Unsurprisingly, the latest data from Hamptons reveals that increasing interest rates are eroding the profitability of buy-to-let for mortgaged landlords in the sector. To ensure investors stand the best chance of turning a profit, they are increasingly buying properties in higher yielding parts of the country.

So far this year a record 73% of new buy-to-let purchases earnt gross yields above 5%, up from 63% in 2016 when the buy-to-let tax system began to change. Almost a quarter – 23% – of new investors earnt gross yields of 8% or above, up from 20% in 2015.

With an average gross yield of 4.9%, London offers the weakest returns of any region in England & Wales. This is one of the main reasons why London based investors are increasingly purchasing buy-to-lets beyond the capital, targeting higher yielding areas. So far this year, a record two-thirds (66%) of London-based investors chose to purchase a buy-to-let property outside the capital, up from just 26% a decade ago.

A fifth – 20% – of London investors bought properties in the North of England, up from 9% in 2016 and just 1% a decade ago. Here, gross yields sit at 7.4%, outpacing the 6.1% average across England and Wales. London landlords buying outside the capital bought 105.7 miles away on average – 20.9 miles or 25% further than in 2016.

Today, 29% of all properties in England and Wales bought as a buy-to-let are located in the North West, North East or Yorkshire & Humber, triple the share a decade ago.

For the 50% of landlords who use a mortgage to fund a buy-to-let purchase, rising interest rates mean that many will face higher outgoings when they come to re-mortgage. This will eat into the profitability of their buy-to-let.

Since August 2021, the average mortgage rate on a typical 75% LTV buy-to-let has risen from 1.79% to 3.51% last month. This means the average landlord who bought a £222,000 buy-to-let last year will likely see their annual interest-only mortgage payments nearly double from £3,010 to £5,903 if they re-mortgaged last month. If Thursday’s (22 September) 0.5% base rate rise to 2.25% is fully passed on, this will increase payments to £6,743 for an investor re-mortgaging this month.

As a result, the net annual profit made by a higher-rate taxpaying investor who earns an average yield of 6.1% could fall from £3,198 in August 2021 to £212 with the new base rate, down 93% due to higher rates when re-mortgaging.

If the base rate reaches 2.5%, the average higher-rate taxpaying investor with a typical 75% LTV mortgage is likely to start making a loss. They will need to yield around 7% or more to stay out of the red – a figure only achievable on average in 23% of local authorities in England and Wales, 65% of which are in the North of England.

Lower-rate taxpayers or limited company landlords have much more wiggle room. While the average lower-rate taxpaying investor achieving the average yield (6.1%) in England and Wales will have also seen their profit shrink over the last year (from £5,070 to £2,750) when re-mortgaging, the base rate would have to reach 4% before they start making a loss. Every local authority in the country offers an average gross yield above this mark.

Since hitting a record high of 11.5% in May, rental growth continues to cool. At an average of £1,165pcm, the cost of a newly let home in Great Britain rose 7.4% year-on-year in August (table 1). In part, this is due to signs that the supply-glut has hit rock bottom. There were 8% more new rental homes coming onto the market in August than at the same time last year, although, stock levels remain low compared to historic standards.

Rental growth slowed in every region of the country, apart from the South East, South West and Wales where rents rose at the same pace as last month. But London continues to see the strongest growth.

In the capital, rents rose 11.3% year-on-year in August, slightly down from the 12.4% growth recorded in July. This has been bolstered by a 29.9% annual rise in Inner London, where rental growth has been running above 10% for the last eight months (chart 3, table 1). However, this strong growth continues to reflect the weaker market last year, and this will begin to drop out of the picture in early 2023.

Aneisha Beveridge, head of research at Hamptons, said: “Over the last few years, investors have needed to seek higher-yielding properties in order to make the sums stack up. This is because taxation changes, which removed the ability for landlords to offset mortgage interest from their tax bill, have compelled investors to maximise their rental income in order to cover their costs. This is a trend that has become more embedded in 2022 as rising mortgage rates eat further into profits and in some cases, push those profits into the red.

“If Section 24 changes were reversed, meaning landlords could fully offset their mortgage interest, the average higher-rate landlord would turn a profit of £2,065 each year instead of £884. It also means they could weather a base rate of up to 4.0% before their profit turned negative, instead of 2.5% under the current rules.

“While around half of landlords who own their buy-to-lets outright won’t be under the same pressure from rising rates, those looking to purchase a new investment property with a mortgage are increasingly running out of options. If the yield doesn’t meet a lenders’ rent-cover requirements, they’ll have to put down a bigger deposit.

“This is going to make investing in Southern areas, where yields are lower, tricky for landlords who are heavily reliant on mortgage finance, restricting buy-to-let to those with the deepest pockets. In turn this will put further pressure on already low stock levels.”

Rental growth on newly let properties

Source: Hamptons

Kwasi Kwarteng tries to calm the markets by pledging to outline in November how he plans to cut debt