Will this turn out to be the most impeccably timed exit from the U.K.'s red-hot buy-to-let property sector? A couple of math teachers who became famous in the country for amassing a property empire over the years by using buy-to-let mortgages have just sold their entire portfolio.
The Financial Times reports that Fergus and Judith Wilson have sold off around 900 properties to a consortium of Arab investors, both institutions and individuals. Earlier in the year, the couple, who had been trying to unload their portfolio since the financial crisis in 2007 to 2009, sold about 100 homes to Chinese and Indian investors.
The U.K. property sector has been a magnet for foreign investors, especially since returns on other assets have been relatively low. But despite the enthusiasm shown by other foreign investors, now may not be the time for U.S. buyers to step in -- in fact, quite the contrary. Buy-to-let has grown so quickly that it has raised the concern of the Bank of England. If you take a look at the chart below, it becomes obvious why:
Source: Bank of England
The chart shows that buy-to-let is the primary driver of mortgage lending, which is still at very depressed levels vs. before the financial crisis, while house prices have been galloping ahead, rising by over 7% a year. Not the most stable of environments to start with, but a deeper look reveals even more worrying features.
Those who take out buy-to-let mortgages in the U.K. do so on an interest-only basis: they only have to pay back the interest, relying on continued house price inflation to pay back the principal at the end of the loan, presumably from the proceeds from the sale of the property. Rent revenue must represent 125% of the interest payment, with interest rates on buy-to-let mortgages typically around 5% to 6%.
While all seems well at these rates, the picture changes radically if interest rates begin to increase. The Bank of England's stability report notes that "for example, if mortgage rates rose by 300 basis points ... nearly 60% of buy-to-let borrowers who took out loans recently would see their rental income no longer covering 125% of their interest payments."
If that isn't a worrying enough statement, there are three more headwinds to consider. The first is the fact that, in a couple of years time, the tax relief that buy-to-let borrowers get (they can deduct the cost of the interest they pay on the mortgage from taxes) will begin to be phased out. This may cut the profits or even eliminate them for some of these investors.
The second is the fact that a supplementary tax of 3% has been introduced on purchases of buy-to-let properties in the U.K. from April next year, in an attempt to rein in the sector's rapid growth and tilt the balance a bit towards owner-occupiers.
The third is probably the most worrying: rents, especially in London and the south-east of England, have risen so high that more and more people find themselves unable to pay them. A recent report by housing charity Shelter found that one in every 21 rented homes in the borough of Enfield in London was calculated to be at risk of eviction.
It therefore doesn't look like rent increases are a viable strategy for landlords to make up for increased taxation and costs. Perhaps other U.K. buy-to-let investors will follow the Wilsons to the exit soon.
