3 September 2015
Buy-to-let
by Lynda Goetz
‘Buy-to-let’ is a term coined in the Nineties referring, obviously, to the purchase of property for the purpose of letting or renting it out. This was, of course, no new phenomenon, but there had been a massive decline in the UK housing stock which was available to rent, from a high before the First World War until the Housing Act 1988 produced the Assured Shorthold Tenancy. Prior to 1988, the problem for potential landlords was the various acts which had been passed throughout the twentieth century to regulate the relationship between landlord and tenant.
The first of these was the Increase of Rent and Mortgage Interest (War Restrictions) Act 1915. This was intended as a temporary measure to deal with the excessive rent increases which had been taking place as the lack of construction during the war resulted in a general housing shortage. The right of landlords to evict tenants and increase rents was controlled for the first time. Previously these matters had simply been a matter of contract between the parties – with of course an imbalance of power in favour of the property owner. The Act, however, out of fairness to landlords who had borrowed money for their acquisitions, also controlled the rights of mortgagees to increase the interest payable on their loans. Rent controls of various sorts remained in place for a large proportion of the century. This, combined with the lack of availability of mortgages for this type of property purchase, as well as the Protection from Eviction Act 1977 and the Rent Act introduced in the same year to combat Rachmanism* produced the lack of rental property which the Housing Act of 1988 was designed to remedy. Sections 8 and 21 gave landlords substantially more power to evict tenants.
The Housing Act 1988, combined with the effects of the recession in the 1990s resulted in a revival of the rental market, but it was the marketing initiative of mainstream lenders in 1996 which really galvanised the buy-to-let boom which followed in the 2000s. Expensive commercial loans which landlords had had to take out hitherto, were replaced by niche products, taking into account the potential rental income. The Association of Letting Agents (ARLA) can take the credit for the scheme as well as the coining of the term with which we are all now so familiar. Buy-to-let mortgages became increasingly easy to obtain, barely more expensive than residential mortgages, and ‘buy-to-let’ became a popular investment for a wide variety of people.
The death of ‘buy-to-let’ seems to have been first called as long ago as 2002. According to a BBC Radio 4 programme in August that year, by 2001 the number of mortgages taken out was 72,200 (worth £6.9 billion), up from 44,000 two years earlier. At that time there were 70 mainstream and specialist lenders in the market. It was the rising house prices at the time which many felt would sound the death knell of buy-to-let. Too many people were afraid that if they did not climb aboard the gravy train of rocketing house prices they would, to mix metaphors, ‘miss the boat’. The Royal Institute of Chartered Surveyors described the situation at the time as ‘simply too many landlords chasing too few tenants’. The economist Roger Bootle apparently warned that “The whole buy-to-let phenomenon….has many of the characteristics of a bubble. The biggest mistakes in investment are made by assuming it is right to do something now which it was right to do five years ago. I think it’s the wrong time, the bird has flown”.
Of course, as we know, more and more people continued to pile into buy-to-let until the credit crunch and the financial crisis put the brakes on in 2008. Banks and Building Societies realised they had lent too freely. Landlords were faced with tenant rent arrears and mortgage payments they couldn’t meet. Both sides, in many cases, were saved by the Bank of England slashing the base rate to 0.5% in 2009. At that point, mortgage lenders looked ‘back to the future’ and commercial lending. Rates for buy-to-let are now considerably higher than those on offer for potential homeowners, larger deposits are required and lenders are far more choosy about who they will lend to. There may also be fewer products on the market than there were back in the buy-to-let heyday, and once again, the pundits are predicting the death of buy-to-let. This time, as in the past, it is legislation that is about to change the market.
