One way or another, homeowners across the country are starting to feel the impact of rising interest rates. For the half of landlords who own their buy-to-let with a mortgage and are either on a variable rate or coming to the end of a fixed-term deal, rising rates are rapidly pushing up costs. In some cases, this means that landlords may start to see their profits turn into losses.
Since August 2021, the average mortgage rate on a typical 75% LTV buy-to-let rose from 1.79% to 3.51% last month. This means the average landlord who bought or re-mortgaged a £222,000 buy-to-let with a 25% deposit in August will likely see their annual interest-only mortgage payment nearly double from £3,010 to £5,903 compared to last year.
While investors already on fixed-rate deals will be immune for now, if last Thursday’s 0.5% base rate rise to 2.25% is fully passed on, this will increase annual mortgage payments to £6,743 for those re-mortgaging with a 75% LTV deal.
Landlords who bought several years ago will be more immune from rising rates than new investors. This is because their mortgage is likely to be smaller in cash terms and rents have risen since then to help cover the costs.
How will rising rates effect landlords’ profit?
This will have profound consequences for the profitability of buy-to-let. The net annual profit (after costs and taxes) made by a higher-rate taxpaying investor who earns an average yield of 6.1% could fall from £3,198 in August 2021 to £212 with the new base rate, down 93%.
*We assume a buy-to-let landlord in Great Britain has a 2-year fixed rate 75% LTV mortgage on a £222,000 property, which generates £13,542 a year in rent. Their net profit is based on how much profit they make after mortgage costs, maintenance costs (£4,198) and tax at 40% for a higher-rate taxpayer. We assume that any increase in the base rate is passed onto the average mortgage rate in full.
If the base rate reaches 2.5%, the average higher-rate taxpaying investor with a typical 75% LTV mortgage is likely to start making a loss. They will need to yield around 7.0% or more to stay out of the red – a figure only achievable on average in 23% of local authorities in England and Wales, 65% of which are in the North of England. Alternatively, paying off some of the mortgage debt will help reduce monthly payments.
Lower-rate taxpayers or limited company landlords have much more wiggle room. While the average lower-rate taxpaying investor achieving the average yield (6.1%) in England and Wales may have also seen their profit shrink over the last year (from £5,070 to £2,750) when re-mortgaging, the base rate would have to reach 4.0% before they start making a loss. Every local authority in the country offers an average gross yield above this mark.
How can investors protect themselves against higher mortgage rates?
To ensure investors stand the best chance of turning a profit, they are increasingly buying properties in higher yielding parts of the country. This guarantees that they have more rental income coming in to cover the mortgage costs.
So far this year a record 73% of new buy-to-let purchases earnt gross yields (before costs and taxes) above 5%, up from 63% in 2016 when the buy-to-let tax system began to change. More than one in five (23%) new investors earnt gross yields of 8% or above, up from 20% in 2015.
While many landlords in London have made their money through capital growth, at an average gross yield of 4.9%, the capital is the lowest yielding region in the country. This is one of the main reasons why London based investors are increasingly purchasing buy-to-lets beyond the capital. So far this year, a record two thirds (66%) of London-based investors chose to purchase a buy-to-let property outside the capital, up from just 26% a decade ago.
A fifth (20%) of London investors bought properties in the North of England, up from 9% in 2016 and just 1% a decade ago. Here, gross yields sit at 7.4%, outpacing the 6.1% average across England and Wales.Today, 29% of all properties in England & Wales bought as a buy-to-let are located in the North West, North East or Yorkshire & Humber, triple the share a decade ago.
What impact will this have on the rental market?
While around half of landlords who own their buy-to-lets outright won’t be under the same pressure from rising interest rates, those looking to purchase a new investment property with a mortgage are increasingly running out of options. If the yield doesn’t meet a lenders’ rent-cover requirements, they’ll have to put down a bigger deposit.
This is going to make investing in some Southern areas, where yields tend to be lower, tricky for landlords who are heavily reliant on mortgage finance - therefore restricting buy-to-let to those with the deepest pockets. For investors who are re-mortgaging at higher rates and finding themselves in the red, if they can’t pump more money in to reduce their mortgage debt, it’s highly likely they’ll be forced to sell up. All in all, this is likely to put further pressure on already low stock levels.
What’s happening to rental growth?
Since hitting a record high of 11.5% in May, rental growth continues to cool. At an average of £1,165 pcm, the cost of a newly let home in Great Britain rose 7.4% year-on-year in August. In part, this is due to signs that the supply-glut has hit rock bottom. There were 8% more new rental homes coming onto the market in August than at the same time last year, although, stock levels remain low compared to historic standards.
Rental growth slowed in every region of the country, apart from the South East, South West and Wales where rents rose at the same pace as last month. But London continues to see the strongest growth. In the capital, rents rose 11.3% year-on-year in August, slightly down from the 12.4% growth recorded in July. This has been bolstered by a 29.9% annual rise in Inner London, where rental growth has been running above 10% for the last eight months. However, this strong growth continues to reflect the weaker market last year, and this will begin to drop out of the picture in early 2023.