Surging UK rents will prop up buy-to-let landlords against interest rate rises
While the prospect of increasing interest rates has many re-examining their mortgage affordability, UK buyto-let (BTL) landlords will benefit from substantial affordability buffers through rising rental income, according to a Moody’s Investors Service special report.
“With a 0.5% interest rate hike, the percentage of BTL landlords with insufficient rental income will increase to 0.4% from the current level of 0.2%, and those facing tight affordability will rise to 2.2% from 0.9%. However if we take rental price appreciation since loan origination into account, the proportion of landlords with insufficient rental income and tight affordability in a 0.5% rate increase scenario actually falls to 0.2% and 1.5%, respectively,” said Emily Rombeau, analyst at Moody’s.
“Voids are at a record low, so strong occupancy levels will further support the BTL market’s resilience to moderate interest rate increases,” said Francesco Di Costanzo, associate analyst at Moody’s.
Without accounting for rent increases, Moody’s analysis indicates that the proportion of BTL landlords with tight affordability buffers would rise to 2.2% from 0.9% currently, if interest rates rise by 0.5%. The rating agency forecasts that the Bank of England base rate will start to rise progressively at the end of Q1 2016 to about 1.0% by the end of Q3 2016, from 0.5% currently. Low interest rates have prompted a gradual decline in arrears in UK residential mortgage-backed securities (RMBS) backed by BTL loans since 2009.
The rating agency’s research shows that landlords’ ability to pay their BTL mortgages is fairly even across different regions in the UK, despite a stronger rental market in the South of England. However, BTL borrowers located in the South of England will be slightly better positioned when rates start rising. Taking into account rental price appreciation, the proportion of BTL loans with insufficient rental cover is 5.5 times higher in Wales and Scotland combined than in the South of England.
Similarly, the proportion of mortgages with rental shortfalls is 2.5 times higher in the North of England versus the South of England, albeit at negligible levels— at 0.12% versus 0.05%.
Moody’s calculations determine the interest coverage ratio (ICR) for each BTL loan, or the gross rental income as a share of mortgage payments.
They indicate that a cumulative interest rate rise of 0.5% would cause only a total of 0.4% of UK BTL borrowers to earn insufficient rental income to cover their mortgage installments, which is a very marginal proportion.
Moody’s calculations estimate the distribution of ICRs of the UK BTL RMBS sector for various increases in the bank base rate, based on either rental income at loan origination or indexed in line with rental price appreciation (as reported by the Office of National Statistics).