The Buy-to-Let Dilemma

This is a challenging period for individuals considering property investments for rental purposes. With rising mortgage rates, less favourable tax conditions, and stricter regulations, the financial calculations are no longer as enticing for many prospective landlords. While the demand for rental properties remains high, it’s premature to write off the market entirely; it still shows signs of life. However, the days of substantial profits and effortless property management are waning.

As a result, an increasing number of property owners are opting to exit the rental sector. Those who choose to stay are contemplating how best to adapt to these new market conditions.

There is a glimmer of hope on the horizon. Mortgage rates have somewhat stabilized after the spike following last year’s Truss-Kwarteng mini-Budget, and the Bank of England base rate might have reached its peak or is close to it. It’s possible that rates could start decreasing again by late 2023 or 2024, although a return to the levels seen in 2021 appears unlikely.

Higher interest rates mean that achieving the same profit levels now requires either a higher-yielding property or a lower loan-to-value (LTV) ratio.

The “stay or go” dilemma is a complex one for potential buy-to-let investors. The impact of mortgage rate fluctuations varies significantly based on borrowing levels and the income generated by each property. Property owners in London and the south-east, in particular, are feeling the squeeze due to high property prices. According to Q4 2022 data from Hamptons, average yields in these regions hover around 5%, notably lower than the 7.5-8% yields seen in the north of England, in areas such as Liverpool and Newcastle.

Monthly profitability is also a critical consideration for lenders. They typically require a minimum interest coverage ratio of 125%, which measures gross rental income against mortgage interest payments, to approve a buy-to-let mortgage.

However, it’s not all negative news. Property investors with a low LTV are less affected by interest rate fluctuations, and those with ample cash reserves may identify opportunities in the current downturn. Furthermore, there’s a fair chance that interest rates will start declining in the coming year. For landlords with strong tenant relationships who wish to retain their properties, it may simply be a matter of weathering the storm.

Nonetheless, the market is undergoing changes and experiencing heightened entry barriers. Some landlords with unprofitable properties may exit the market, while others may need to inject more equity to make their mortgages more manageable, particularly in the high-priced south-east.