The buy-to-let boom is on its last legs – what happens now?

Is this the beginning of the end for the buy-to-let property market?

An interesting article by James Pickford in the FT yesterday suggests that it might be.

It looks as though a growing number of landlords are throwing in the towel and putting their properties on the market.

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A combination of the end of tax relief, rising stamp duty and the fear of rising interest rates may finally have proved too much for the once-booming buy-to-let market.

So what happens now? Is this enough to crash the housing market or will it continue to totter along in suspended animation?

The time bomb in the buy-to-let property market has gone off

Growth in the total number of outstanding buy-to-let mortgages is no longer keeping up with growth in the number of new buy-to-let loans being written, says Pickford, quoting analysis by estate agent Savills.

In other words, even although new landlords are arriving on the scene, other buy-to-let loans are being paid off at an increasing rate. As a result, overall growth in the market is slowing. Indeed, the gap between the two measures new loans taken out vs the overall loans outstanding hit a ten-year high in the year to June 2017.

In the year to September 2007, the number of new buy-to-let loans at around 180,000 almost precisely corresponded to the growth in the number of outstanding loans, The Sunday Times points out. But now the figures show that, while 78,000 new loans were granted in the year to June 2017, the outstanding loans figure grew by only 28,000.

"This strongly suggests some buy-to-let mortgages are being redeemed as investors sell rental properties," notes Pickford. Savills is quick to point out that this isn't an "exodus". But it does suggest that "the combined range of tax measures is causing some people to re-evaluate whether or not buy-to-let is for them".

We've written on several occasions about the time-bomb lurking in the buy-to-let market. In case you didn't know, landlords get tax relief on the interest they pay on their mortgages. So if you have an interest-only mortgage, you can offset your monthly mortgage payments against your monthly rental income, and only pay tax on the excess.

But that's changing. George Osborne announced a slow-motion end to this tax relief when he was chancellor a while ago, but it's only starting to kick in now. That potentially means a much higher tax bill for landlords. And as so often happens with these sorts of changes, they do seem to be taking at least some people by surprise. My colleague Merryn Somerset Webb wrote last month about how these changes could drive house prices lower. This report is some of the first concrete evidence we've seen that this is really happening.

It's hard to see why landlords would want to expand right now

Of course, this is not a surprise. Indeed, it's hard to see how it could fail to happen. Put simply, the reduction in tax relief means that anyone buying an investment property with a mortgage, now needs the property to generate a higher yield than before in order to turn a profit after tax.

For yields to rise, rents either have to go up or prices have to go down (or a bit of both). Landlords' pressure groups always argue that anything which increases the costs for landlords will drive rents up. However, this just can't be true.

I am not casting aspersions on landlords here. But they are just like any other service provider in a relatively free market: they will charge what the market can bear. So logically speaking, the rents that they charge should (on average; clearly, there are outliers) already be as high as they can go, given levels of competition and tenant demand.

Therefore, if rents are already at the highest level possible (or thereabouts), then the only thing that can drive yields up is for prices to go down.

Now, this might not matter as much if property was currently cheap. If yields were at double-digit levels, people would still be happy to buy into the market at current prices, even if the yield had dipped a bit.

But, of course, that's not how these things work. A decade of low interest rates and quantitative easing has driven investors into a frenzied "quest for yield". As a result, people have been diving into property (and everything else) without really worrying too much about the size of the rental income. Yields particularly in the southeast and London had already hit rock-bottom levels.

Bear in mind that published yields don't generally take into account all of the disasters that can hit landlords. I've met quite a few people who've rented out properties in the past, and I have to say, it's not a business that appeals to me.

The number of nightmare tenants is surprisingly high (and I speak as someone whose sympathies tend towards the tenant in most cases). Then there are "voids" periods where the property is vacant, which can destroy your profits in just a few weeks, depending on how much give is in your yield figure. And then there are your day-to-day repairs boilers breaking down, plumbers needing to be called, all the rest.

So it's not necessarily easy money by any stretch of the imagination.

Until now, I suspect, amateur landlords have been willing to hang on to their homes as long as they are covering their costs every year. If the property has ended up costing them money one year, it doesn't matter the paper profits they've made on the capital gains side more than make up for it. So their "mental accounting" is still biased in favour of ownership.

But it's going to become ever harder to square that circle. As soon as they fill in their next self-assessment form (or their accountant sends them the bill), some of the most marginal landlords are going to get a nasty shock. Rather than making a few hundred quid, their property may well end up costing them a few thousand pounds.

And all of this is before we start taking account the fear of further interest rate rises, or the more general crackdown on lending requirements for buy-to-let mortgages, or even the 3% added stamp duty that anyone who still fancies getting into the market has to fork out.

The bigger picture still depends on the course of interest rates

This of course still leaves cash buyers. They aren't affected by the tax relief issue, and they might be willing to suck up the extra stamp duty. However, they are still affected by the fact that yields simply aren't all that appealing right now.

And they are also affected by the fact that weighing up the likely direction of interest rates, not to mention the political uncertainty in the UK right now the environment simply looks pretty ugly for over-priced residential property today.

Could a buy-to-let exodus drive a severe house price crash? I still struggle with that idea. I think for a "proper" property bear market, you would need to see significantly higher interest rates.

But that said, buy-to-let has become a much bigger part of the UK market in the last 20 years or so. And we could also see pockets of "forced" selling (where the landlord effectively has to sell fast in order to get a money-losing asset off their hands before it costs them anymore).

So a crash probably not. But a bumpy ride and the odd localised bargain? Most definitely.