Article | Creating Resilience

Why are landlords leaving the rental market?

July 28, 2023 9 Minute Read

By Scott Cabot

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Being a residential landlord has become increasingly difficult in recent years. First, the additional rate of stamp duty for second properties was introduced in 2016. This was followed by the phasing out of mortgage interest relief between 2017/18 and 2020/21. These have increased the amount of tax payable on both the purchase of a buy-to-let (BTL) property and its rental income, ultimately reducing viability.

More recently, this has been compounded by the rapid rise in interest rates. Since the start of 2022, the base rate has risen from 0.25% to 5%. This has fed through to higher mortgage costs. For example, the interest payments on a new BTL mortgage of £150,000 would have been around £300 per month in January 2022. Now, the interest on the same mortgage has more than doubled to £640 per month.

These cost pressures have driven many BTL landlords out  of the sector. Our analysis of UK Finance data suggests that, on a net basis, approximately 273,500 rental properties were sold between 2016 and 2021. And since the start of 2022, when the Bank of England began increasing the base rate, it is estimated that a further 126,500 rental properties have been sold. This means that, since 2016, a total of 400,000 rental homes have been lost. If sales continue on a similar trajectory, it will equate to a loss of almost 10% of the UK’s private rented households by the end of this year.

Figure 1: Cumulative net reduction in buy-to-let loans (UK) and Bank of England base rate, Jan 2022 – May 2023

Source: CBRE analysis of UK Finance data, Bank of England

In addition to these higher costs, BTL borrowers may start to struggle to meet banks’ lending criteria. In particular, interest coverage ratios stipulate that the rent from the property needs to cover 125% to 145% of the interest on the loan. As mortgage rates increase, the rent needed to satisfy these conditions also increases. Using the above example, at the start of 2022 a rent of £435 per month was needed to cover 145% of the £300 interest cost. In the current environment, an interest payment of £640 now requires a rent of almost £930 per month to meet the higher coverage ratio. As mortgage rates increase, the rent needed to satisfy these conditions also increases.

This relationship is one reason for the recent increase in rents across the UK. However, despite these rises, UK Finance data suggests that landlords are close to breaching these ratios. Moreover, CBRE forecast that the base rate will rise to 5.75% by the end of the year. Under these circumstances, rents may need to increase by another 15% for higher leveraged landlords to continue to meet their lending obligations. However, tenants’ affordability is already extremely stretched. HomeLet reported that UK tenants are now spending an average of 32% of their salary on rent. This rises to 37% in London. General guidance across the industry is that tenants are subject to an affordability test to ensure they aren’t spending more than 40% of their gross salary on rent. This points to limited headroom, particularly in London, for rents to rise much further. As a result, more landlords may soon be forced to sell their properties.

Figure 2: Proportion of income spent on rent, June 2023

Source: HomeLet

Together with the effect of policy and mortgage rate changes, high inflation has increased other costs associated with owning and managing a property. A recent survey by the National Landlords Association, for example, found that 80% of landlords stated that the biggest impact of inflation was the rising cost of repairs and maintenance. These costs are another key driver of landlords’ portfolio and rent decisions. Additionally, new regulation (in the form of the Renters’ Reform Bill and updated Energy Performance legislation) are other factors potentially contributing to this sell-off.

Overall, as BTL property is becoming increasingly unviable to operate, many more landlords are selling their properties, either by choice or necessity. This means the supply of rental homes in the UK is shrinking at a dramatic rate. In theory however, this should free-up housing supply for owner-occupiers and ease affordability pressures. This was arguably the reason for the policies introduced since 2016. But this has not been the case, with the average UK house price rising by a further 40%, or £80,000 since January 2016.

One hopeful prospect, however, is large-scale institutional investment into the rental sector, known as Build-to-Rent (BtR). CBRE has recorded a total of £26.5bn of BtR investment since 2014 and investors are continuing to target the sector. Our recent Investor Intentions Survey highlighted that, for the first time, residential is the most preferred sector for UK investors in 2023. CBRE’s data also shows high demand for BtR homes, with our latest Multifamily Index recording an occupancy rate of 98%. In addition, the latest report from HomeViews highlighted that reviewers continue to rate BtR higher than any other form of new build housing. As such, continued investment into the sector needs to be supported and, as we highlighted in our recent report, regulation plays a major role in the allocation of funds by investors. Although it’s clear that regulation can be effective in some cases, investors need predictability and even the anticipation of future prohibitive regulation will deter investment and ultimately hinder supply. As a result, many investors were relieved when the Labour Party reversed its plan to introduce rent controls should it win the next election.

BtR now forms a vital part of the UK’s private rented sector and is delivering a substantial volume of high-quality rental homes. According to the British Property Federation and Savills, there are now more than 250,000 Build-to-Rent homes across the UK. However, based on the analysis above, this is still a potential net reduction of 150,000 rental homes. And when we factor in that only about 90,000 are built, this net fall increases to 310,000. The economic headwinds are now also impacting the delivery of BtR homes, with new starts down 45% year-on-year in Q2 2023.

Despite the increase of institutional investment in the private rented sector, private landlords still play a vital role in the provision of rental stock and the current situation appears drastic. With interest rates predicted to continue rising, and limited ability to further increase rents to compensate, landlords are going to come under increasing pressure over the next six to twelve months. Bold solutions will be needed to ensure the supply of rental homes in the UK doesn’t completely cease. These could include the reintroduction of mortgage interest relief, and/or either a temporary or permanent exemption of additional stamp duty for BTL homes.

Notes to this article

Our mortgage interest cost analysis is based on an interest rate on a new buy-to-let loan of 2.4% in January 2022 and 5.1% in April 2022. This is taken from UK Finance data.

Our calculations on the number of properties sold are based on the net change in buy-to-let lending and new advances in the period. We assume that the property is being sold to repay the loan.

Our calculation of rents needing to rise by 15% is based on a standardised loan of £150,000 on average buy-to-let loan terms according to UK Finance and an assumed interest rate of 6.5%, with the rent needing to meet an interest coverage ratio of 145%.

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