| THREE THINGS YOU NEED TO KNOW | ||
|---|---|---|
| 1. Nearly three million more households are renting today than in the late 1980s during the last rate-hiking cycle. And the number of buy-to-let mortgages has risen too with the invention of the buy-to-let mortgage. | ||
| 2. To date, higher interest rates have put greater upwards pressure on rents than they have downward pressure on house prices. Higher rents reflect additional finance costs alongside the increased burden of wages and building materials. | ||
| 3. We expect rents to rise 25% over the next four years, more than four times the pace of house price growth. But even after this, many landlords will still find themselves worse off than they were in 2021. | ||
There’s a strong argument that the Bank of England’s quest to quell inflation has hit the rental sector harder than any other part of the housing market. The average rent on a newly-let property in Great Britain rose by 9.9% in July, marking the 27th consecutive month in which rental growth has exceeded 5%. Despite affordability pressures, many tenants have agreed to double-digit increases when moving into a new home, in tacit acknowledgement that their options are limited.
Homeowners of all types have been squeezed by increases in mortgage repayments, but the ability and willingness of landlords to absorb higher rates has been more limited. Nearly 70% of all landlords have a mortgage or some form of borrowing, most of whom are on interest-only deals where rate rises are amplified. When the interest rate doubles, so do their repayments. Extending the term of the loan makes no difference and often isn’t even an option given the average age of landlords.
There are close to three million more households renting today than at the time when interest rates last rose sharply in the late 1980s. The number of landlords who rely on leverage has increased thanks to the introduction of buy-to-let mortgages in the early 1990s.
This new source of finance increased the supply of rental properties which kept rental growth running below inflation for many years. Over the last decade rents have risen 49% across GB compared to 67% house price growth. But the shift towards a reliance on borrowing has probably left the private rented sector more exposed to higher interest rates than the owner-occupier market.
Private landlords are ‘rent takers’ rather than ‘rent setters’. Their capacity to pass on higher costs to tenants is constrained to a large degree. But some are passing on these costs, and others are leaving the business, causing a rapid rise in rents which seems set to continue for the foreseeable future.
There has not been a mass exodus of landlords. But the numbers entering the business since 2016 are 25% below the previous average. Why? Because it’s considerably harder to make the sums stack up for a landlord who needs to borrow.
The direction of rents will primarily be set by where interest rates settle in the medium term. Higher mortgage rates have proved to be modestly deflationary for house prices, but they have proved highly inflationary for rents. The markets may expect interest rates to stabilise at a point below where they are today, but this will still be above the level to which landlords have grown accustomed over the last decade.
There are signs that landlords are steadily reducing their borrowing, with UK Finance reporting a 30,000 fall this year in the number of outstanding buy-to-let mortgages. Some landlords will have sold properties; others will have paid off their mortgages, without selling.
We forecast that rents will rise 25% across Great Britain between 2023 and 2026, with the most rapid pace of increase in 2023 and 2024. Such a rise would normally encourage a stampede into the buy-to-let business. But, despite the upward surge in rents, many landlords will still find themselves materially worse off than a couple of years ago.
Higher mortgage rates have stressed landlord finances most in the places where they are more likely to have a mortgage and where yields are lower. And this is why we think rental growth will be led by the North of England and London over the next year. These are places where there are typically fewer accidental landlords and larger portfolios which are more likely to be reliant on some form of finance, be it a traditional buy-to-let mortgage or a development loan.
Steeper borrowing costs are not the only issue, with substantial regulatory reforms on the horizon. The Renters Reform Bill is likely to further add to landlords’ costs, and more regulation may be in the offing whichever party wins the general election. However, there has perhaps been a softening of the political rhetoric in recent months, with a recognition of the pressures on landlords.
Another factor may push up the cost of finance for landlords. The Basel 111 regulations, which are designed to strengthen the banking sector, are finally set to go live in 2025. These will oblige banks to hold a great deal more capital against lending to portfolio and HMO landlords.
Against this background, it is hard to see where meaningful downward pressure on rental growth could come either this year or in 2024. In the longer term, however, lower house price growth, coupled with above-inflation rental growth may entice new investors which might help ease the supply glut.
