A few weeks ago, I wrote that I was concerned about the buy-to-let market. Nothing new there, you may say – it has long concerned me that people are relying on capital gains rather than rental returns to make their gains. But there is something new – rough sums suggested to me that the changes to the tax relief on buy-to-let mortgage interest would push quite a few investors into negative cash flow even before interest rates rise to force sales (or at least discourage new purchasers), and possibly push prices of buy-to-let style properties down at the margin. Add in a couple of changes in interest rates (upwards) and carnage might not be far behind.
Very few people have joined me in these worries. For them, buy-to-let is an almost perfect investment, one which has been boosted not just by legislative changes that have shifted power from tenants to landlords, but by fast-falling interest rates, the ease of getting a mortgage (lenders don’t have to be as tough on buy-to-let borrowers as residential borrowers), and the (completely connected) house-price boom in the UK. That’s why buy-to-let lending is now 18% of total mortgage lending: everyone wants to be in this market, and almost no one sees the risks.
So I was pleased to see that I’m not the only journalist who is getting more and more worried. Writing in the FT, Patrick Jenkins (the FT’s financial editor) compares buy-to-let to the “dotcom darlings of 1999, Chinese stocks in 2015, $100 oil”, and declares this “frenzy no different to past passions… alarm bells should be ringing”.
He also asks investors to remember that falling house-prices are possible in the UK: they halved in the early 1990s. What might make the buy-to-let market tip over, dotcom style? I’d worry, as I say above, about the change to tax relief, and I’d worry that the Bank of England might try and make it tougher to get a buy-to-let mortgage (it has asked for powers over this, and consultation is under way). But the really big and immediate risk is a shift in interest rates.
Two thirds of buy-to-let loans are interest-only. That not only means that the tax relief has been a huge part of returns for higher rate tax payers, but that “only a couple of incremental shifts in the base rate will double the cost of many buy-to-let mortgages”.
The Bank of England is well aware of this: it has just put out a report that points to the problem. If the rise in interest rates (which Mark Carney says is almost upon us) stops the rise in house prices (which it surely will), and landlords who are now seeing both negative cash returns start to see negative capital returns too, they will surely start to sell up. And that, says the Bank of England, means that buy-to-let could “pose a risk to financial stability”.