Financial Pressures on Buy-to-Let Landlords

Aivanaa Maraea
February 14, 2024
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Many buy-to-let (“BTL”) landlords are facing severe financial pressures today. The underlying factors generating these pressures are:

  • a dramatic rise in mortgage rates,
  • stagnant rental incomes, and
  • weak property price appreciation.

This article sets out a BTL investment “Base Case” and considers the impact of the different sources of financial pressure.

Base Case

A typical BTL investment involves:

  • an initial equity investment to fund part of the BTL property’s acquisition cost, with the remaining funds raised through an interest-only mortgage;  
  • thereafter, ongoing cashflows based on rental income minus operating expenses, interest costs and taxes; and
  • net proceeds from the eventual sale of the property.

As a BTL landlord, after making your initial investment, you expect to receive a stream of net positive cashflows throughout the life of the investment and capital gains from an appreciation in the value of the property when you eventually sell it.  

Overall, you might expect to make a c. 11% per annum return on your equity investment, also known as the “internal rate of return” or “IRR”. In simple terms, this is the equivalent of investing £100 of equity upfront and, assuming an investment horizon of five years and no interim receipts, realizing net proceeds of c. £169 at the end of five years (calculated as £100 x (1.11^5)).

The BTL investment Base Case is set out in more detail below:

Item Assumptions t0
(start)
t1
(year 1 end)
t2
(year 2 end)
t3
(year 3 end)
t4
(year 4 end)
t5
(year 5 end)
IRR
1 Property purchase price 850,000
2 Stamp Duty Land Tax ("SDLT") 55,500
3 Conveyancing and valuation expenses 3,000
4 Total cost of acquiring property 908,500
5 Equity investment by landlord 333,500
6 Interest only mortgage 575,000
7 5-year fixed mortgage rate 1.7% 1.7% 1.7% 1.7% 1.7%
8 Annual property price appreciation 10.0% 10.0% 10.0% 10.0% 10.0%
9 Property price 935,000 1,028,500 1,131,350 1,244,485 1,368,934
10 Loan-to-value ratio 67.6% 61.5% 55.9% 50.8% 46.2% 42.0%
11 Gross rental yield 4.0% 4.0% 4.0% 4.0% 4.0%
12 Annual insurance and maintenance inflation 5.0% 5.0% 5.0% 5.0%
13 Annualised cashflows
14 Annual rental income 34,000 37,400 41,140 45,254 49,779
15 Annual letting commission -4,488 -4,937 -5,430 -5,974 -6,571
16 Annual management fee -2,448 -2,693 -2,962 -3,258 -3,584
17 Annual service charge -3,000 -3,150 -3,308 -3,473 -3,647
18 Annual insurance and maintenance costs -800 -840 -882 -926 -972
19 Gross profit before interest 23,264 25,780 28,558 31,623 35,005
20 Annual interest -9,775 -9,775 -9,775 -9,775 -9,775
21 Cashflow after interest 13,489 16,005 18,783 21,848 25,230
22 Tax @ 20% on gross profit after deduction of 20% of interest -4,262 -4,765 -5,321 -5,934 -6,610
23 Cashflow after interest and tax 9,227 11,240 13,462 15,915 18,620
24 Property sale price 1,368,934
25 less Interest only mortgage -575,000
26 less Selling commission (3.6%) -49,282
27 less Solicitor's fee -3,000
28 Equity proceeds 741,652
29 Equity proceeds less initial SDLT and conveyancing and valuation expenses 683,152
30 Capital gains tax (“CGT”) @ 28% -191,283
31 Equity proceeds after CGT 491,869
32 BTL landlord's net cashflows -333,500 9,227 11,240 13,462 15,915 510,490 11.5%

The IRR of 11.5% under the Base Case is predicated on some fundamental assumptions, which were broadly realistic for some parts of London until about five years ago.

Size of interest only mortgage

Under the Base Case, the purchase price of the property of £850,000 (Item 1) is funded in part by an interest only mortgage of £575,000 (Item 6), with an initial loan-to-value ratio (“LTV”) of 67.6% (Item 10) and an initial interest rate of 1.7% (Item 7).  

If the level of borrowing was higher, say £775,000 (at 91.2% LTV) instead of £575,000 (at 67.6% LTV), all other things being equal, the amount of initial equity investment required from the BTL landlord would be lower, £133,500 instead of £333,500, and the expected IRR would increase from 11.5% to 26.2%. Mortgage lenders, however, usually do not allow an initial LTV of more than 60% - 70% and BTL landlords, therefore, typically have no choice but to invest c. 30% - 40% of the upfront investment cost as their own equity.  

If, on the other hand, the level of borrowing was reduced to, say, £375,000 (at 44.1% LTV) instead of £575,000 (at 67.6% LTV), all other things being equal, the amount of the BTL landlord’s initial equity investment would increase from £333,500 to £533,500 and the IRR would decrease from 11.5% to 6.5%.  

This demonstrates how a BTL landlord’s equity investment would not have been financially worthwhile without the availability of substantial levels of borrowing, even if this is usually capped at 60% - 70% LTV by BTL lenders.

