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UK Property Markets Bank Of England Financial Stability Report December 2015 | Issue No. 38





The buy-to-let sector continues to drive growth in the mortgage market. Greater competition in this sector has not to date led to a widespread deterioration in underwriting standards of UK banks. Nevertheless, strong growth in buy-to-let lending may have implications for financial stability. The FPC will monitor developments in buy-to-let activity closely following the tax changes to the buy-to-let market announced by the Chancellor in the Budget and Autumn Statement. The FPC supports the programme of work initiated by the PRA to review lenders’ underwriting standards.


Prices in the UK commercial real estate (CRE) market have risen significantly and the funding of investments is becoming riskier, with growing use of leverage and strong inflows to open-ended funds. A severe downturn in the CRE market could reduce the ability of some firms to access bank finance, given their use of commercial real estate as collateral.

Housing market risks

Housing market activity is picking up from low levels, with mortgage lending driven by the buy-to-let sector… Mortgage lending growth has been gradually picking up but remains well below pre-crisis levels (Chart A.23). Mortgage approvals for house purchase were 69,000 in September 2015, higher than the 62,000 level six months earlier, but well below the 1994–2007 monthly average of 99,000. Despite modest lending growth and activity, house price inflation has risen, to 7.8% on a three-month on three-month annualised basis in October, and forward-looking indicators suggest it will remain strong in the near-term (Chart A.24).




The buy-to-let sector continues to drive growth in the UK mortgage market. Since 2008, the outstanding stock of buy-to-let lending has grown by 5.9% per annum on average, compared with only 0.3% in the stock of lending to owner-occupiers. In the year to 2015 Q3, the stock of buy-to-let lending rose by 10%, compared to 0.4% for owner-occupiers. The total flow of buy-to-let lending in 2015 will be close to its pre-crisis peak if it continues to grow at its current rate, although the share accounted for by remortgaging is now higher (Chart A.25).


…due to structural factors and strong competition. Strong growth in buy-to-let lending is driven in part by a structural shift in tenure to the private rental sector. Since 2008, this has been driven largely by the reduced availability of high loan to value (LTV) mortgage lending, which has increased the age at which many potential first-time buyers leave the private rental sector. Population dynamics, including


migration, have also played a role. These increases in rental demand, alongside low interest rates and low returns on alternative assets in the post-crisis period, have boosted the attractiveness of borrowing for buy-to-let investment. Over the past two years, buy-to-let lending spreads have fallen by nearly 1 percentage point and, over the past 18 months, the share of new lending by lenders outside the largest six UK banks has risen from 27% to 42%. This greater competition has not to date led to a widespread deterioration in underwriting standards of UK banks. Major lenders have tightened affordability criteria over the past year. However, some smaller lenders have loosened their lending policies, for example by raising their maximum LTV thresholds. Strong growth in buy-to-let lending, and the potential for underwriting standards to slip, may have implications for financial stability.

Compared to lending to owner-occupiers, buy-to-let borrowers may be more sensitive to rising interest rates…New loans to buy-to-let investors are often subject to less
stringent affordability tests than loans to owner-occupiers. According to industry standards, the affordability of a buy-to-let loan is typically tested by ensuring that the rental
income exceeds 125% of loan interest payments at a mortgage interest rate of 5%–6%. In contrast, and in accordance with the FPC’s June 2014 Recommendation, the affordability of loans to owner-occupiers is tested by ensuring that the borrower has sufficient income to cover their
mortgage payments at a more stringent mortgage interest rate of around 7%, despite owner-occupier mortgage rates tending to be around 0.7 percentage points lower.(1)


Assessed against these affordability metrics, buy-to-let borrowers may be more vulnerable than owner-occupiers to an unexpected rise in interest rates or a fall in income. For example, if mortgage rates rose by 300 basis points, the increment by which the FPC recommended the affordability of
mortgages to owner-occupiers is tested, nearly 60% of buy-to-let borrowers who took out loans recently would see their rental income no longer covering 125% of their interest payments. By comparison, only 4% of recent owner-occupier borrowers would see their mortgage debt costs rise to above 40% of income, a level above which households are more likely to experience payment difficulties (Chart A.26).


…amplifying a downturn in house prices. The latest NMG survey suggests that around 15% of
buy-to-let investors would consider selling their properties if their interest payments were no longer covered by rental income. A further 45% would be inclined to sell if property prices were expected to fall by more than 10%. Such procyclical behaviour could exacerbate the scale of a fall in
house prices following an unexpected rise in interest rates or a fall in income, which could impact adversely consumer spending and economic stability.





Buy-to-let lending can increase household indebtedness during an upswing in house prices…
During an upswing in house prices, investors seeking capital gains can increase leverage, including through the purchase of multiple properties, for example by extracting equity from existing properties. The resulting boost in demand can add further pressure to house prices, prompting both buy-to-let and owner-occupier borrowers to take on larger loans, thereby increasing indebtedness. The FPC’s June 2014 Recommendations aimed to limit risks from a further significant rise in the number of highly indebted households. Nevertheless, the level of household debt relative to income
remains elevated in the United Kingdom and is an important indicator of systemic risk (see Risk outlook chapter).



...and has suffered higher credit loss rates than owner-occupier lending in the past.
Over recent years, credit losses across all types of mortgage lending have fallen, reflecting falls in unemployment and a contraction in mortgage interest rate spreads. However, credit loss rates incurred on buy-to-let loans in the United Kingdom have been around twice those incurred on lending to owner-occupiers (Chart A.27).




