Making sense of 6 months of change in Buy-to-Let
- Published: Friday 14 October, 2016
- Category: Economy
- By: Andrew Turner
- Updated: Wednesday 22 March, 2017
Expert view: Andrew Turner, CEO, Commercial Trust
Commercial Trust’s CEO Andrew Turner gives his views on the buy-to-let market, the factors that have shaped it over the last 6 months and looks to the future to see how things are shaping up for 2017.
In the space of the last six months, the buy to let industry has experienced some of the biggest changes it has ever seen since its popularity grew in the 1980’s. With changes including stricter lending requirements, stamp duty increase, post Brexit market fluctuation and the new tax rules outlined in Section 24, the buy to let landscape is changing at a rapid rate. We are yet to see what the full impact of Brexit will be.
Given such change and uncertainty, I wanted to outline my view on what those changes could mean to landlords such as yourself and the options open to you to help ensure your portfolios remain profitable through these challenging times.
Whilst I discuss matters of tax within the below, I urge all landlords to seek professional, independent tax advice.
The post Brexit buy-to-let market
In June Britain voted to leave the EU and become a sovereign state. While there have not been the large scale problems many predicted, the housing market, and more so the buy to let market, has suffered from fluctuating property prices. Additionally, and lest we not forget, Brexit has not actually happened yet so there is still a great deal of uncertainty ahead.
Until a deal is struck as to how the UK will trade with Europe, the outcome of Brexit is anyone’s guess.
What I can say is, once that deal has been struck, we will have a clearer picture of what is to come and I will share with you my thoughts on this; the best you can do at present is to keep informed.
House prices since the vote
House prices fell in the three months since the Brexit vote, according to the latest Halifax House Price Index, which indicated that UK house prices decreased during the third quarter of 2016. At -0.5%, the quarterly pace of decline was the fastest for just over five years, which contrasted with the 1.6% rise in house prices during Q2 2016.
Current average house prices
The average house price in the UK now stands at just over £214,000, down just over £1,000 from June. Although house prices remain lower than the peak seen in June pre-Brexit, the subsequent month-on-month drops have yet to plateau, however, this does include the seasonally slow summer period which usually results in a dip in the markets whilst everyone goes on holiday.
Strong growth in tenant demand during September 2016
In a recent survey from the Royal Institution of Chartered Surveyors, tenant demand increased firmly during September (non-seasonally adjusted figures), with the reading signalling the strongest rate of growth in twelve months. Landlord instructions were more or less unchanged at the headline level*, but did increase notably in London and Wales.
*Specifically the 10 regions that make up the national readings are: 1) North 2) Yorkshire and Humberside 3) North West 4) East Midlands 5) West Midlands 6) East Anglia 7) South East 8) South West 9) Wales 10) London
This data can be looked at in two ways.
- Firstly, due to tenant demand rising, landlords will be able to let out their properties quicker and maintain profitability and those looking to increase their portfolios in the UK can buy properties at reduced prices.
- Secondly, with a rise in tenant demand, a growing need for more buy to let properties will become apparent, with those looking to invest in new properties facing an increased tax rule change and a higher stamp duty.
Whichever way you choose to look at the data, one thing we can agree on is that landlords will need to be mindful of the uncertainty in the market. Until the Brexit Article 50 is triggered and we can see the lay of the land, the prospects for the market will continue to remain unclear.
Stamp Duty rise for additional homes
On 1st April 2016, HMRC brought in a new Stamp Duty Land Tax (SDLT) surcharge adding a further 3% to all second home purchases. This was felt hardest by landlords who will now face higher rates on nearly every property they buy. As the table below shows, even those properties that previously avoided stamp duty (under £125K) are now included in the tax hike.
|Band||Existing residential SDLT rates||New additional property SDLT rates|
|£0* - £125k||0%||3%|
|£125k - £250k||2%||5%|
|£250k - £925k||5%||8%|
|£925k - £1.5m||10%||13%|
* Transactions under £40,000 do not require a tax return to be filed with HMRC and are not subject to the higher rates. Source https://www.gov.uk
In real terms for landlords, these new changes to the SDLT, will affect any property you buy. For those of you who rent your properties out through a limited company or are thinking of setting up a limited company to circumvent the changes, the new rules will also include you.
