A recent surge in interest rates and the government’s crackdown on the buy-to-let sector have sparked growing concerns among landlords, leading many to consider exiting the market due to mounting financial pressures. According to Savills’ research, profits from buy-to-let investments have plummeted to their lowest level since 2007, raising a “very real risk” of landlords abandoning the Private Rented Sector (PRS) in significant numbers.
Savills’ findings indicate that, during the first quarter of 2023, average net profits for mortgaged buy-to-let buyers dropped below 4%, signifying a dramatic shift in financial fortunes. This decline can be attributed to a combination of 12 consecutive increases to the Bank base rate and reduced tax relief, which have eroded profitability for landlords, resulting in the lowest average net profits since 2007.
Lucian Cook, the head of residential research at Savills, observed that 2023 represents a turning point for Britain’s private rented sector after a period of prosperity for buy-to-let landlords. From 2014 to 2021, landlords typically enjoyed “year 1” cash profits equivalent to 23% of rental income. However, successive interest rate hikes have caused this figure to plunge to under 4% this year.
Cook further emphasized the potential impact of impending regulatory changes on investors’ caution. The forthcoming Renters Reform Bill, the abolition of Assured Shorthold Tenancies, and increasingly stringent Energy Performance Certificate (EPC) regulations are expected to compound landlords’ concerns. The need to invest in upgrading properties to meet minimum EPC requirements will further diminish profits, potentially driving landlords to exit the sector. This exodus, particularly among highly leveraged landlords, may intensify the pressure on a market already plagued by significant demand-supply imbalances in various locations.
Despite burgeoning tenant demand, landlords’ ability to maintain profit margins will largely depend on their level of debt exposure, as stated by Cook. Smaller landlords with higher debt levels approaching the end of fixed-rate periods are likely to face viability challenges. In contrast, larger, wealthier landlords are better positioned to benefit from rental growth following the post-pandemic period.
Savills’ research reveals that three out of four mortgaged buy-to-let properties have a Loan-to-Value (LTV) ratio below 60%, with one in three having an LTV below 50%. In Q1 2023, those with an LTV of 60% achieved an average profit of 10.2%, while those with an LTV of 50% generated 16.5% in profits. Conversely, landlords with 80% leverage experienced negative profitability (-2.4%).
Cook predicts that future investment in the sector will be dominated by cash buyers and those with low borrowing requirements. Landlords with moderate levels of gearing are now more likely to enter the market or expand their existing portfolios in areas outside of London, focusing on smaller properties offering higher returns.
Compounding the challenges, a significant number of landlords who became active during the buy-to-let boom of the early 2000s are approaching retirement or have already retired. This situation poses a risk of limiting the future supply of rental properties.
According to Savills’ research, 620,000 landlords aged over 65 currently own 1,911,000 properties, with an additional 1,982,000 properties owned by landlords aged between 55-64.
While existing tenants stand to benefit from greater security, a combination of factors, including a dwindling rental supply, may reduce options for new tenants. The limited availability of rental properties could inadvertently favor tenants with higher incomes and more secure employment, potentially disadvantaging less affluent households. Cook emphasized the need for measures to increase rental supply to address this issue.
In conclusion, as landlords grapple with diminishing profits, rising interest rates, and impending regulatory changes, the buy-to-let sector faces the potential departure of numerous investors. The resulting consequences could exacerbate the existing demand-supply imbalance and limit rental options for tenants, particularly those from less affluent backgrounds.