In its housing market update, Capital Economics said the rise in mortgage rates could see a small number of landlords paying more in mortgage repayments than they earn on rent, prompting landlords to leave the sector. 

Andrew Wishart, senior property economist at Capital Economics, said a drop in house prices meant returns would be “very weak” in 2023 and 2024. 

Capital Economics calculates gross rental yields by dividing average rents based on its own data by average house prices based on data from Nationwide. It found that in Q3 this reached 4.3% and predicts that over the next two years, this will rise to 5.4%. 

It said first-time buyers delaying property purchases and nominal increases in pay would support rental growth and offset the impact of declining house prices. 

However, Capital Economics forecasts a 12% fall in house prices over the next 18 months, which will still weaken landlord returns. It predicts total returns will fall to negative 5% in 2023, then rise to +1.5% the following year. 

Wishart said: “Following a decade in which total returns averaged almost 9% per annum, at first glance a couple of weaker years may not appear too problematic.” 

Yet, because most buy-to-let investments are funded through borrowing, Capital Economics said once the cost of servicing a mortgage had been accounted for, landlords would see paper losses and the cost of their mortgage exceed rental income. 

‘More vulnerable to rate changes’

Further, Capital Economics said 80% of buy-to-let mortgages are interest-only, which makes them more vulnerable to rate changes. 

It said the average buy-to-let mortgage rate would reach 5.9% next year, up from 2% in early 2022. This will lead to a “stark increase” in debt servicing costs, Wishart said.

Wishart added: “A landlord with a 60% loan to value (LTV) interest-only mortgage against the average rental property would see their annual mortgage payments jump from £4,600 to £12,400 and absorb all their net rental income, albeit relatively briefly.” 

Additionally, nearly a third of landlords have an LTV ratio of over 60% on their portfolio meaning a small number will make a cash loss. Landlords facing a cash loss and coming to the end of their fixed rate period will be unable to pass mortgage stress tests, and so will have to move onto standard variable rates. 

Capital Economics said these changes to returns came at a time when landlords were already being squeezed through policy such as restrictions on tax relief and a 40% tax on rental income for higher rate taxpayers.

Just recently, it was announced in the Autumn Statement that the annual exempt amount for Capital Gains Tax is set to more than halve from £12,300 to £6,000 in April next year, then fall again to £3,000 in April 2024. 

No mass landlord exit yet 

Wishart said: “Putting that altogether, it seems likely that some landlords may choose or be forced to exit the market altogether. That doesn’t appear to be the case yet, with the landlord instructions balance in line with its five-year average in October and UK Finance suggesting that the number of outstanding buy-to-let mortgages rose slightly in Q3, to just over two million.  

“Admittedly, with the interest rate on three quarters of buy-to-let mortgages fixed for two to five years, the squeeze on landlord finances will be gradual.” 

He added: “But with house prices falling, the capital gains tax exemption being reduced, and landlords with high LTV ratios set to have difficulty remortgaging, we suspect that some buy-to-let landlords may attempt to sell in short order.”