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How will higher rates play out for landlords?
Market Insight: Summer 2023

Are lots of landlords quitting the business?

Some landlords are hanging up the keys because the profitability of their businesses has been dented by the soaring cost of finance. Mortgage rates are around 6% for landlords who own homes in their personal names - and approaching 7% for those who operate through limited companies. But there has yet to be a significant sell-off over and above natural replacement levels. Landlord sales account for about 15% of homes sold to date this year - slightly below the 16% recorded in 2016.

Why are landlords choosing to stay rather than go?

We think there are two main reasons: the sector’s demographics and the buy-to-let’s record of generous returns. Millennials - or even Generation X - landlords have relied most heavily on mortgage finance to scale up their portfolios. They are, perhaps, being squeezed the most, but their age means they are not ready to throw in the towel just yet.

Many have seen the returns made by their elders and are willing to take skinnier profits in the hope that things will improve. Older investors, who may be weighing up their retirement options, tend to be sitting on more capital growth. This gives them more wriggle room to limit the impact of higher mortgage rates. These investors are paying down their debt in order to shore up their profits.

Which landlords are most likely to quit?

The increase in rates is hitting landlords coming to the end of fixed-rate loan deals, and those acquiring new properties. We think that about 10% of existing landlords will be at break-even or suffering a small loss if they have to remortgage today - which they may choose to endure for a few years. Others will sell up and invest elsewhere.

Those who sell are most likely to be landlords who bought a relatively low-yielding property during the last few years. How things play out in the medium to long term for all landlords will mostly depend on whether high-interest rates are here to stay – and the level at which they ultimately settle. But most landlords are unlikely to settle for simply breaking even.

Which landlords are most at risk of making a loss?

Typically those who bought relatively recently, in lower-yielding parts of London or the South East. Older investors who have extracted a significant proportion of their property’s equity over the past couple of years are also vulnerable. If mortgage rates level out at much above the 5% mark, some investors in pockets of the Midlands and the North, long seen as buy-to-let safe havens due to the higher yields on offer, could also be facing negative returns.

A rate of 8.0% would mean that around half of all landlords – and 70% of those with a mortgage – would be operating at a loss. Since landlords who are higher-rate taxpayers cannot offset all their mortgage interest, they are at risk of being taxed on a loss. Limited company investors are slightly more sheltered.

How are landlords weighing up their options?

Most moderately leveraged landlords who need to remortgage over the next year or so will consider the past returns from buy-to-let, remembering the years when even supposedly best-buy deposit accounts offered meagre rates of interest. Currently deposit rates are rising. But when the base rate starts to move downward, savings accounts will quickly follow suit.

A sustainable return from buy-to-let is certainly hard to achieve at present. This could change, in the medium term, however, if the cost of mortgages drops. There is also the prospect of continued strong rental growth and the possibility of some capital growth over the next few years too.

How will increases in rents influence landlords’ decisions?

This case for buy-to-let has been substantially strengthened by the level of rental growth over the past five years. Over that period, the average rent has increased by 26%, with the pace of increase picking up rapidly in the past 24 months. The prospect of more rental growth over the next few years looks much stronger than that for house price growth. New landlord purchases are also being bought on the back of higher yields. The average return on a 2023 purchase stands at 6.6%, up from 6.0% in 2020.

Higher rents account for 81% of the (albeit reduced) profits of a landlord who bought five years ago and is coming up to the end of a cheap mortgage deal. However, rents would still have to rise by another 31% to cover the average landlords rise in mortgage costs at rates of 6%.

Will rent increases attract new landlords into the industry?

In the years leading up to 2016, a record number of landlords entered the market, holding down rents. Consequently, tenants enjoyed real term falls in their rents, while their landlords benefited from decent margins.

However, rents are set to become more expensive, thanks to a cocktail of higher mortgage costs, a larger number of landlords ready to retire and the availability of more generous returns from cash. Higher rents are not translating into increased profits for landlords as was the case in past. This means that buy-to-let is only likely to stack up for the opportunistic investors with the deepest pockets. New landlords are likely to remain low over the next 12 months, which will put upward pressure on rents.

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