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Is buy-to-let regulation the answer to the housing crisis?

Is buy-to-let regulation the answer to the housing crisis?
March 2nd, 2015
Author: Ben Gosling

In October 2014, the Bank of England requested the power to place limits on both buy-to-let and residential mortgage lending. By using so-called ‘powers of direction’, the Bank’s Financial Policy Committee (FPC) hoped to be able to direct financial sector regulators to place limits on loan-to-value and debt-to-income / interest coverage ratios granted by lenders [1].

The government released proposals to grant the FPC this legally enforceable power with respect to the residential market, but said that it would “consult separately” on the buy-to-let market in 2015 [2]. This month, it emerged that this consultation would likely not take place until after the general election [3].

What is the case for limiting buy-to-let lending?

The UK’s economy is tied inextricably to its housing market, both directly and indirectly.

More of the UK’s banks’ finances are tied up in mortgages than any other asset. This threatens the economy directly, as mass mortgage defaults will cripple the banking sector. The indirect threat comes from the fact that mortgages represent 80% of household debt [4], meaning that they could impact upon consumer spending (a significant driving force behind any healthy economy).

The Bank of England argues that buy-to-let investment pushes up house prices and encourages owner-occupiers to take on bigger loans to compete, limiting their spending elsewhere and increasing their risk of default. The majority of buy-to-let mortgage debt is also interest-only, which again increases the likelihood of loans being written off.

The Bank of England cannot control house prices, but it can control a number of the factors that influence them. By curbing mortgage lending, they hope to limit the speed at which house prices rise and prevent an asset bubble [5].

So is regulating buy-to-let the answer?

Housing freefoto.comIn a country where a drastic housing shortage is the primary cause of house price inflation, it is unclear what material affect buy-to-let actually has on house prices. It can be said that it still represents only a small part of the market; just 13.4% of gross mortgage lending in 2014, according to official figures [6], [7].

It is true that the widening regulatory gulf between the buy-to-let and residential markets could be giving buy-to-let investors more purchasing power than owner-occupiers. Buy-to-let applicants are not generally subject to the same scrutiny of their income and expenditure as residential borrowers, and loan-to-income caps do not apply to buy-to-let loans.

However, lending to landlords is constrained naturally by other factors, such as lenders’ attitudes to risk. The maximum loan-to-value ratio for a buy-to-let loan (without additional security) is 85%, meaning buy-to-let investors require larger cash deposits than homebuyers. Interest rates and fees for a buy-to-let loan are typically higher. And how much a buy-to-let landlord can borrow is still limited – just by the asset, rather than the borrower themselves.

A property’s potential rental income affects how much money can be borrowed against it. Typically, properties need to ‘self-finance’ by a margin of at least 120%, which already makes it more difficult for average investors to buy in premium regions like London and the South East [8].

If imposing limits on buy-to-let lending restricts the supply of rental properties – which, arguably, it will – the cost of renting will rise. Higher rents means higher earning potential for individual properties, which will means that larger buy-to-let loans could be secured against them. And even if debt-to-income ratios were capped to mitigate this, it would do nothing to solve the problem of rising rents.

Choice is the key factor in UK housing; choosing where to live and work, and choosing whether to rent or buy. The rental sector is an important element of this, but similarly, the country should not become too reliant upon it.

The simple truth is that building the homes we need will balance the scales and help to turn the housing market into something that can provide for everyone; homeowners, investors and renters alike. When this happens, piling regulation on top of regulation will no longer be necessary.

Written by Ben Gosling for Commercial Trust

References:

[1] Financial Policy Committee statement on housing market powers of Direction from its policy meeting, 26 September 2014. Bank of England. 2 Oct 2014.

[2] Government launches consultation on further housing market powers for Bank of England. HM Treasury. 30 Oct 2014.

[3] Callanan, N. and Gower, P. Buy-to-let booms as BOE awaits powers to curb mortgages. Bloomberg Business. 26 Feb 2015.

[4] Financial Stability Report press conference, Thursday 26 June 2014: Opening remarks by the Governor. Bank of England. Retrieved on 27 Feb 2015.

[5] FPC statement on housing market powers.

[6] Buy-to-let gross advances (CML) [XLS]. CML. Retrieved on 27 Feb 2015 from www.cml.org.uk/cml/statistics

[7] Advances (gross) by type of lender (BOE) [XLS]. CML. Retrieved on 27 Feb 2015 from www.cml.org.uk/cml/statistics

[8] A guide to debt-service coverage ratio (DSCR). Commercial Trust. 3 Dec 2014.

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