I came across a great research article from Lawrence Bowles at Savills Research earlier this week which I think is worth sharing. As I explain to most new clients, ‘yield’ is vital when understanding the relative merits of an investment and enables us to compare one asset class with another. In general, with your money safe and usually instantly accessible a bank deposit account will pay 1% even in this day and age. Stocks and share have more risk but tend to offer 3-5% in dividend yield and again your money is pretty easy to cash in. Property is much riskier, harder to sweat to get the yield and can take much longer to cash in. It’s for this reason that I think property needs to show a (gross) return of 6% or better.
Buy-to-let yields have fallen across most regions of the UK because house prices have grown faster than rents. Lending to buy-to-let investors is falling fastest in areas with low yields and Savills predict it will fall a further 27% the next five years.
Lending to buy-to-let landlords is falling as a changed tax regime squeezes investor margins – so called ‘Section 24’ changes, particularly those for those with borrowing. New analysis using UK Finance data allows us to see the extent to which these falls are concentrated in the UK’s most expensive housing markets, as clearly demonstrated by the maps below.
As shown in the chart below, lending to buy-to-let investors fell 53% over the last two years in the districts with the lowest yields (sub 5%). Meanwhile, they fell 36% in middling districts (5-6% yield) and just 19% in high yielding districts (with yields over 7%).
These yield figures are gross, meaning they exclude costs to the landlord including maintenance, letting fees, and void periods when the property sits empty between tenants. Net income yields may be a quarter to a third lower than gross yields. For context, the FTSE 100 currently yields 3.8%t.
Many of these lower yielding markets are in London. In Islington in London for instance where gross yields average just 4.5%, buy-to-let lending fell by almost three-quarters (72%) over the last two years. In Richmond-upon-Thames, where yields average 3.8%, lending fell 69%.
In the past, it made sense to borrow (very often on an interest-only basis) against investment properties. Most buy-to-let investors did so. But now stricter rules around lending and reduced tax relief make buy-to-let borrowing look significantly less attractive, particularly in lower yielding markets. Since 2016, landlords have had to pass the same interest rate stress tests as owner occupiers. They must demonstrate they can charge enough rent to cover almost one and a half times their mortgage payments. And the amount of tax relief landlords can claim on their mortgage interest payments is shrinking: from 6 April 2020 relief will be limited to 20 per cent, increasing costs for higher-rate taxpayers.
When I crunch the numbers I estimate that only a third of the nations 4m private landlords have a mortgage and many will not be impacted by the changes but some undoubtably will and for them there will be little option but to sell up.
This is just the beginning. Savills predict that buy to let lending will fall another 27% by 2022. Those falls will likely be concentrated in the higher value, lower yielding markets of London and the South East.
I’m unconvinced about the possible outcome Lawrence suggests. Whilst the falls in buy-to-let lending could reduce the amount of stock available on the rental market I expect cash investors will step in to buy up additional stock or, as the Government hopes, more owner-occupies will.