What’s Next for UK Interest Rates
How Will This Affect Property Investors and Buy-to-Let Landlords?
The Bank of England has aggressively raised interest rates over the past year in an effort to tame spiralling inflation. This has major implications for the UK housing market, both for homeowners and property investors. In this blog post, we’ll analyse the outlook for interest rates and examine the key impacts on the buy-to-let sector.
A Series of Aggressive Rate Rises
Since December 2021, the Bank of England has raised interest rates 14 times in a row from a record low of 0.1% to the current level of 5.25%. This is the most aggressive tightening of monetary policy in over 30 years.
The aim has been to curb inflation, which hit a 41-year high of 11.1% in October 2022. While inflation has come down slightly to 10.7% in November, it remains extremely elevated. The BoE has a 2% inflation target, so further rate rises are likely needed.
Markets expect interest rates to peak at around 5.5% in 2023 before starting to edge down. However, rates are forecast to remain elevated for years to come compared to the ultra-low levels we’ve become accustomed to.
The Lagged Impacts on Households
Due to the prevalence of fixed rate mortgages, the full effect of higher interest rates is yet to be felt by many households. Around 94% of UK mortgages are currently on fixed rates for 2-5 years.
As these fixed terms come to an end in 2023/24, millions of households will feel the pinch of refinancing at significantly higher rates. Their disposable incomes will take a major hit.
This lagged impact means the Bank of England can continue raising rates without immediately crushing the economy. But the pain is simply being delayed rather than avoided.
Serious Challenges for Highly Leveraged Investors
For buy-to-let investors, the implications are already clear. Those with high leverage on interest-only mortgages are facing a tremendously difficult environment.
As fixed mortgage terms expire, landlords are finding it incredibly tough to refinance at the same loanto- value ratios previously available.
Typical buy-to-let mortgage rates have shot up from around 3% to well over 5% within a year. This has wiped out the cashflow on many properties, especially for highly geared investors.
According to research by Savills, at 70% loan-to-value, buy-to-let mortgage payments now exceed rental income on a typical property. Investors are being forced to inject fresh equity or sell.
The Rise of High Arrangement Fees
Seeking to limit new lending risk, many buy-to-let lenders are now charging arrangement fees of 5-7% of the loan amount.
These chunky fees get added to the mortgage, increasing loan sizes. This gradually erodes equity over multiple refinancing cycles.
Critically, arrangement fees don’t get included in standard affordability checks. This enables landlords to pass affordability tests despite not covering the true cost of finance.
In effect, this practice is kicking problems down the road. In a few years time, investors could end up with mortgages exceeding the original purchase price of their property due to accumulated fees.
This situation may create unexpected tax headaches. Specialist tax advice is essential for highly geared landlords in the current environment.
Strategies for Surviving the Downturn
For buy-to-let investors, the clear lesson is to avoid excessive leverage at all costs. Loan-to-value ratios below 60% are prudent given the uncertain outlook.
Despite higher borrowing costs, there remain opportunities to profit. As the market cools, there is growing divergence between high-quality homes and poor condition properties.
Savvy investors should target dated, unmodernised homes in promising areas at discounted prices. Strategic refurbishment can still yield strong gains.
Lease options present another way for investors to secure control of properties without huge upfront equity requirements. The key is creativity and avoiding unnecessary risk exposure.
Huge Opportunity in Commercial-to-Residential Conversions
Likely the biggest opportunity emerging from higher interest rates is in commercial-to-residential conversions.
Commercial real estate has been hit much harder than the residential market by rising rates. Demand is plummeting, driven down by the weak economic outlook.
Values of retail, office and industrial properties are set to fall by at least 30% from peak levels, based on trends in previous recessions.
Converting empty shops, offices and warehouses into apartments offers strong prospects. Residential demand remains more resilient, despite the challenges facing buyers.
Permitted development rights also make commercial conversions administratively easier than ever. This is where astute investors should be looking.
Final Thoughts
In summary, further interest rate rises are probable but appear largely priced into expectations. Buy-to-let investors face major headaches from higher borrowing costs if overleveraged.
Yet market corrections always bring opportunities. For financially conservative investors, there are deals to be found in commercial conversions and strategic refurbishments.
The key is avoiding excess risk while deploying capital sensibly to benefit from evolving market conditions. Patience and diligence will be rewarded.