One of the key differences now is that coverage ratios are higher for individuals than limited company borrowers, reflecting the additional costs an individual will be incurring as mortgage interest tax relief becomes limited. In addition, longer term fixed rate products will not carry the same stress rates and therefore these products may provide different levels of funding when compared to variable rate products.
From September this year, a further distinction between investors and portfolio landlords is drawn, with the cut-off point struck at ownership of four properties. Those in the latter group will require a specialist underwrite with greater attention paid to experience and financials of the overall portfolio and underlying business. This is likely to limit larger landlords’ access to some of the keener priced retail BTL products.
These regulations were implemented to tighten underwriting standards and ensure investors were not too highly geared. The regulator is concerned about the impact landlords and BTL can have on overall property price volatility. There was some evidence of more aggressive lending returning to the BTL space, and it has grown rapidly during 2015 and 2016 in contrast to the wider residential housing market.
Implications of enhanced underwriting criteria
Lenders are always required to adopt responsible lending practices and need to consider the affordability of their loans to their borrowers. The changes to mortgage interest tax relief has reduced the net cash flow of a mortgaged investment property, and therefore needs to be reflected in the underwriting approach.
However, this is a complex area as tax information can be historic and is highly likely to change in the future, prompting lenders to look at ways to manage this risk and ensure good outcomes for their customers. Most are adopting higher interest coverage ratios to account for this tax change.
Considerations for a limited company structure
In truth, a limited company structure offers advantages and disadvantages to landlords. Whilst interest is fully allowable, investors need to consider the impact of property disposals in a company (effective tax higher once profits are distributed). For many investors, long term estate planning is most important and for them a company structure offers more options for effective planning.
The point is there are many considerations and operating through a limited company will involve more costs (finance costs and associated fees generally higher), together with higher levels of administration.
Ultimately, it is vital landlords take specialist advice considering all the implications, rather than defaulting to thinking a limited company is an easy or appropriate solution. There is evidence that many landlords are increasingly looking to mitigate the additional costs through rental increases rather than choosing corporate structures.
Refinancing on a like-for-like basis
Re-mortgages without additional capital being raised (excluding fees) are excluded from the underwriting standards. However, the changes to interest tax relief affect many unincorporated landlords and will have historical debt levels that would make the investment ‘loss-making’. Lenders will be unwilling to take on such customers and question the responsibility of doing so if that level of debt is not sustainable for the borrower. These customers are also likely to then fall onto higher reversion rates which will amplify the impact on their cash flow. It is hugely important that landlords spend time working out the impact this has, as well as using this time to take action.
Many have options which include a review of rental levels, selling property to reduce debt, reducing other costs (self-managing), or setting aside other income they have to cover any shortfall.
The Greater London and South East market
London and the South-East will always hold strong investment appeal. Yields are somewhat lower and the stamp duty changes announced in April 2016 will have made some properties seem unaffordable, but with an influx of foreign investment, capital growth is likely to remain. This may not be at the same level as historically, but the stability in the market may attract people looking for growth opportunities.
If investors are looking for cash flow over longer term capital gains, then the higher yielding properties in more regional areas - particularly further North - may be more of a focus.
Southern hotspots remain and regions such as Southend-on-Sea are attracting more investment with strong yields at circa 7%, good capital growth and an improving infrastructure, all within 40 minutes of London.
How well-capitalised investors need to be in the future
Highly leveraged investors are most exposed and will feel the impact of the tax relief changes acutely. Those that have grown in a sustainable way, sacrificing pace of growth for less debt, will undoubtedly be better positioned to take advantage of the changing market conditions.
We are entering into a phase of lower gearing for investors, however the fundamentals of BTL remain compelling.
Yields relative to other assets are attractive, it offers long term capital gain potential, and the supply / demand imbalance of the UK housing market and its population growth all support tenant demand. Landlords just need to adjust and accept higher deposits and potentially slower growth. Unfortunately human nature will always see some driven by greed, risking their whole portfolio by gearing to the max.
Advice to landlords who are highly leveraged on their properties moving into 2017
Most importantly understand the impact of the tax changes to your net cash flow. It is important to have a good team around you providing the right advice to ensure you reach a positive outcome. Tax advice and a professional mortgage broker would be the first numbers to call in order to build this.
Take action – whether that be through deciding to deleverage through some sales or consider rental levels and review your other costs to see if there are savings to be had. Reviewing your existing financing costs can often be a good idea as pricing in the market has improved materially during the last few years.
What to consider during the application process
There are some pitfalls but much of any BTL underwrite - particularly on the specialist side - just needs to be viewed with common sense.
Simply put, one of the main questions a lender will ask is; 'can the customer afford the loan, and can they prove it?' Everything else should play a supporting role within a strong risk framework that protects both lender and borrower.
Shawbrook has always encouraged a long term, sustainable and sensible approach to lending, and one of the reasons we have managed to achieve this is through our tightly managed panel of professional mortgage brokers whose value cannot be understated.
Other helpful tips include the quality of your properties (remember the valuer will inspect and the lender will make assumptions based upon the quality of the property), as well ensuring you adhere to any and all licensing requirements. Avoiding minor credit oversights is also important as is your digital footprint, which is something most lenders will review.
Karen Bennett is the managing director of commercial mortgages at Shawbrook Bank.
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