This reflects both a higher incidence of possession for buy-to-let loans, and greater losses in the event of possession. The latter is despite the fact that fewer buy-to-let loans are extended at high LTV ratios. Since these loans tend to be extended on interest-only terms, loan values on buy-to-let loans do not decline as the loan matures. The FPC remains alert to financial stability risks arising from rapid growth in buy-to-let lending and will monitor developments in buy-to-let activity closely following the tax changes to the buy-to-let market announced by the Chancellor in the Budget and Autumn Statement. It supports the programme of work initiated by the PRA to review lenders’ underwriting standards. HM Treasury is planning to launch in 2015 a consultation on giving the FPC similar powers of Direction on buy-to-let lending as those it has already provided on owner-occupier mortgage lending. In the interim, the FPC stands ready to take action if necessary to protect and
enhance financial stability, using its powers of Recommendation.

Commercial Property Risks

UK commercial real estate prices continue to rise rapidly,
outpacing rents… Following the onset of the global financial crisis, prices in the
UK commercial real estate (CRE) market fell by 44%, far in excess of the peak-to-trough fall in residential property prices of 20%, with some lenders suffering significant losses. In aggregate, 9% of the UK banks’ pre-crisis stock of CRE debt was written off between 2008 and 2014, while lenders with lower-quality underwriting standards typically had write-off rates above 20%. Over the past century, the United Kingdom has experienced five CRE cycles and similar cycles have been
seen in a range of developed economies.

Commercial property prices have risen strongly since 2013, especially in the prime market and particularly in London (Chart A.28).



With rents rising at a slower pace, rental yields have fallen and are very low by historical standards, reaching around 4% for some properties in September 2015.(1) While these rental yields do not look compressed relative to current, unusually low, medium-term real interest rates, if these rates were to rise, commercial property valuations could look
stretched (Chart A.29)




As an illustration, a common industry approach is to consider a property’s ‘investment value’, in which a prudent valuation of the future proceeds of sale are discounted at an appropriate
target rate of return alongside future rents received until the point of sale. For example, a valuation could be constructed on the basis that a property is sold after five years at a price consistent with a long-run rental yield. 
Discounting this value alongside rents by a range of target rates of return depending on ten-year government yields and different risk premia assumptions — shows that, while the UK CRE market appears ‘fairly valued’ overall, some parts of the market look overvalued (Chart A.30). …driven by foreign and non-bank investors, including leveraged investors… Investment in UK CRE has been strong over the past three years. 





This has been driven by overseas investors, notably from the United States and Asia. Following the
financial crisis, equity financing of CRE investment increased significantly, with a diminished role for leverage. However, the use of leverage, particularly in London, has begun to
increase a little over the past year or so (Chart A.31).




Leveraged investors create credit risk for lenders and may have a higher propensity to act as forced sellers of property, due to re-financing risks and covenant breaches.

There have also been strong inflows to open-ended funds investing in UK CRE (Chart A.32). 

These funds now have more assets under management than in 2007 and hold approximately 5% of the total stock of UK commercial property. Open-ended funds offer investors short-term
redemptions against large and illiquid property investments.During the 2007–08 downturn in the UK CRE market, they experienced sharp outflows, becoming forced sellers of CRE investments and amplifying price falls.…posing a risk to UK financial stability.

Over the past six years, foreign banks and non-bank lenders have gained market share and now account for 60% of the flow of new lending to the CRE sector. Nevertheless, exposures of the major 

UK banks remain substantial, averaging around 50% of their common equity Tier 1 capital at
end-2014.(1) The resilience of UK banks to a downturn in the CRE market was assessed in the 2014 annual stress test. This considered the impact of a 30% fall in UK commercial
property prices and a significant rise in Bank Rate on banks’ CRE exposures at end-2013.(2) A Bank survey conducted in 2014 examined flows of new lending and found that almost
30% of UK banks’ new prime commercial property lending was at an LTV of 65% or over, a level beyond which high losses have been incurred under stress historically.



If prime CRE prices were to fall to valuations consistent with historic
average rental yields, this share could more than double.A severe downturn in the CRE market could also reduce the ability of some firms to access bank finance, given their use of commercial real estate as collateral. A recent Bank review of bank lending to small and mid-sized companies further found that 75% of firms that borrow from banks rely on commercial real estate as collateral to support their borrowing. The FPC continues to monitor closely developments in the UK CRE market. The Bank is also engaging with industry on:proposals to develop a CRE debt database; and whether alternative approaches to valuing commercial property could be a useful warning indicator or risk management tool.(3) Risks from open-ended funds are covered in the FPC’s work on investment funds (see Box 2).

     BoE Financial Stability Report, December 2015



Bank of England Financial Stability Report December 2015 | Issue No. 38


Further Reading 


Government encourages online real estate agents and Fintech , A better deal: boosting competition to bring down bills for families and firms 

Bank of England concerns over Property buy-to-let boom


Bank of England dampens prospects of early UK rate rise >Raising interest rates to deal with housing market problems would hit the rest of the economy too hard 


BoE forecasts for inflation relative to the market curve of interest rate, in particular its projection at the two-year horizon.

How low can you go ? speech by Andy Haldane BoE Chief Economist 

Online Estate Agent Purplebricks.com valued upto £250M IPO as Early as December 2015

Slight Softening of House Price Growth in UK Housing Market