Buy-to-let was disproportionately affected by the severe disruption to wholesale funding and structured finance, as many lenders relied on securitisation to fund their lending. The inevitable consequence has been a curtailed appetite to lend, with some providers withdrawing from the market altogether.
Of the six largest buy-to-let lenders in mid-2007, two are now state-owned, two have merged and are heavily state-influenced, one has received support from the Irish government, and one is not lending while there is no new funding.
Seven consecutive quarters of decline have left buy-to-let gross lending at very low levels. There were 21,600 new buy-to-let loans advanced in the second quarter of 2009, a relatively modest 4% decline from 22,400 in the preceding three months, but 69% lower than the second quarter of last year and 75% lower than the same period of 2007.
By value, buy-to-let gross advances totalled £1.9 billion in the second quarter of this year, which equated to 5.6% of total gross mortgage lending (compared with £8.9 billion in the second quarter of 2008 and 11.9% of total gross mortgage lending).
But buy-to-let’s overall share of the total value of mortgages outstanding in the UK continues to increase. It represented 11.5% of outstanding mortgages at the end of June this year, compared with 10.9% a year earlier. It will continue to grow as the UK owner-occupied mortgage book shrinks (as people repay and redeem their mortgages) relative to the buy-to-let market, which will remain more static as the majority of loans are on an interest-only basis.
Is there demand to be met?
A classic argument in support of the buy-to-let market has been its counter-cyclical qualities: the assertion that when house prices weaken and households are reluctant to buy, they will rent instead, rental yields will firm and it becomes attractive for landlords to hold and expand their portfolios.
But another effect has emerged as a result of falling house prices: the reluctant landlord. Surveys by the Association of Residential Lettings Agents (ARLA) suggest some downward pressure on rents, with the number of rental properties available outstripping the number of tenants because an increasing number of home-owners who are unable to sell their properties are choosing to rent them out instead.
For existing buy-to-let landlords, substantial falls in house prices may result in paper losses. But the majority of rental stock is held by landlords with a portfolio of properties and most of these are long-term investors in property. Successive ARLA surveys have suggested there is little appetite to sell properties even if house prices fall. In the second quarter of 2009, 82% of landlords did not expect to sell.
Thwarted first-time buyers
Private renting meets the housing needs of adults at all stages of life. But it has increasingly served as a “buffer zone” for young households unable to afford home-ownership or meet the strict credit criteria that have become a feature of the mortgage market since the financial crisis began.
If house prices recover before the flow of funding returns to the mortgage market, then many would-be first-time buyers may have no option but to continue to rent. But involuntary landlords may then decide to sell, decreasing the supply of available rental properties and pushing up rents.
However, rising unemployment will also have an impact on tenant demand and rental yields. Recent ARLA surveys have reported increasing numbers of landlords struggling with tenants in rental arrears.
The housing shortage
Rental demand remains underpinned by strong fundamentals over the long term. There is a continued shortage of housing in the UK and the government is highly unlikely to achieve its target of building 240,000 new homes each year until 2016. Only 105,000 houses were started in England in 2008, and the 2009 total looks likely to be lower still.
The UK also has a relatively small private rented sector compared with other industrialised countries, providing scope for further growth of the buy-to-let market.
Lower interest rates mean landlords should be able to cover mortgage payments more easily, especially where they have a portfolio of properties. Where the property is let, the incentive for most landlords will be to sit tight on the improved cash flow.
Prospects for new acquisitions are mixed. Lower house prices are an incentive for investors to add to their portfolios. But the impact of sharp falls in house prices on indexed loan-to-values, and tightened lending criteria will limit borrowers’ ability to remortgage and re-leverage their portfolios of property.
In the medium term, profits will be driven by rental income and there will be limited appetite from speculative investors, given the uncertain prospects for capital gains.
Arrears on buy-to-let mortgages
Lower interest rates are making it easier for buy-to-let borrowers to meet their contractual payments and recover from past arrears. The buy-to-let sector benefits significantly from lower interest rates as the majority of loans are on an interest-only basis, and these loans will see a larger proportionate decline in monthly payments than repayment loans.
Buy-to-let arrears improved on all measures in the second quarter of 2009, but still remained high on a historical basis. There were 29,400 mortgages in arrears of three months or more (2.49% of all buy-to-let mortgages), down 17% from 35,600 (3.06%) in the previous quarter. And the number of mortgages in arrears of more than 1.5% of the balance outstanding fell 20% from 28,800 (2.47%) at the end of April to 22,900 (1.94%).
There are other signs that more buy-to-let landlords are managing to pay off arrears and recover their position. Anecdotally, lenders are reporting an increase in the number of landlords being allowed to resume control of their properties once again, having earlier appointed a receiver of rent to manage a property in mortgage arrears.
The number of possessions was unchanged from the first quarter at 1,400 (0.12% of all buy-to-let mortgages). Low interest rates will continue to help struggling landlords and stem enforcement actions. And there is some confidence within the sector that a bulge of actions arising from fraud is subsiding.
An important factor overall will be the resilience of many existing landlords and their portfolios. The outlook for the buy-to-let sector is one of slow growth, constrained by the shortage of funding and number of active lenders. Conflicting factors will impact rental demand in the recession, but long-term prospects remain strong.