Tax changes put the squeeze on buy-to-let landlords
The Council of Mortgage Lenders predict that the increasing tax burden on buy-to-let landlords will result in a decline of buy-to-let purchases.
On 6 April, buy-to-let landlords will begin to feel the direct effects of the next tightening of taxation of the sector. From that date, tax relief on landlords’ mortgage costs will be restricted to the basic rate of income tax. And, over the next three years, the proportion of their borrowing costs that landlords can offset against tax will taper down to zero.
On top of this, landlords are affected by new rules restricting other deductible expenses that they incur from renting property, including reforms limiting tax relief for wear and tear in fully furnished properties. The government has published guidance and a series of worked case studies to help landlords understand how the changes will affect them.
A new raft of restrictions limiting what landlords can offset against tax follows the introduction of higher rates of stamp duty on property purchases by landlords. Since April last year, anyone buying a second home has had to pay 3% on top of the normal rate of stamp duty applying to the property. So, each investment by a landlord will have a stamp duty bill of at least 3% and as much as 15% of the purchase price, depending on its cost.
The increasing tax burden on landlords coincides with a tightening of regulatory requirements on the buy-to-let sector. That means that, since the beginning of this year, lenders have had to adhere to the Prudential Regulation Authority's (PRA) supervisory statement 13/16. This requires firms to consider likely future interest rates over a five-year period (unless the loan rate is fixed or capped for five years or more). And specifically lenders have to:
- stress test their lending against an expectation of an increase in buy-to-let mortgage rates of at least two percentage points; and
- assume a minimum rate of 5.5% even if the stress test of a two-percentage point increase would actually produce a lower rate than that.
In a further tightening of regulatory requirements, firms will, from the end of September this year, also have to apply special underwriting rules to landlords with a portfolio of four or more managed properties. The PRA has said that lending to portfolio landlords is inherently more complex because of the potential problems associated with higher debt totals, more complex cash flows, multiple tenancies and risks of property or geographical concentration.
The PRA has therefore said that lenders should take a proportionate approach based on their knowledge of the borrower, alternative sources of income and the property portfolio. They should also take into account the borrower’s experience in the buy-to-let market, assets and liabilities (including tax liabilities), historical and future expected cash flows, and the merits of new lending in the context of their business plan.
Meanwhile, the Financial Policy Committee also now has powers of direction over loan-to-value and income cover ratios for buy-to-let lending – although it has not yet used them.
The Growth of Private Renting
Over a relatively short period, we have therefore seen the introduction of a raft of fiscal and regulatory measures that bear down on landlords and buy-to-let lending. The combined effects have resulted in a significant reduction in new property purchases by landlords, which can be clearly seen from our data. Some of the measures have also encouraged landlords to sell existing rental properties.
It is still too early to predict long-term effects of all these measures on the balance of tenure. But we may already be beginning to see the reversal of a long period of expansion of the private rented sector. Over the last two decades, the number of privately rented homes has more than doubled from just over two million to more that 5.3 million, or from 9% to 19% of households.
Some are concerned about the expansion of buy-to-let, arguing that it reflects increasing affordability pressures for owner-occupiers. But it is also true that the growth of buy-to-let has widened choice for tenants in the private rented sector and delivered higher standards of accommodation.
Buy-to-let lenders and landlords have also responded to demands for longer-term tenancies from some of those living in the private rented sector. Of course, some people choose to rent because they want short-term flexibility, but the housing charity Shelter acknowledged last year that there had been a significant shift in the availability of mortgages for landlords who would like to offer longer-term tenancies.
In research published at the end of last year, we found that almost 40% of landlords offer longer-term leases, with a further 17% saying they would do so but there is no demand. Some other key findings from our research, which was based on a large-scale, nationally representative survey of UK landlords, were that:
- Around half of landlords had no mortgage debt at all.
- Buy-to-let landlords held larger and more valuable portfolios than other landlords, and accounted for almost half the properties in our survey.
- More than half of buy-to-let landlords had mortgage debt amounting to less than 60% of the value of their portfolios.
- More than 60% of all landlords, and around half of buy-to-let landlords, owned just one property for let.
- Landlords typically own properties close to their own home, and are just as likely to manage it themselves as to use an agent.
- A larger number of landlords were expecting to reduce, rather than increase, the size of their property portfolios – although the differential was modest. When the survey was conducted last June, a net 5% of buy-to-let landlords expected to reduce their holdings over the next year, with the proportion rising to 11% for those who thought they would reduce their portfolio size over five years. Just over one-third said that higher taxes were a motivating factor.
Earlier this year, we also published the findings of a smaller survey of landlords with properties in London. This found that:
- Landlords in the capital had higher incomes than elsewhere in the UK.
- They were more likely to be renting out flats (79%, compared to 40% in the rest of the UK) and less likely to be letting houses or bungalows (47%, compared to 84% elsewhere).
- They were just as likely as landlords elsewhere in the country to offer longer-term tenancies, and were more likely to be using mortgage finance. They had higher levels of awareness of tax changes affecting the sector and – on balance, and unlike those in the rest of the UK – expected to make net acquisitions to their portfolios over the next five years.
Buy-to-let lending continued to grow last year – as it has done since 2011– but there were some significant shifts in the balance between lending for house purchase and remortgaging. Last year, lenders advanced £14.9 billion for housing purchase and £25.1 billion for remortgaging, while, in the preceding year, they funded £15.6 billion of property purchases and £21.9 billion of refinancing.
But the data for last year also masked some major changes in activity levels before and after the introduction in April of higher stamp duty affecting landlord property purchases. In the first three months of the year, there were 49,100 buy-to-let purchases, worth £7.3 million, while, in the final quarter of 2016, there were 19,300 purchases, worth £2.7 billion (down by 61% and 63% respectively).
The announcement by the PRA of its new stress tests was a signal for many lenders to begin to tighten affordability criteria for buy-to-let landlords. This effect has also been reinforced by the tax changes affecting landlords. As a result, we have predicted that lending for buy-to-let house purchase reached a peak in 2015 and will decline over the next two years.
Increases in remortgaging did, however, mean that the total number of loans edged up last year (from 252,000 to 259,000). We expect the total to decline this year and next. In recent years, house purchases by buy-to-let landlords have made a significant contribution to the growth in overall net mortgage lending. But the decline in buy-to-let purchases has led us to forecast a levelling-off of net lending over the next couple of years.
We have acknowledged that the PRA’s reforms are appropriate, and broadly reflected lenders’ existing approaches to assessing affordability and risk. But buy-to-let landlords will also be affected by a series of tax changes over the next three years and beyond. We are predicting a decline in buy-to-let property purchases, and will continue to monitor the effects on the property market and the balance of tenure.