For those of you who were at the last Property Success Network, you will know that my lettings update looked at the current challenges relating to increasing mortgage rates for buy-to-let landlords and the potential impact this could have on the UK rental market.
As I’m sure you will be aware, it’s relatively common for buy-to-let landlords to face mortgage rates upwards of 5% or 6% when purchasing or remortgaging. The challenge here, is that a buy-to-let mortgage on an average terraced house in Medway (currently £274k) would experience a significant increase.
Here’s the challenge: at a pretty standard 75% LTV, you would need a £205,500 mortgage to purchase the average terraced house.
A year ago, limited company rates were about 3.5%, meaning an interest only repayment of around £598 per month, however if this rate increases to say 6% the mortgage costs will be around £1,025 per month (£855 at 5%)!
That’s a whopping increase of £427 per month, leaving very little room (or none atal) for any profit, maintenance or running costs. Basically, the buy-to-let simply becomes untenable.
However, here’s the sting in the tail as mortgage companies often stress test affordability at needing rent to be 125% of 3% above the rate charged (to evidence affordability for BoE rate rises). So, for example, a rate of 5% would need rental payments to be 125% of 8%.
For ease, I’ll outline this below using the example above of a £205,000 mortgage on a standard Medway terraced house:
These figures are pretty scary, and I don’t see any scenario where Medway properties currently renting for c. £1,100 per month will shoot up by over 50% to meet affordability criteria.
I’ve been reading around this and there appears to be an increase in amateur landlords considering selling up as their portfolios become untenable and the increased mortgage rates could leave some with no option.
Here’s the thing. There isn’t a simple solution, and this challenge would probably make most buy-to-let mortgages untenable! Mortgage brokers I’ve spoken with don’t anticipate rates to be this high for too long, but whilst they are it’s a challenging situation. I asked my good friend Saam Lowni for his input and he explained that:
“In the short term there is undoubtably significant turbulence in the market which has not been helped by Liz Truss uncosted mini budget. Prior to the mini budget debacle, interest rates were inevitably going to rise following the significant government stimulus through C19 from ‘furlough’ to ‘bounce back loans’ and ‘eat out to help out’.
Combined with supply-side disruption linked to Brexit and the war in Ukraine, the economy was in a fragile state prior to Boris Johnson stepping down. Now with Rishi Sunak taking the reins, the market has already stabilised and BoE interest rate of 6%+ are no longer likely.
That said, we could see highs of upto 5% which means interest rates could reach double digits for borrowers in a worst-case scenario. The aim is to control inflation and bring it down from 10%+ back to its 2% target.
It is my expectation that once inflation hits 4% again, BoE interest rates can start to fall and will likely find a new norm around the 2% to 3% for the next decade.
In the meantime, whilst protecting existing assets by increasing rents and reducing other costs is important, a buyer’s market will emerge paving the way for investors to secure properties at more attractive yields than have usually been on offer”.Saam Lowni, Managing Director – Merryoaks Property Finance
The housing crisis was already pretty bleak what with the war on landlords leading to a reduction in stock. This crisis will only but make stock levels worse (and calls for rent controls that are growing louder from Sadiq Khan really don’t help)!
Enough of the doom and gloom though as us property investors are a resourceful, positive bunch and we will get through this hump. People will always need homes to live in, there may be an increase in opportunities and surely the government cannot let the sector collapse, leading to tens of thousands of evictions??
Starting on a positive, take a look at how the South East has seen the UK’s largest positive increase in year on year increases for yields in Q3 2022. In addition, we have experienced significant house price increases over the past few years which is helpful when it comes to remortgaging.
So, what can landlords (many small landlords hold property as a large part of their pension) learn from this? Here’s a quick-fire list of my headline thoughts:
- Always review rents and increase accordingly when renewing tenancy agreements
- Have lower LTVs (the days of highly leveraged portfolios could be over and it could be those landlords facing the worst crisis). We may see average LTVs drop down to below 60%
- Remember that cash is king and always have a good level of reserves (6-12 months) to stabilise your business
- Remember that the current storms will pass in time and property is always reliable over a long term (even if cash needs to be put into their business for the time being)
- Investors should use the current crisis as an opportunity to reflect on and stress test their long-term goals. For example, if trying to build a retirement income should this be done on the basis of an 80% LTV mortgage at a rate of 3.5% or lower LTV and higher rate?
There are more unanswered questions here than answers and only time will tell, however my advice is not to panic. Remember that property has proven itself to be a strong asset class, but some adapting of strategy may be needed.