RIP buy-to-let?

To create a buy-to-let portfolio, investors are aided by easy access to finance, low interest rates, rising house prices, a favourable tax regime, and sensible regulations. Landlords have enjoyed these conditions since the 1990s and built up property portfolios that have consistently delivered strong yields, but today the sector has lost its shine.

As the generation of landlords that began their property investment journey three decades ago start to sell up and retire, it was expected that a new generation would emerge to take their place. However, without the same conditions that made buy-to-let so attractive, fewer young  people are becoming landlords and as a result the number of rental properties available has started to decline. Is this the end of buy-to-let?

Capital is harder to access 

Buying properties is a major investment and access to mortgage capital is therefore a necessity for most investors looking to build a buy-to-let portfolio. Whilst mortgages remain accessible, the terms upon which they are provided have become more challenging since interest rates have increased from summer 2022. The banks need to ensure that the mortgages they offer can be serviced by the rental income from the property.

In an interview with Housemartin, mortgage specialist Dorian Lovett of CMG Adviser LLP explained: “The Interest Rate Cover Ratio [ICR] remains the key focus for most providers, whilst this ratio has remained stable at around 140%, the rise in mortgage rates relative to rents has meant that banks have significantly scaled back the funds they will provide to buy a property.”

The impact on landlords of these increased rates is startling. To illustrate this change: an investor looking to secure a mortgage on a property that delivers £24,000 rent per year, on the basis of an Interest Rate Cover Ratio of 140% and a mortgage interest rate of 3% would be able to borrow £571,428 (=(Rent/ICR)/InterestRate) – perfectly achievable in mid-2022. However, now interest rates have increased, a more realistic borrowing rate is 6%. At this rate, the same property would only be mortgageable to the tune of £285,714.

As a consequence, investors looking to purchase a buy-to-let property today will need a lot more of their own funds than investors of yesteryear.

The cost of capital has spiralled

The Guardian reported in an article in November 2022 that rents in London had risen by 22% in the nine months to September 2022 and now stand at a record average of £571 per week. Whilst renters have undoubtedly been squeezed, the recent interest rate rises are arguably even more painful for landlords as finance costs have risen proportionately much more than rental income.

Dorian Lovett went on to explain: “Many landlords are no longer able to shop around for the most competitive yields as their Interest Rate Cover Ratio is now well below 140%. This means they are being rolled into expensive floating rate mortgages with existing providers.”

To put this into perspective, one landlord we spoke to that enjoyed a fixed rate mortgage of 2.5% up to November last year, and has just been rolled into a new floating rate mortgage, complains that mortgage payments have gone from around £400 to over £1,300 in the space of a few months.

Tax changes have depressed yields further

Whilst increasing rents are insulating gross yields to a degree, changes to the tax rules mean that many of the costs associated with owning a property can no longer be offset against income from it. The most prominent of these is the change to Section 14, introduced by George Osborne in 2015, where from the tax year 23/24 individual landlords will not be able to offset any of their mortgage payments against rental income if they are higher rate taxpayers.

In an article published at John Charcol, Mortgage Technical Manager Nick Mendes explains the raft of other changes facing landlords that may make property a less attractive investment opportunity, including:

• A surcharge of a further 3% stamp duty when buying a second property or buy-to-let or when buying through a company.
• The replacement of the Wear and Tear Allowance with Domestic Items Relief, which means that landlords will no longer be able to claim an annual tax deduction based on 10% of their rental income. 
• A 50% reduction in the relief period for Restriction of Private Residence Relief.

In an article for FT Adviser, Valerie Bannister, a board member at Propertymark concludes that these tax changes have resulted in landlords “…being hammered from all angles” with higher costs and lower net yields.

The administrative burden of being a landlord continues to rise

There has undoubtedly been a growing narrative over the past few years that landlords have profited at the expense of tenants. Whether or not this is true, the government has responded by introducing new legislation that will increase the administration time and costs of being a landlord. The clearest example of this is the requirement to improve the energy efficiency of properties across the UK. And there is more to follow. In June 2022, the government published an 86-page document titled A Fairer Private Rented Sector. This has not yet been made into law but many commentators expect a raft of new rules for landlords.

A revolution in property investment

The results of these changes have been predictable. The English Homes Survey or the Private Rented Sector showed 4.6m landlords in 2018/19, falling to 4.4m in 2020/21, and analysts believe this number will fall further as 500,000 buy-to-let properties are sold over the next five years. The headlines will focus on renters who are likely to suffer higher rents as a result, but this is also a significant problem for a younger generation of investors who feel like they are being shut out of property investment, and are instead turning to other investment options with lower initial outlays like cryptocurrencies.

The recent changes have had a dramatic impact on landlords, but the overall benefits of property investing have not changed. Property is still an effective hedge against inflation and asset diversifier that delivers stable income and long term capital growth. However, investors need to change how they invest in property to enjoy those benefits.

In the following series, we will explain how Housemartin overcomes the new obstacles to property investing; how our platform has made investing in property a more accessible investment opportunity; and why property should still be part of your diversified investment portfolio.