Cash is king: how the current climate caters to HNW landlords

Anthony Rose is director of LDNfinance

The well-bandied around term ‘cash is king’ has never been truer when talking of the UK buy-to-let (BTL) property market in the wake of the pandemic. With the country facing twice the amount of redundancies compared to the last recession, higher property prices and the recent eviction ban legislation (as well as further discussions around rent freezes in the capital), BTL lenders have never been tighter with their affordability criteria. In short, if you want to secure a high-value rental property, you need to be armed with a sizeable deposit and a strong income profile to boot in order to satisfy stringent income checks and offset lender concerns around risk.

You don’t have to be a property finance expert to know the BTL market is extremely strict and restrictive – even before the Coronavirus took hold. From the Bank of England’s Prudential Regulation Authority (PRA) changes to George Osborne’s tax change crusade to curtail BTL purchase activity and now the pandemic, the last five years have been especially tough on landlords and property investors looking to expand their portfolios.

And whilst the recent stamp duty changes have allowed BTL investors to benefit in the same way as other buyers for the first time in a very long time, there is still very much a divide in who can and can’t afford to invest on high-value BTL property in the current climate – especially in London – and this comes down to affordability.

As such, the real winners in the current climate are high net worth (HNW) individuals – and most notably, HNW landlords and property investors. As has been the case in countless events of economic turbulence in bygone times, HNW individuals have the unique ability to remain resilient in the face of recession whilst others simply do not have the vast wealth profile required to ride the choppy waters of an uncertain and ever-evolving prime property market.

Why is the BTL market a trickier proposition for landlords with a modest income?

A BTL lender looks at how much an investor landlord can borrow by determining the rent the property is estimated to receive. This really penalises London BTL property which is generally low yielding from a rental perspective; in lots of cases, you can get 70-75% LTV on a £100,000 home in the north of England, but on a two-bed flat in prime central London you will more than likely be looking at a figure around 40% LTV or less – the rent is still high, but it’s not high enough to be in kilter with the value of the property.

This means that when a lender comes to do a rental calculation under normal circumstances, the LTV they get is very low, and so those on a steady income wouldn’t be anywhere close to the size of loan required to be able to afford the repayments of their investment without a significant amount of risk at play.

What overrides this problem, however, is a very high income and something known within the industry as ‘top slicing’.

What is top slicing?

Top slicing is when a BTL lender uses a HNW borrower’s personal income to ‘top-up’ any shortfall in rent which is needed for the borrower to obtain the required loan amount. If a HNW landlord’s income is large enough, the standard rental calculation which is usually applied to BTL mortgages becomes mostly irrelevant and they are able to borrow right up to the lender’s lending limit of 75% LTV (which is the maximum most providers would lend on a BTL property under any scenario). Effectively, the property’s rent no longer determines how much the bank will lend as the lender takes a view on their HNW income instead.

Top slicing became a lot more prominent following the UK tax changes introduced in 2016 and 2017 which impacted BTL landlords. From April 2016, stamp duty on second homes increased by 3% and from mid-2017 George Osborne took a huge swipe at landlords’ portfolio profitability by reducing the income tax relief on BTL mortgages by 25% a year up until 2020. Foreseeing the effect of the changes, the PRA introduced even tighter affordability rules on BTL lending at the start of 2017.

Prior to these regulatory changes, most BTL investors were on a level playing field as the interest coverage ratio (ICR) was stress-tested at 125% with an assumed 5% interest rate for everyone. After the changes, however, banks required that for a two-year fixed mortgage a property’s rental income had to equal 145% of the mortgage payment at an assumed 5.5% interest, meaning that many potential landlords with a more modest income just couldn’t make the numbers fit.

But for HNW landlords, their high income and asset profile effectively insulated them from these restrictions, as in a lender’s eyes they posed a much lower a risk in regard to affordability. As such, lenders were happy to use top slicing as a way of circumnavigating inflexible criteria to help HNW landlords achieve their property finance aspirations.

In practice, this means that for a HNW landlord it often doesn’t matter what the rent of the property is or if there is no tenant; if the borrower earns £1 million a year and their tenant isn’t paying their £3,000 a month rent, it might annoy them in the short-term, but they won’t default on their mortgage.

Whereas if someone who only earns £40,000 a year has a high-value BTL that they are acquiring through whatever means and the tenant is paying £5,000 a month, that person has a big problem if the tenant disappears or doesn’t pay their rent. This seems particularly pertinent in the current climate, as the Coronavirus eviction ban – as well as many a discussion about extensions and rental freezes happening at the moment, too – has meant increased protection for many tenants who have been financially affected by the pandemic.

For HNW landlords, they can weather the tide of missed rent, but for those who rely heavily upon their rental income, this has posed a serious problem when it comes to repaying their mortgage.

How else does the post-Covid market benefit HNW landlords?

Whilst Covid hasn’t really changed the BTL market too much – the restrictions were already there – the rest of the market has been impacted significantly. The pre-Covid days of lenders comfortably offering high LTV products on residential purchases have all but disappeared for the immediate future; 90% LTV mortgages are mostly off the table, with a very large reduction of 80-85% deals, too.

As such, HNW landlords are now presented with an opportunity as competition has been greatly reduced because a higher percentage of buyers are struggling to secure high-value property because they currently don’t meet the criteria.

An area of business we have dealt with increasingly over recent times for HNW individuals, is where a client is looking to remortgage their existing residential property onto a BTL facility: a let-to-buy. By pushing LTV to the maximum 75%, the client can then release a sizeable amount of equity to act as a large deposit for the purchase a new high-value property.

The let-to-buy structure also allows clients to move quickly, which is especially helpful right now as the market has picked up and timescales are tight. If a HNW client has seen a new property they want to buy immediately, there’s no time to wait for their existing property to sell, and so we’re seeing many HNW individuals opt for a let to buy facility so as to secure the new property with haste.

It’s a great option, you just need the money available to be able to do it. For a client on a more modest income, this just doesn’t work as their affordability means they won’t be able to get anywhere near 75% LTV. In fact, more often than not, you would find that this person wouldn’t even be able to cover their own mortgage by transferring their existing property to a BTL.

How can non-HNW BTL landlords benefit from the current climate?

Although the high-value BTL market seems geared toward HNW individuals, there are still some fantastic opportunities for the taking for those with a more modest income.

At LDNfinance, we’ve noticed a big shift in investor sentiment away from city centre BTLs due to potential changes to many people’s work/life balance toward UK holiday lets – and as these properties have a very different income structure, they present mortgage opportunities whether you’re a HNW investor or not.

As many in the UK are currently favouring a stint in St Ives over a trip to St Kitts, the demand for UK holiday rentals in the wake of Coronavirus has skyrocketed and when combined with the temporary cuts to stamp duty, it’s not hard to see why many potential investors are keen to secure their own slice of the holiday home action.

Rather than a long-term BTL, a holiday let mortgage allows you to purchase a property that will be let out on a short-term basis to holidaymakers as a business (at a much higher price point), whilst also allowing you to personally use it as a holiday home. Whilst many other brokers are struggling to secure desirable outcomes in this area, our specialist holiday let mortgage advisers have been dealing with a huge amount of holiday rental business.