018-2019 as buyers struggle to find deposits and compete for housing.

This situation does seem akin to a slow motion train crash: buy-to-let landlords with mortgages are standing on the track in a game of chicken with regulatory locomotives, hoping to time their exit as best as possible. This high-risk game will almost undoubtedly leave casualties.