As the Bank of England raises concerns over buy-to-let ahead of an increased base rate, what should investors be mindful of?
When the Bank of England speaks, any wise investor will tend to listen.
So when the Bank this week released its bi-annual Financial Stability report and highlighted the UK’s buy-to-let market as a sector it has concerns about, both for investors and the overall economy, should it have given those with money tied up in bricks and mortar in the British private rented sector (PRS) any reason for concern?
What did the Bank say?
“Looser lending standards in the buy-to-let sector could contribute to general house price increases and a broader increase in household indebtedness.”
The Bank believes that this risk is worth assessing fully given that it’s likely to soon raise interest rates in the UK for the first time since the economic crisis began to take effect in 2007.
In recent years, consumers are finding it easier to lend money to find credit, one of the contributing factors behind the UK buy-to-let market’s growth. The most recent data shows that 15% of outstanding loans can be attributed to buy-to-let investors that have borrowed money, as well as 18% of the flow of new mortgages.
This is what the Bank is concerned about ahead of a rise in interest rates.
“Buy-to-let borrowers are potentially more vulnerable to rising interest rates because loans are more likely to be interest-only and extended on floating-rate terms, and affordability tends to be tested at lower stressed interest rates than owner-occupied lending.”
How do interest rates affect property investment?
In short, interest rates both high and low have a huge impact on any investment asset.
For example, since the recession caused the base rate to hit record-low levels, the UK property market as a whole gradually started to get back on its feet. That’s because those purchasing property were able to do so after securing low fixed-rate mortgages, thus increasing demand, kick starting growth and generating higher capital returns for investors.
When the base rate rises, it becomes more expensive to borrow money, and mortgages are offered at a lower loan-to-value ratio, reducing the amount people have available to spend on purchasing property. Although this could in turn reduce property values, high interest rates usually boost consumer wealth, which could result in a surge in demand for property, boosting prices and pushing many properties out of reach for investors with comparatively low levels of borrowed finance.
Should UK buy-to-let investors be overly concerned with the Bank of England’s report?
Let’s be clear – any rise in interest rates, currently at 0.5%, will be marginal. It will take years for the rate of interest to return to pre-2007 levels.
If you currently own a buy-to-let property, financed by a fixed-rate mortgage, you’re unlikely to be affected to any great extent.
The only investors that may be concerned are those with property that’s currently driving very low NET returns. As the base rate increases, repayments will rise and consequently chips away at those low yields, these investments will begin to struggle. However, if you have property that’s generating strong returns, in a sector and region with high levels of rental demand, you have little to worry about.
Whilst interest rates are still at relatively low levels, there should be no slowdown in the performance of the UK’s PRS.
There are 2 things that investors can do to fully shield themselves from the impact of rising interest rates:
- Buy with cash
Although this will rule out many would-be investors, if you have the ability to purchase your buy-to-let property without the need to lend from a mortgage provider, then this is the only definitive way you can protect yourself from the impact of a rise in base rates.
- Add student property to your portfolio
Currently the UK’s best performing asset class, over £4 billion has been invested in the sector in the first half of 2015. Usually priced at a level that makes a cash investment much more realistic, they also provide considerably higher returns than standard residential property, and it was the only property sector which can boast increase yields for investors each year throughout the recession.