Buy-to-let review

Down valuations don’t equal downturn

Richard Rowntree

Managing director – mortgages, Paragon Bank

Many of us have a personal, vested interest in the property market, and over the past couple of years this has grown as the pandemic has prompted us to re-evaluate what is important about our homes and where they are located.

This piqued interest means that property is regularly the target of speculation, and the market being as buoyant as it’s been for some time now leads to the almost inevitable question of how long the boom will last.

Rising inflation and the costof-living crisis are not just widely reported but are actually being felt by us all at the petrol pumps and when we pay for our groceries and utility bills. This is adding to the sense that the economy cannot sustain such growth in property prices, and it seems that people are looking for clues that the bubble is about to burst.

Surveyors ‘down valuing’ properties is seen as one such clue. The thinking behind it is that lenders are increasingly willing to lend only the amount that they foresee a property being worth once the market passes its peak.

Although I can see the logic behind this and recognise that there is a lot pointing to a slowdown of the market over the remainder of this year and into the next, it could be argued that artificially elevated prices are actually a sign of the market’s ongoing momentum, which is enough to sustain the sector for the foreseeable future.

To understand why this may be the case, we must note the differences between estimated and market-tested property values.

Over the past two years – and maybe even before that, if we think about the impact of Brexit – the property market has been subject to some novel influences.

The race for space has meant that the right properties, particularly those with outdoor space located commutable distances from major cities, are much more desirable to buyers than they may have been previously or if they were located somewhere else.

With buyers relocating to areas where they get more for their money, we see some who may be willing to pay more than a local would. And the relocators are not just willing, they’re also able, because property prices rising at the fastest rate in over a decade have left some enjoying substantial amounts of equity.

Another key driver of properties receiving unrealistic estimated valuations is the fierce competition for homes resulting from prolonged high tenant demand combined with a severe shortage of stock available to buy.

In a survey of landlords carried out on behalf of Paragon, 62 per cent of respondents reported increasing tenant demand – an all-time high. Alongside this, March was the first month since July 2020 when respondents to RICS’ Residential Market Survey reported an increase in landlord instructions, causing a net increase of six per cent from -21 per cent the month before. (April then saw a decrease in new listings.)

This competition has resulted in a rise in sealed bids, which are often over market values and further add to the anomalous pricing of properties.

So we see some scenarios in which buyers may well be willing and able to pay more for a particular home than the broader market value, and we also have to take into account how much sellers perceive their homes to be worth. If we own an asset, we tend to put a higher price on it than we would be prepared to pay someone else for it.

While it’s often said that the value of something is whatever someone is willing to pay for it – true for many goods and services – it’s not the case with mortgage borrowing. Lenders have a responsibility to protect their businesses and their borrowers, and mortgage lending regulations have become much more stringent in the wake of the global financial crisis.

In the case of property, valuations consider a number of factors, and surveyors are subject to standards set by the Royal Institute of Chartered Surveyors. This means that values have to be evidenced, so it’s highly unlikely that a valuation could be based on what a lender predicts the value of a property will be in the event of a downturn. Instead, valuations reflect how much the property is worth when it is valued.

In the rental market, we also consider the potential to generate income when assessing affordability. This means that an HMO located close to a university, for example, could have a significantly higher value than an almost identical property found in an ordinary suburb with no real demand from local students.

Of course, in business, success can be gained by looking at the range of factors influencing a market and forecasting how this may change in future, but in the case of buy-to-let it is important to look at the long-term fundamental drivers of demand.

Societal changes like a growing population and an increase in the number of single-person households, along with a decades-long deficit in the number of social homes needed to meet demand, mean that demand for rented homes will continue for years to come, even if not at the level we’ve seen of late. M I

Helping landlords raise the EPC bar

Steve Cox

Chief commercial officer, Fleet Mortgages

Now that we are halfway through the year, it is possible to have a much clearer idea of what the defining issues of 2022 have been and what is likely to happen in the six months ahead.

Undeniably it’s been a topsy-turvy six months, with a huge number of conflicting issues and challenges making for a difficult environment to work through, particularly for advisers who are having to deal with product/criteria changes on a bewildering level.

In the buy-to-let space, we have an environment that appears relatively stable, albeit with the caveat that it is subject to many headwinds, and, of course, ours is not a sector that is immune to ongoing issues, particularly when it comes to rates, capital markets, and the like.

One of the biggest headwinds is, of course, the level of property supply within the private rented sector (PRS), and the impact this has, particularly on the attraction of property as an investment.

We know for a fact that existing landlords remain highly committed to the sector and want to add to portfolios because of the strong tenant demand that exists. However – as with the owner-occupier market – it is finding, and being able to access, property that’s up for sale that is a very real challenge.

The latest RICS report appeared to suggest that the number of properties coming up for sale has increased recently; however, this has to be couched in terms of purchase demand, which has also increased.

You have to seriously wonder whether the regulatory and taxation measures brought in over the last decade or so have really helped the PRS or merely helped diminish available property to let, just at the time when it was more needed than ever.

While I mentioned existing landlords, I think we all know that new blood is needed in this space, and again, you have to question whether the hurdles and obstacles that wannabe landlords have to surmount in order to enter the PRS are simply too high.

The other big issue in the buy-to-let/private rented sector is, of course, around all things ‘green’ – energy efficiency and, more specifically, minimum EPC levels that rental homes may have to meet. Again, I write “may” because those measures are not yet set in stone, but it seems highly likely that a minimum of EPC level C will become the norm for new and existing tenancies over the next few years.

That in itself has meant a significant amount of gnashing of teeth around the requirements, whether landlords can meet them for certain homes, what this could mean for PRS supply, and what lenders might do in order to incentivise landlords to improve their EPC levels sooner rather than later.

