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Using localised data on rents and capital values, this new analysis assesses the prospects for the mortgaged buy-to-let market and the knock on implications for the wider housing and rental markets following a number of recent policy changes aimed at the sector.
• Tougher underwriting standards for new buy to let mortgages from 2017 will require investors to inject more equity into new purchases.
• Our analysis finds that investors will need to inject 10% or more of the purchase price across half of all rental markets. This will reduce private investor demand in high value, lower yielding rental markets such as London.
• Investors look set to change where they buy investments, shifting to lower value, higher yielding markets to reduce the impact of new underwriting standards. This strategy comes with added risks.
• Tougher underwriting standards will impact on the ability to remortgage to a new lender in markets where rental growth has been low and where LTVs are high.
A changing policy environment – fiscal and regulatory
BTL has been an important driver of mortgage lending growth in the last 4 years with mortgaged investors accounting for 11% of all housing sales in 2015 and higher in some local markets. The increase in stamp duty from 1 April 2016 and the tapering of mortgage interest tax relief for higher rate tax payers are already impacting investor demand with more using limited companies to lessen the impact.
Until recently the majority of lenders have based BTL lending decisions on the requirement that the gross rental income from a property should be at least 125% of the interest payments of the proposed loan (ICR). The ICR, together with the stress mortgage rate and rent level, dictate the maximum LTV up to a typical industry maximum of 75%.
The Prudential Regulation Authority (PRA) recently published a Supervisory Statement setting out new expectations for underwriting standards for BTL loans to apply from January 2017 onwards. The statement describes how lenders should approach the underwriting of BTL loans. Some lenders had pre-empted the PRA announcement increasing mortgage stress rates and interest cover ratios (ICR) for new business.
Tougher underwriting standards will force investors to increase equity
Lenders that have recently moved to higher ICRs for new originations have tended to shift to 145% ICR with a c.5.5% mortgage stress rate. Some lenders have been looking at higher ICRs of 155% or higher in anticipation of the likely impact of reduced mortgage tax relief on higher rate taxpayers.
As lenders introduce tighter underwriting criteria so investors have to commit additional equity to fund a purchase. Our analysis finds that investors will need to contribute more than 10% additional equity to fund new purchases at 145% ICR and a 5.5% mortgage rate across half of rental markets.
The map at figure 2 shows the geographic impact and the amount of additional equity required to buy a 2 bed property with a BTL loan assuming a 145% ICR and 5.5% stress mortgage rate from 2017. This is before paying the additional 3% stamp duty introduced from April 2016.
Our analysis shows that new buy to let originations will more likely be at LTVs of between 55% and 70% with investors putting in an extra £25,000 to £35,000 of equity and much more in the lowest yielding and highest value housing markets.
The impact varies by property size and figure 1 shows the impact of higher stress rates and ICRs greatest for larger, higher value homes.
Figure 1 - What proportion of rented housing market is viable at 75% LTV by property size?
Source: Hometrack analysis
New investment moving to higher yielding markets to reduce impact?
Assuming investors are looking to maximise leverage, then the net result of higher buying costs and changed underwriting criteria will be to push more investment into lower value, higher yielding homes where it is easier to pass higher ICRs and stress rates.
Yields reflect risk whether it be the outlook for capital growth, saleability or the strength of the underlying cashflow. A move by investors up the ‘risk curve’ will boost house price growth in local markets but lenders will need to understand the additional risks from a change in the profile of new acquisitions by private investors.
Hometrack’s UK City House Price Index reveals strong growth in regional cities where capital values remain low and with rental yields well above average. Much of this growth can be attributed to a general improvement in demand for housing but additional investor demand will have some impact.
Impact of higher ICR and stress rates on remortgaging
Remortgaging accounts for a sizable part of BTL lending volumes and is therefore important for business planning. An important driver of remortgaging potential is how the rental value for a property has changed since the original loan was arranged. Taking capital value data from 2013 and assuming different mortgage amounts the analysis assesses whether rental growth has been sufficient to pass the new higher stress rates and ICRs. The results are shown in figure 2.
Assuming all BTL loans originated in 2013 were at 65% LTV the analysis shows that 83% of rented housing is in local markets where remortgaging is achievable. However, our analysis finds that 17% of rented housing in markets where remortgaging could be more challenging – we have split this group into marginal fails where the gap to the ICR hurdle is <10% and those where it is over 10% where borrowers may struggle to remortgage to a new lender. For higher LTV loans the ability to remortgage to a new lender diminishes more rapidly.
Markets where remortgaging would be a challenge as a result of proposed affordability tests tend to correlate to areas where there has been low rental growth in recent years, specifically regions such as Wales, Yorkshire & Humberside, the North West and North East. Rents in these regions look very affordable by historic standards and as the economy and incomes grow so rental growth could alleviate some of the challenges of remortgaging over time.
Figure 2 – Estimate for the impact of higher ICR and stress rates on mortgages originated in 2013
Source: Hometrack analysis
In markets where it would be a challenge to remortgage borrowers would have the following options:
1) stay with the current lender and pay at the product rate; 2) move to another lender with lower ICR requirements; 3) move and inject more equity; 4) try to push the rent higher
Increasing rents sounds attractive and has had much traction in the media but the reality is that private landlords are ‘rent takers’ not ‘rent setters’, they can only obtain what the going rent is in the market. Landlords can try and push rents but if the rent needed to refinance is well ahead of the rest of the market in an area then the net result will more likely be a void period.
Outlook for weaker demand in high value markets but a need to manage risk in low value, high yielding markets
• Expectation for tougher underwriting standard for mortgaged investors will have the greatest impact in London and the South East where yields are low and the cost of investing is higher.
• Weaker demand from investors will re-enforce the current slowdown in house price growth in London. Rental supply owned by private landlords looks set to tighten which will support rental growth in the near term.
• In contrast, we expect continued demand for rented property in regional housing markets and major cities but investors need to consider the risks associated with buying high yielding property where the cashflow appears strong but the liquidity of the asset, in the event of a sale, could be less certain.
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