For those who were seduced into it in the early days buy-to-let has almost certainly proved lucrative, if on the capital appreciation alone. It must not be forgotten, of course, that unlike a main home, gains on the sale of buy-to-let property are subject to Capital Gains Tax (at 18% or 28% on the profit after deduction of the £11,000 allowance). Unlike a main home, though, the mortgage interest is tax deductible – for now. (As some readers may possibly remember, there was from 1969 a system of mortgage interest relief available for residential properties known as MIRAS. This was introduced by Roy Jenkins to encourage home ownership. It was finally completely abolished by another Labour Chancellor of the Exchequer, Gordon Brown in 2000, whose view of it was that it had become a middle-class perk.) It is this ‘for now’ that is causing the media once again to announce the possible demise, or at least the dangers, of ‘buy-to-let’ (Patrick Jenkins, FT 24th July; Merryn Somerset-Webb, MoneyWeek 27th July Richard Dyson, Daily Telegraph Saturday 22nd August).
In the 2015 summer budget George Osborne announce a reduction in interest relief for owners of residential property. Whereas, under the current tax regime, mortgage interest is fully tax deductible, from 5 April 2017 a gradually increasing part of the deduction will only attract relief at basic rate. By 2020 (when the measures will be fully implemented) tax will be due at the landlord’s full rate on the entire rental income, with only a deduction at basic rate tax (20%) on the interest. A landlord may thus suffer tax even though he is not making a profit once interest is taken into account. Add to this the proposal to disallow one of the current allowances for notional repairs and some landlords could see their after tax profits not just reduced, but slashed.
Are these concerns for the sector valid or are they over-stated? The people making them certainly do not lack credentials and their views cannot be disregarded. The problem is the numbers of ‘ordinary’ (whatever that may mean in the context) people who have been drawn into this form of undoubtedly profitable investment. Many however have been drawn in without the funds to support their investment should the going get tough. According to the Bank of England Financial Stability Report July 2015, buy-to-let mortgaging now accounts for 15% of the stock of outstanding mortgages and the concern is that any bursting of this bubble could cause a threat to the housing market and general financial stability (although the last fortnight might have led to a revision of the events liable to cause instability!) The worry is that landlords whose indebtedness is too high will be unable to retain their properties should mortgage interest rates move higher. If too many need to sell, will this destabilise the housing market? World events have moved on since July and a rise in interest rates is not looking as imminent as it was; however, George Osborne’s tax changes do appear to pose more of a threat to the housing market than imminent rate rises.
As Richard Dyson points out, those who are wealthy enough to own rental property that is not mortgaged will not really be affected by the changes announced in George Osborne’s budget. They will not be paying more tax to HMRC. However, those who have bought their rental properties with the help of a mortgage will be very aware of a difference in the amount of tax they will be paying from 2017 onwards.
There are many who will argue that the rise and rise of the landlord class over the last twenty years has done little but distort the housing market. It is probably true that the relatively easy availability of credit has made it far more possible for those ‘ordinary’ people to invest in property, but is George Osborne’s surprise attack on landlords going to help all those twenty and thirty-something first-time buyers who are struggling to get into the market, or is it going to be yet another of those legislative interventions which will cause unforeseen or unintended consequences? Apart from the possibility of a house-price fall caused by a large number of over-indebted landlords having to sell up, which may or may not be a good thing depending on where you stand, who is going to provide the rental housing needed by those who still cannot, for whatever reason, get onto the housing ladder?
Are councils going to be in a position to provide public sector rentals when private sector rentals are disappearing? That seems unlikely under the current financial restraints. The fact that we are to have a phased approach to this new tax regime does not seem to make it any better or any fairer. Are the Conservatives, like Gordon Brown with MIRAS, trying to get rid of what they see as a ‘middle class perk’ or is this supposed to be a phased deflation of a bubble which has been predicted to burst anyway since 2002? Either way, it looks likely to cause discussion and disturbance for a while yet; whether it will cause a swing of the pendulum back to the twentieth century situation is more questionable, unless of course Jeremy Corbyn manages to win more than a leadership election any time soon.
*Rachmanism entered the Oxford English dictionary as a term for the exploitation and intimidation of tenants; named after a notorious West London landlord of the 50s and 60s, Peter (born Perec) Rachman.