I would be the first to admit this is not an easy issue to resolve, but I can’t help but feel that the initial attempts at green mortgages, for example, have been less than inspiring. They seem overly focused on rewarding those landlords who have already purchased properties at EPC levels A to C, in a margin giveaway, rather than being aimed at supporting those who need to carry out the work required to get to these standards.

That has to be the major priority for lenders: not simply seeking to beef up the mortgage books to have as many A–C properties as possible, but rather helping to raise the EPC bar for those whose properties are not yet at the standard.

This, again, is a major challenge, because landlords already have a significant number of costs to factor in when bringing a property to the PRS, and while some properties might not need much to improve their EPC, others may need a large amount of (quite costly) work.

In that sense, I suspect advisers are going to play a crucial role here because the likelihood is that landlords will need help in (re)structuring their debt to help them pay for the works. For portfolio landlords who have multiple properties requiring action, this will be particularly important, but there is clearly an opportunity here, especially if they are able to take advantage of potential capital gains made over the last few years.

We should also think about whether there is an opportunity for further advances – difficult for those lenders that securitise – and whether the lender fraternity could be more flexible in terms of its acceptance of second-charge mortgages, both of which are likely to be an option for landlords seeking to fund works – providing, of course, that the primary lender either offers or accepts them.

Essentially, for advisers this will be all about working with landlord clients to ensure there is a plan in place – a plan that highlights those properties that may not meet the new standards when they are in brought in; a plan that highlights the work required; a plan that highlights the cost; and a plan that highlights how the work is going to be funded.

This is not going to be an issue just in the opening six months of this year or the next six months; it is going to be around for a number of years to come. So let’s look at what we can do as advisers and lenders to support our landlord borrowers to meet this challenge, and to provide the financial solutions necessary to meet these standards. M I

Market factors boosting growth potential of BTL sector

Cat Armstrong

Mortgage club director, Dynamo for Intermediaries

To fully understand the buy-to-let market, we also have to appreciate the factors at play throughout the purchase arena and the financial squeeze being placed on potential first-time buyers (FTBs), many of whom are currently renting. Now, you would probably struggle to fit all these factors into a book, never mind an article, so I’m not going to try to dip too deep into these, but one obvious place to start is rising house prices, deposits, and upfront costs.

HOUSE PRICES AND FTB FISCAL DEMANDS

New research from Zoopla outlined that a £29,000 rise in the price of an average UK home has seen an estimated 4.3 million homes being pushed up into a higher stamp duty bracket since the start of the pandemic. Twenty-eight per cent of the affected properties are now said to have moved above the initial £125,000 stamp duty threshold in England and Northern Ireland. In Wales and Scotland, rising house prices also mean that a further 360,000 homes have been pushed across the initial threshold at which stamp duty becomes payable (£145k in Scotland, £180k in Wales).

Rising house prices are also having a huge effect on those keen to get their foot on the property ladder. First-time buyers are now spending an average of £225,000 to buy their first home – an increase of £27,000 compared to just two years ago. This means that this group of prospective buyers now requires an additional £4,000 for a deposit, despite average annual earnings increasing by only £2,704 over the last two years. They also need an additional £5,000 in annual household earnings or income in order to secure a mortgage, which equates to £417 per month.

These figures demonstrate the fiscal impact on FTBs, and the ability to add to any saving pots is likely to diminish further as escalating living costs swallow up a growing percentage of household incomes; for tenants, rising rents are also playing their part. So, with some homeownership aspirations being tempered – for now at least – it’s little wonder that the private rented sector is experiencing such strong levels of tenant demand.

TENANT DEMAND

This was outlined in recent data from Paragon Bank, in conjunction with BVA BDRC, which suggested that the first quarter of the year saw the number of people seeking privately rented homes grow consistently. The 62 per cent of landlords who reported increasing tenant demand in Q1 2022 was said to be double that of the same period a year ago and almost four times the level reported in Q1 2020, when only 16 per cent of landlords felt that demand was growing.

In addition, when asked to assess tenant demand over the previous three months, 34 per cent of landlord respondents reported a “significant increase”, with a further 28 per cent reporting slight increases. Perceived decreases in tenant demand, both significant and slight, were recorded by just three per cent of landlords, the lowest on record.

Analysing the results regionally highlights the impressive resurgence of the Central London rental market. Increasing tenant demand was reported by 84 per cent of landlords operating in the inner capital, a substantial increase on the 12 per cent seen in Q1 2021. This places Central London alongside the South West and Wales as the regions seeing the highest levels of increasing tenant demand during the previous three months.

This data really does speak for itself, and the fact that we’ve seen another record high in the proportion of landlords reporting increased tenant demand outlines the sustained potential on offer across the BTL sector, alongside a pressing need for additional rental stock across the country.

THE GREEN MORTGAGE MARKET

Alongside the requirement for additional rental stock, issues also remain around quality and suitability, especially for older properties when it comes to meeting potential future legislation around improved EPC ratings for rental purposes. Thankfully, the number of green mortgage offerings is growing across the BTL sector, with a recent study from Defaqto suggesting that there are now more than three times as many mortgages available to landlords. At the time of study in late April, there were said to be 292 green buy-to-let products on the market, compared to just 85 last October. Conversely, the number of green mortgage products available to residential borrowers has fallen, with just 356 mortgages available compared to 465 last year.

This marks a highly encouraging trend for this key area of the market, and energy efficiency is something that landlords will need to evaluate carefully for individual properties within their portfolios in future. And, as always, the advice process can prove integral to ensuring that the right solutions are accessible, and the right decisions are being made at the right time. M I