The effect of stamp duty changes on future property purchases
The examples below illustrate how these new changes may affect you, for your future purchases:
An additional residential property is purchased for £200,000. SDLT is calculated as follows:
3% on the first £125,000 = £3,750
5% on the remaining £75,000 (the portion between £125,000 and £200,000) = £3,750
The total SDLT due is therefore: £3,750 + £3,750 = £7,500
An additional residential property is purchased for £100,000. SDLT is calculated as follows:
3% on £100,000 = £3,000.
A report from Rightmove eased fears that with new SDLT rules coming in the number of buy to let properties on the market would decrease, citing that:
“The brief pause in activity didn’t lead to a reduction in new rental supply that some were predicting, with newly-marketed rental properties up 6% in Q3 compared to 2015. London continues to lead the way for new supply, with a year-on-year increase of 15% over the same period.”
The stamp duty increase is the cost of business; however, most landlords will simply pass them onto tenants in the form of raised rents. The increased rent is a consequence of landlords currently being ‘political punch bags’.
In March of this year, The Prudential Regulation Authority (PRA) announced plans to tighten the buy to let underwriting criteria standards, including a minimum level of stress testing. The changes aim to ensure that any loans would still be affordable should rates rise.
Currently, most of our lenders stress test BTL affordability, looking for coverage of 125% of the monthly mortgage payment percentage. However, the new rules surrounding affordability of loans are much firmer.
The new buy-to-let mortgage affordability criteria
The PRA are now stating that the affordability should be set at 145% at a rate of 5.5% and become the industry standard, with this figure being independent of the Bank of England’s base rate.
The first stage of the stress test integration comes into effect in January 2017, and will be fully implemented by September 30th 2017.
If you had a rental income of £1000, with current stress test figures of 125% at a rate of 5%, you could take out a loan of £192,000.
From January 2017, the same rental income of £1000 with a 145% at a rate of 5.5% will now give you a loan of £150,470.
The PRA said that:
“Rental income is an important factor when determining the ability of buy-to-let landlords to service their debt. Accordingly, a widespread market practice in the buy-to-let lending market is to use the mortgage’s interest coverage ratio (ICR) in assessing affordability.”
These mortgage affordability changes will impact future purchases and your ability to remortgage your existing property, when the time comes. The deal you could secure today, with more lenient affordability criteria, will not be available in the future.
Opportunity, not penalty
While we could view this stricter underwriting as being a further tightening of the strait jacket for landlords, I still think that the buy to let market is still one of the most financially sound opportunities available. It will also allow landlords to better weather any future upward rate changes with confidence.
Section 24 appeal loss
One of the most recent developments in the buy to let market has been the appeal, and subsequent rejection at the Royal Courts of Justice, of the proposed Section 24 of the Finance (No. 2) Act 2015 known as the ‘Tenant Tax’. The campaign, brought about by two current landlords, asked for a judicial review of the legislation that sought to prevent landlords with mortgages from offsetting their mortgage interest costs against their rental profits before calculating tax.
What should you do?
For some, no action need be taken at present, save for a review of your portfolio to ascertain that this is the case. For anyone wishing to bring their portfolios in line with the coming changes, some planning may be required to identify how best to structure your investments and associated mortgages.
If you would appreciate guidance on this, talk to us.
What are the changes?
The changes will be phased in over three years as shown below:
|Tax year||Percentage of finance costs deductible from rental income||Percentage of basic rate tax reduction|
|2017 to 2018||75%||25%|
|2018 to 2019||50%||50%|
|2019 to 2020||25%||75%|
|2020 to 2021||0%||100%|
Who will bear the cost of Section 24?
Contrary to the intended easing of first time buyers getting on to the property ladder, the inevitable outcome of Section 24 will actually be higher rents for tenants as landlords seek to maintain their after tax profit margins.
What does the future hold? Q1 2017 forecast
Looking ahead to the start of next year, I believe that, despite the impending changes, the buy to let market will continue to grow and start to step out of the shadows of post Brexit uncertainty. Fundamentally the property market is driven by two factors 1) the current cheap cost of debt, and 2) the relationship between the demand and supply of property.
The rates on offer for buy-to-let mortgages are cheap and offer an enticing way into the BTL market. Currently the demand for rental properties greatly outweighs the supply. Tenants looking for lets are on the rise and show no signs of abating and with this in mind, property still remains one of the best long term investments for your money.
This information should not be interpreted as financial advice. Mortgage and loan rates are subject to change.