Mortgage rates

However, the Base Case also assumes a benign mortgage rate of 1.7%, which was the reality for mortgage borrowers, including BTL landlords, for a prolonged period, from c. early-2009 until as recently as November 2021.  

However, mortgage rates have increased dramatically since November 2021 to a c. 6% level today, creating enormous financial pressure on BTL landlords.  

Revised Base Case

The Revised Base Case set out below demonstrates how the increase in the mortgage rate has led to almost catastrophic ongoing negative cashflows for BTL landlords, while also lowering the IRR to 5.4% (if, that is, BTL landlords are able and willing to inject further equity funds into their BTL investment and fight on for five years in the example below).  

Item Assumptions t0
(start)
t1
(year 1 end)
t2
(year 2 end)
t3
(year 3 end)
t4
(year 4 end)
t5
(year 5 end)
IRR
1 Property purchase price 850,000
2 Stamp Duty Land Tax ("SDLT") 55,500
3 Conveyancing and valuation expenses 3,000
4 Total cost of acquiring property 908,500
5 Equity investment by landlord 333,500
6 Interest only mortgage 575,000
7 5-year fixed mortgage rate 6.0% 6.0% 6.0% 6.0% 6.0%
8 Annual property price appreciation 10.0% 10.0% 10.0% 10.0% 10.0%
9 Property price 935,000 1,028,500 1,131,350 1,244,485 1,368,934
10 Loan-to-value ratio 67.6% 61.5% 55.9% 50.8% 46.2% 42.0%
11 Gross rental yield 4.0% 4.0% 4.0% 4.0% 4.0%
12 Annual insurance and maintenance inflation 5.0% 5.0% 5.0% 5.0%
13 Annualised cashflows
14 Annual rental income 34,000 37,400 41,140 45,254 49,779
15 Annual letting commission -4,488 -4,937 -5,430 -5,974 -6,571
16 Annual management fee -2,448 -2,693 -2,962 -3,258 -3,584
17 Annual service charge -3,000 -3,150 -3,308 -3,473 -3,647
18 Annual insurance and maintenance costs -800 -840 -882 -926 -972
19 Gross profit before interest 23,264 25,780 28,558 31,623 35,005
20 Annual interest -34,500 -34,500 -34,500 -34,500 -34,500
21 Cashflow after interest -11,236 -8,720 -5,942 -2,877 505
22 Tax @ 20% on gross profit after deduction of 20% of interest -3,273 -3,776 -4,332 -4,945 -5,621
23 Cashflow after interest and tax -14,509 -12,496 -10,274 -7,821 -5,116
24 Property sale price 1,368,934
25 less Interest only mortgage -575,000
26 less Selling commission (3.6%) -49,282
27 less Solicitor's fee -3,000
28 Equity proceeds 741,652
29 Equity proceeds less initial SDLT and conveyancing and valuation expenses 683,152
30 CGT @ 28% -191,283
31 Equity proceeds after CGT 491,869
32 BTL landlord's net cashflows -333,500 -14,509 -12,496 -10,274 -7,821 486,754 5.4%

The reality for many BTL landlords is that they have little choice but to exit their now disastrous BTL investments by resorting to distress sales of their BTL properties.  

Pauzible

Pauzible may be able to provide an alternative solution to distress sales by covering the increase in interest costs facing BTL landlords for a period of up to five years, in return for a fair share in the value of their properties.

Rental income

While mortgage rates have risen dramatically since November 2021, rents in parts of London have been stagnant for the last 3 – 5 five years and have, indeed, started to decline slightly in recent months. ONS data suggests however that landlords in most other parts of the country have managed to pass on some or all of the increased mortgage costs to tenants by increasing rents which have jumped 6.2% on average1.

This factor naturally puts even further financial pressure on BTL landlords.  

If, as compared to a gross rental yield of 4% under the Revised Base Case above, we were to assume a lower gross rental yield of 3%, all other things being equal, this would result in even worse negative cashflows and even lower IRR (if, that is, the BTL landlord is able to hold on for five years):

