Late last year, not long after the shortest serving Prime Minister in history and her razor sharp chancellor delivered a less than popular budget, we delivered a presentation to an investor group on the Property Market in ‘uncertain’ times.
Whilst Government plans for new legislation, invariably designed as a search for urban votes at the expense of private Landlords (ironically so often cited as their core voters) was topic for some debate, the overriding concern was House Price falls and ‘squeezed’ equity. A survey of industry leading figures at the time (and we’ll set aside the bias that over half were portals or leading estate agents) suggested 2023 would see falls across the board of between as low as 5% and as high as 20%, but with 10% emerging as a fairly acceptable consensus.
So as we rapidly approach half-time, have these predictions become reality, or was it all an overreaction in response to what many believe was a much needed slowdown and overdue ‘correction’. Well, we think the jury may still be out on that one, but without doubt the market has slowed, with all major indices confirming falls (albeit below what many expected) and agents in the large reporting a significant slowdown in business, along with lower asking prices. From those we have spoken with; including urban, suburban and more remote offices, an adjustment of 10% does appear to be widely accepted and not everything is moving, even after such reductions.
But what was more surprising (and rather blinkered in our view) was the lack of concern at the steep rise and availability of Mortgages (and BTL finance in particular), something which is surely far more important for most?
For most BTL Landlords, it’s a long game. Much like shares in Blue Chip firms or index tracking funds, they accept that the market moves up and down, but overall their investments provide a relatively stable, if not always fantastic, return and, over time, capital growth is relatively assured. As such, whilst short spikes or corrections are painful to the balance sheet, they become rather less critical than they will be to a developer or Estate Agent.
The key to the longevity of their investment however is often the regular and reliable income achieved and, in a market with relatively ‘light touch’ regulation, a sustained tenant demand and historically low interest rates, this is not too difficult, even for landlord with gearing of above 75%. As prices have steadily risen over the past decade and with interest rates staying low, many landlords have taken larger Loan to Value (LTV) mortgages and switched to interest only deals, thus reducing payments and retaining a greater share of the rent received.
So, whilst this factor is always mentioned in any BTL market debate it has rarely been credited with the importance it deserves – why?
The answer to this may be due to the proportion of mortgages on a fixed deal, with 2, 3 or 5 years being the norm. At the time of our research and based on FCA data, 75% of UK mortgages were fixed rate with 95% of new mortgages being issued on such a deal. Perhaps understandably therefore, not everyone immediately rushed to sell when interest rates rose quickly in 2022 and we even heard one industry commentator, speaking at a major property show, describing this as something of a protection for landlords. This it may be, but it’s a protection with an increasingly short lifespan and, being only human, some of us are rather prone to sticking our heads firmly in the sand.
The matter and impact of interest rates on BTL landlords is not the ‘Elephant in the room’ it’s the ‘Whale in the bathtub’, as one mortgage broker was keen to refer to it. At the start of 2021 you could get a 65% LTV mortgage at 2.25% but 18 months later there was little available below 6.00%. For a £250,000 mortgage (interest only), that’s the difference between monthly repayment of under £500 to in excess of £1,200. We don’t know many landlords able to accommodate such an increase… but it can get worse!
Given the higher borrowing costs, the return on your investment is sufficiently wounded to result in the associated affordability test of any new loan to fail. If this happens, and assuming you don’t have the cash reserves to pay down the loan (or loans) then the alternative is the dreaded variable rate – and you could now be looking at somewhere between 7% and 8%, and that’s over triple your current monthly spend.
Let’s put this into practice… a real life example.
Our client has a small block of apartments (3 flats) with an overall value of around £500k. They have held a £200k mortgage, issued at 50% LTV (now around 40%) on the property for 5 years at a fixed rate of 3.99%, from a reputable and well known BTL lender. The repayments during the fixed term were £665 pcm and the gross rental value of the property is around £20,000. Taking into account voids, management fees, services charges and maintenance, the pre-mortgage monthly income has been around £1,065, so they’ve been sufficiently covered, with around £400 pcm pre-tax income.
Towards the end of 2022, they received notification of the end of their fixed rate term and were invited to make contact to review and renew, or move directly onto the variable rate of 6.99%. Arriving at just about the worst possible time, following the Kwarteng budget, they decided to let it slide for a month or two, but each month received notification of further increases, as the lender followed BoE rate rises. Enquiries to the lender resulted in a fixed deal offer no cheaper than the variable rate, whilst their rent levels and Ltd Company status meant that nothing much else could be found below 7.49%.
“Whilst the rents have been increased to partly offset the rise, resulting in a pre-mortgage income of around £1,200, this simply can’t cover the mortgage payments and we’re currently out of pocket by £100-£200 per month.”
At the end of March, they were advised of a further rate increase, this time to 7.74%. This latest rise had, in practice, increased the monthly mortgage payments to £1,290 pcm, almost double what they were paying just a few months prior, when the fixed rate deal was in place. So, despite putting up rents to partially offset the increase, they were now losing money (around £200) each month.
Considering the loan in this case sits at around 40% LTV, we can only imagine some of the situations faced by landlords with loans of 75% (or even 85%) LTV, now coming off fixed rates. With rent defaults on the rise, further legislative demands on the horizon and the cost of insurance and maintenance all rising, the culmination of these items is surely unsustainable, with the impact of a flurry of rate increases in quick succession being perhaps the greatest hurdle.
This is not a minor issue and must be happening across the length and breadth of the country. We have now seen some fixed deals available at around 5% (with lender fees across the fixed period are duly factored in), but lending criteria remains relatively strict and many may well be left with little alternative than to pay the higher rates, sell up, or face significant financial upheaval.
So how big is the problem?
Potentially, it’s huge… Remember, 75% of mortgages are on fixed deals, with most ranging between 2 and 5 years. Even a borrower who fortunate enough to be among the very last to benefit from locking in low rates, they would now be over half way through a 2 year deal. This suggests that, every month, more and more borrowers will be faced with significant hikes in mortgage costs, perhaps up to three times current levels.
How many Landlords are really planning for this?
Are they actually aware of what’s around the corner? Perhaps most are simply praying that new and lower deals are available by the time their lender calls?
To conclude, we believe this is a far bigger issue than abolishing Section 21 or meeting EPC targets. Put simply; if net rental yields remain significantly below costs of finance (predominantly dictated by interest rates) in a market with a high average LTV, then the overall investment case simply doesn’t work!
