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Property price rises have far outstripped rent increases, narrowing landlords’ profits and making them vulnerable to higher rates
Britain’s two million buy-to-let investors are already anxious about what tax changes or other policies might do to their property holdings under a new government, as even the Conservatives have been less than supportive.
But quite separate to that – and possibly far more threatening – is the risk of a rise in interest rates.
In recent years lenders have been focusing attention on buy-to-let, one of the only points of growth in an otherwise stagnant mortgage market. As a result rates have fallen to all-time lows.
But this has coincided with a period in which property prices have risen, in general, far faster than rents. As a result, yields have dropped to record lows, especially in the South and other costly areas.
It leaves some landlords – particularly those who have bought recently and borrowed the typical maximum of 75pc of the price – vulnerable to even modest rate increases.
With an already narrow margin between rental income and mortgage outgoings, the danger is that a rate rise could push them into a position where they are losing money each month.
The figures, above, show average property prices and average rents for 10 UK regions.
The “mortgage now” figures show the monthly cost of servicing an interest-only mortgage of 75pc of the property value at a rate of 3pc. This is currently a competitive “starter” rate – either on a fixed or discounted basis – for a typical buy-to-let loan with a 25pc deposit.
The “future mortgage” figure is based on taking the same loan, but pushing the rate up to 5.5pc. This higher rate is a typical “follow-on” buy-to-let mortgage rate charged by the biggest landlord lenders.
So if, for example, a borrower came to the end of their fixed rate period and was unable to remortgage to another, cheaper deal, they would typically pay 5pc to 5.55pc.
In this scenario, property investors in seven out of 10 regions would be at risk of negative cashflow, as monthly mortgage costs rose above rents.
What could trigger an increase in loan rates?
David Whittaker of Mortgages for Business, a landlord broker, said there was “no problem with the supply of finance” and any rate rise would be more likely to result from the Bank of England pushing up its benchmark Bank Rate – either in response to a fall in sterling or in the normal course of the continued economic recovery.
Any political anxiety over, for instance, the prospect of a second Scottish referendum or Britain’s relationship to the EU could weaken the pound and bring that rise closer.
David Hollingworth of broker London & Country said “a weakening in sterling could lead to higher inflation and therefore begin to raise the expectation of an interest rate rise, which could feed through to mortgage pricing”.
He pointed out that many lenders were “waking up to the danger” and increasingly likely to factor in potential rate rises when first advancing the loans.
“Lenders typically want rental income to be 125pc of the mortgage cost,” he said. “And they may well use as the basis of their calculation a much higher rate, such as 6pc.”
That would imply that most landlords had a greater degree of “headroom” than the figures above suggest.
And the figures above are based on average properties and average rents, while many landlords can be assumed to have made investments where yields are higher.
Even so, little of today’s total returns for landlords comes from rental income. Property group LSL said average national total returns for the year to February 2015 were 12pc, of which 5pc was rental income and 7pc property price growth.
It said on average yields across the country were now 5pc before costs, a figure which has been steadily falling for the past two years.