Item Assumptions t0
(start)
t1
(year 1 end)
t2
(year 2 end)
t3
(year 3 end)
t4
(year 4 end)
t5
(year 5 end)
IRR
1 Property purchase price 850,000
2 Stamp Duty Land Tax ("SDLT") 55,500
3 Conveyancing and valuation expenses 3,000
4 Total cost of acquiring property 908,500
5 Equity investment by landlord 333,500
6 Interest only mortgage 575,000
7 5-year fixed mortgage rate 6.0% 6.0% 6.0% 6.0% 6.0%
8 Annual property price appreciation 10.0% 10.0% 10.0% 10.0% 10.0%
9 Property price 935,000 1,028,500 1,131,350 1,244,485 1,368,934
10 Loan-to-value ratio 67.6% 61.5% 55.9% 50.8% 46.2% 42.0%
11 Gross rental yield 3.0% 3.0% 3.0% 3.0% 3.0%
12 Annual insurance and maintenance inflation 5.0% 5.0% 5.0% 5.0%
13 Annualised cashflows
14 Annual rental income 25,500 28,050 30,855 33,941 37,335
15 Annual letting commission -3,366 -3,703 -4,073 -4,480 -4,928
16 Annual management fee -1,836 -2,020 -2,222 -2,444 -2,688
17 Annual service charge -3,000 -3,150 -3,308 -3,473 -3,647
18 Annual insurance and maintenance costs -800 -840 -882 -926 -972
19 Gross profit before interest 16,498 18,338 20,371 22,618 25,099
20 Annual interest -34,500 -34,500 -34,500 -34,500 -34,500
21 Cashflow after interest -18,002 -16,162 -14,129 -11,882 -9,401
22 Tax @ 20% on gross profit after deduction of 20% of interest -1,920 -2,288 -2,694 -3,144 -3,640
23 Cashflow after interest and tax -19,922 -18,450 -16,823 -15,026 -13,040
24 Property sale price 1,368,934
25 less Interest only mortgage -575,000
26 less Selling commission (3.6%) -49,282
27 less Solicitor's fee -3,000
28 Equity proceeds 741,652
29 Equity proceeds less initial SDLT and conveyancing and valuation expenses 683,152
30 CGT @ 28% -191,283
31 Equity proceeds after CGT 491,869
32 BTL landlord's net cashflows -333,500 -19,922 -18,450 -16,823 -15,026 478,829 3.8%

Property prices

Property prices have stagnated in parts of London over the last 3 - 5 years and are not expected to appreciate at anything like the high historic rates of c. 10% per annum or more for the next 3 - 5 years.  

This exacerbates the financial pressure on BTL landlords even more.  

If, as compared to a property price appreciation rate assumption of 10% under the Revised Base Case, we were to assume a lower a property price appreciation rate of 5%, as well as a lower gross rental yield of 3%, all other things being equal, this would result in continuing almost catastrophic negative cashflows and negative IRR (if, that is, the BTL landlord is able to hold on for five years):

Item Assumptions t0
(start)
t1
(year 1 end)
t2
(year 2 end)
t3
(year 3 end)
t4
(year 4 end)
t5
(year 5 end)
IRR
1 Property purchase price 850,000
2 Stamp Duty Land Tax ("SDLT") 55,500
3 Conveyancing and valuation expenses 3,000
4 Total cost of acquiring property 908,500
5 Equity investment by landlord 333,500
6 Interest only mortgage 575,000
7 5-year fixed mortgage rate 6.0% 6.0% 6.0% 6.0% 6.0%
8 Annual property price appreciation 5.0% 5.0% 5.0% 5.0% 5.0%
9 Property price 892,500 937,125 983,981 1,033,180 1,084,839
10 Loan-to-value ratio 67.6% 64.4% 61.4% 58.4% 55.7% 53.0%
11 Gross rental yield 3.0% 3.0% 3.0% 3.0% 3.0%
12 Annual insurance and maintenance inflation 5.0% 5.0% 5.0% 5.0%
13 Annualised cashflows
14 Annual rental income 25,500 26,775 28,114 29,519 30,995
15 Annual letting commission -3,366 -3,534 -3,711 -3,897 -4,091
16 Annual management fee -1,836 -1,928 -2,024 -2,125 -2,232
17 Annual service charge -3,000 -3,150 -3,308 -3,473 -3,647
18 Annual insurance and maintenance costs -800 -840 -882 -926 -972
19 Gross profit before interest 16,498 17,323 18,189 19,098 20,053
20 Annual interest -34,500 -34,500 -34,500 -34,500 -34,500
21 Cashflow after interest -18,002 -17,177 -16,311 -15,402 -14,447
22 Tax @ 20% on gross profit after deduction of 20% of interest -1,920 -2,085 -2,258 -2,440 -2,631
23 Cashflow after interest and tax -19,922 -19,262 -18,569 -17,841 -17,077
24 Property sale price 1,084,839
25 less Interest only mortgage -575,000
26 less Selling commission (3.6%) -39,054
27 less Solicitor's fee -3,000
28 Equity proceeds 467,785
29 Equity proceeds less initial SDLT and conveyancing and valuation expenses 409,285
30 CGT @ 28% -114,600
31 Equity proceeds after CGT 294,685
32 BTL landlord's net cashflows -333,500 -19,922 -19,262 -18,569 -17,841 277,608 -8.3%

Regional variations

While the situation for many BTL landlords in parts of London may be nothing short of being almost catastrophic, forcing them into distressed sales of their BTL properties, the same is not necessarily the case in some other parts of the country. Indeed, gross rental yields in some parts of northern England, for example, are c. 7% - 9%. Moreover, property prices in some parts are expected to appreciate at annual average rates of c. 8% - 10% over the next 3 - 5 years.  

So, in conclusion, while a dramatic rise in mortgage rates has created unbearable financial pressure for many BTL landlords in some parts of the country, with this situation being exacerbated further by stagnant rental income in prime central London and low property price appreciation, many BTL landlords in other parts of the country have been able to stave off the pressure due toby bumping up already high gross rental yields and through property price appreciation.

Recommended Reads:

Protect buy-to-let from rising rates
Retaining “Buy to Let” Investment Despite High Mortgage Rates

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