Since 30 September last year, buy-to-let lenders have had a greater responsibility to carry out deeper affordability assessments in the case of mortgage applications by portfolio landlords. The new lending measures, set down by the Prudential Regulatory Authority (PRA), define a portfolio landlord as any landlord with four or more mortgaged buy-to-let rental properties. The main thrust of the change is that lenders must consider the landlord’s exposure across the entire portfolio of properties, not just the sole property on which a mortgage is currently being sought.
Under the new rules, buy-to-let lenders are obliged to apply “stress-testing” affordability assessments. In practical terms, this means that many lenders will look for an interest cover ratio (the level of rental income in proportion to the corresponding mortgage repayments) of around 145% for standard buy-to-let properties. For more complex borrowing cases – for example where the property is a house in multiple occupation (HMO), mortgage applicants can expect an interest cover ratio more along the lines of 170% to be applied.
Applying more robust affordability calculations is just one aspect of the more wide-reaching affordability assessment, however. Portfolio landlords will be expected to provide full details of all properties in their portfolio and their mortgage exposure – regardless of whether the mortgages are held with the same or a different lender – so that ongoing affordability can be assessed across the entire portfolio. Landlords will also normally be expected to provide a business plan and, in some cases, may be asked to provide additional business details, such as a cash flow forecast or a statement of assets and liabilities. Other checks can include rental income validation by postcode and, where personal income is used, an assessment of living costs and expenditure.
Needless to say, the introduction of the tough new rules by the PRA wasn’t exactly met with joy by landlords. While the move ostensibly seeks to ensure responsible lending to buy-to-let mortgage applicants, it’s easy to interpret it as an attack on portfolio landlords and a deliberate move to curb buy-to-let property ownership. Many predicted that it would have a detrimental effect on the buy-to-let investment market, with the likely consequence of preventing landlords – especially those with greater mortgage exposure – from expanding their portfolios, and perhaps even driving some to dump portfolios entirely and seek other forms of investment.
Have those predictions been borne out in the months since the affordability assessment changes came in to effect? The short answer: it certainly seems so. The longer answer is that the implementation of this specific regulatory shift by the PRA is just one of a raft of changes over the past couple of years that are proving to have a quite unprecedented effect on the buy-to-let investment landscape in the UK.
Recent figures from the Intermediary Mortgage Lenders Association reveal that net investment in buy-to-let property in the UK has slumped by an unprecedented 80% in the past two years – from £25 billion in 2015 to just £5 billion in 2017. For context, this is a sharper drop in buy-to-let investment than was seen in the in the aftermath of the 2008 financial crisis and credit crunch. It’s no coincidence that the slump comes alongside a new landlord tax regime that was first announced in the March 2015 Budget, and which is being introduced on a phased basis from April 2017 to April 2020.
Under previous tax rules, buy-to-let landlords could effectively claim tax relief for their mortgage interest, reducing tax liability at the prevailing rate – that is, 20% for basic rate taxpayers, 40% for higher rate taxpayers, or 45% for additional rate taxpayers. By April 2020, landlords will only be able to claim tax relief for mortgage interest at the basic 20% tax rate. This means that landlords who fall within the higher or additional rate tax brackets could potentially see their tax liabilities increase by thousands of pounds.
As if that weren’t enough, the Budget delivered in July 2015 also imposed additional stamp duty liabilities on the purchase of a second or subsequent property. The 3% stamp duty surcharge, which took effect from April 2016, means that buy-to-let landlords are seeing thousands added to the cost of buying a new property, whether that’s their first buy-to-let purchase or expanding an existing portfolio.
Overall, the ongoing changes to tax regulation, the introduction of a stamp duty surcharge, and tighter affordability assessments for both single-property and portfolio landlords, have combined to create an environment in which buying and owning buy-to-let property has become more expensive, while simultaneously it has become more difficult for some landlords – especially those with higher loan-to-value ratios across their property portfolio – to secure mortgage lending. Perhaps unsurprisingly, this has contributed to a buy-to-let market where increasing numbers of landlords are selling properties from their portfolios and not replacing them, are choosing not to expand their portfolios, or are actively paying down mortgages to reduce their exposure.
It’s difficult to predict where the buy-to-let market goes from here; however, professional landlords have been and will continue to be agile and responsive to a changing buy-to-let landscape. While many have divested individual properties or entire portfolios, some are looking at alternative ways of investing in property other than direct buy-to-let ownership – for example via peer-to-peer property lending, or equity crowdfunding. Others have shifted from being residential landlords to investing in commercial property, while others still have chosen to focus on HMOs, where the total yield can potentially be higher than for an individual house or flat.
One final option that many landlords are now taking advantage of is to run their buy-to-let business as a limited company rather than on an individual sole-trader basis. While there can be other costs associated with this – especially if existing properties are transferred from individual to company ownership – it can obviate the ongoing landlord tax relief changes, and allows retained profits to instead be taxed at the lower corporation tax rate, which is reducing to just 17% in 2020.