What happens to buy-to-let in a downturn?
By: Thomas Hale
For landlords, the political tides look ominous. A series of policy measures over recent years, including the elimination of tax-deductibility on mortgage interest, higher stamp duty on second properties, and a proposal to end Section 21 “no fault” evictions, have chipped away at the perceived profitability of letting out a property.
But none of this appears to be showing up in their creditworthiness.
Coventry Building Society, for example, has provided buy-to-let mortgages against over 100,000 rental properties since 2010. It has taken losses on a grand total of four individual loans, amounting to £49,000.
The UK’s £30bn market for buy-to-let securitisations, where mortgages for rental properties are pooled together and sold on to investors as tradable bonds, tells a similar story. A securitisation from 2015, which pools mortgages provided by the specialist lender Paragon, has cumulative losses of zero. Less than 1 per cent of the loans are in arrears.
Why is the rental political climate not feeding into the world of buy-to-let credit? One reason, as with any mortgage, is the security of the collateral. Another is the nature of the loans in question. If landlords stop repaying their debts, for example, creditors can arrange for receivers to directly collect the rental income from the property.
But another is simply that the measures have a marginal impact. They may squeeze the viability of a buy-to-let property as a pensions substitute, but they don't meaningfully increase the likelihood of landlords defaulting en masse. Instead of a sudden collapse, these pressures might simply lead to reduced wealth in retirement, or smaller windfalls for their children (which explains why BTL activity has fallen).
There are early hints that the risks might soon increase, however. According to Moody’s, the recent calls for an end to so-called Section 21 evictions – which allow landlords to evict tenants without reason after a fixed-term contract ends -- is a “credit negative” for securitised bonds. From a report this week:
… they would slow a landlord's ability to evict tenants, and evictions would require a court hearing, which the Section 21 process usually does not. Additionally, a ban would limit the landlord's right to automatically evict a tenant because the landlord wishes to sell the property. These procedures would limit landlords' ability to maximise rental income, and potentially their ability to sell the property in a timely manner at the best price, thereby weakening their capacity to pay the amounts owed under the securitised mortgages.
Rather than policy pressures, the deeper risks to landlords come from interest rates rising, tenant demand changing, or the labour market worsening. The cash flows that back buy-to-let mortgages ultimately come from the salaries of tenants.
So the relevance of the accumulated policy measures is not that they weaken the creditworthiness of landlords in and of themselves. It is instead the extent to which they could potentially exacerbate the trauma of buy-to-let investment at a time of future economic distress. The cash flows drawn from tenants are likely to be more sensitive to changes in employment markets than the cash flows from homeowners.
If, for whatever reason, unemployment increases, measures that rarely need to be invoked, evictions might become commonplace. In that world, the new policies are no longer marginal at all. Moody’s has additional details:
Without the ability to use Section 21 to more speedily evict delinquent tenants, landlords will have to wait until a borrower is two months in arrears before beginning an eviction process. If the borrower pays off the arrears before the case goes to court, the application becomes invalid and the borrower can build up arrears again. Currently, Section 21 evictions usually do not require a court hearing, saving landlords the cost of legal representation, which can add up if they have to apply for evictions multiple times.
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