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The Financial Times reported last week that Nationwide, NatWest, RBS and Santander are no longer willing to re-finance homes acquired with Help-to-Buy or ‘HtB’. Part of their reasons are that HtB allowed First-Time Buyers (‘FTB’) to over-extend themselves for the five years they received an additional loan of up to 20% (outside of London) or 40% (in London) of the purchase price on an interest-free basis.

At the fifth anniversary when the HtB loan become interest bearing, those borrowers who have not had a substantial increase in their income may struggle to fund both the mortgage and the second-charge HtB loan. Lenders are wary that most new homes are sold at a considerable premium (this price premium was perversely supported by the availability of HtB) and worry that prices of those no-longer brand new properties are either likely to stagnate or even fall by the fifth anniversary, having lost its price premium.

Let’s have a look at how first-time-buyers might have overstretched themselves. A young household in London with a deposit of £26,000 and earning a joint income of £63,500 with a standard mortgage loan without HtB would get a maximum loan at 4.5 x their joint income. This hypothetical income example is close to the average London salary.

Without HtB funding this average London household with its £26,000 deposit and £63,500 earnings p.a. could only afford a £320,000 flat (including costs). But let’s take the example of British Land’s development London Square, Quebec Way in Canada Water where it is offering the same first-time buyers an opportunity to acquire a one bedroom flat starting at £520,000. British Land suggests a FtB with a £26,000 deposit gets a £208,000 HtB loan (interest-free for five years) and fund the balance with a £286,000 first-charge (standard) mortgage. In five years’ time when the interest-free loan starts to incur interest at £1.75% the HtB loan cost will be £3,640 pa.

Due to HtB the hypothetical household have been able to purchase a far more expensive property: £520,000 rather than £320,000. By 2023 this couple would have a remaining first and second charge mortgage of £476,000 in total and they would need a joint income of £105,000 (an increase of 65% in 5 years!) to service the mortgages at current interest rate levels if they would want to do so.

If over the five interest-free years they saved the full £3,640 p.a. and didn’t use it to facilitate day-to-day spending the hypothetical London couple would have saved some £18,000 before tax and could have reduced their HtB mortgage to between £200,000 to £190,000. How much of the new-build price premium they paid for the new flat would have been paid off with that £18,000 would be an interesting question.

The purchase of a one bed flat might seem appropriate now, but in five years’ time one can only imagine that a young household might be growing, wanting something bigger. And other young HtB households in the same block of flats might all be wanting to sell out, too, putting pressure on pricing.

If this hypothetical couple do want to sell their flat once interest becomes payable on the HtB loan, the house price index will need to have risen at over 5% p.a. to allow them to sell their one-bed flat and reduce their HtB loan. Let’s hope that meanwhile the tax rates will not have increased for higher earners.

Her Majesty’s Treasury has been trying to find buyers for the 20%-40% interest they hold in a large number of homes. Many of these HtB loans are located in London and the south of England where property values (particularly in new properties) have fallen over the last five years. Hopefully this will concentrate the Government’s mind on whether this is an efficient means of funding the increased production of new homes and whether FtB’s may come to regret in the future their use of HtB to help them get on the lowest rung of the housing ladder. Parents might regret the scheme as well. Anecdotal evidence suggests  that the Bank of Mum and Dad has funded the deposit and they will be called upon to bridge the refinancing shortfall.

As a parting shot I’d like to end with the observation that this week it was reported that 169,102 properties have been bought using the HtB schemes. However, I think this a material under-estimation as many units are being bought off-plan and have yet to complete. The Institute for Public Policy Research – according to the Times last Friday – believes the figures show that the HtB scheme should be reformed as it’s not helping those most in need.

Since the scheme was introduced in March 2013 reportedly 4% or 6,717 households with an income of more than £100,000 have used the scheme. Over a third of households earned over £50,000 p.a. jointly and 13% over £80,000 p.a.. This is seen as proof that the HtB policy is not supporting the right people. They argue that the majority of those who have bought through the scheme would be able to buy at some point without the support of HtB.

Perhaps the households with the higher incomes buying through HtB are merely a reflection of London and its high pricing, but the IPPR probably make a very fair point that the HtB scheme is not helping those most in need. Bar the housebuilders and the politicians who fear a drop in house prices as it hits the older voters who come out to vote the most, who benefits exactly?

Well, maybe in the future some companies offering redress for the HtB scheme. Will we see adverts  in 5 years time asking “have you claimed for Help to Buy?“ similar to the current adverts asking “have you claimed for PPI?”

Additional reading: https://www.thetimes.co.uk/article/high-earners-are-winners-in-help-to-buy-scheme-xbx3lt825

The author, Charles Fairhurst, is a PRS specialist and ex institutional PRS fund manager, providing training and consultancy through Property Overview. The booming PRS has few with real in-depth hands-on experience and knowledge and Property Overview offers insight and experience through Charles Fairhurst and other senior PRS professionals. Please visit https://www.propertyoverview.co.uk/prs-courses

2018 is a crucial year for the place and case for PRS in my opinion. Whilst market factors are supportive of Institutional PRS, threats to the underlying residential market mean Institutions must tread carefully in selecting stock that will deliver yield and capital growth over the medium to long term.

Many will have become aware that Institutional PRS is finally beginning to build critical mass, evidenced by the latest BPF report into the matter. This report calculates that the Institutional PRS market has grown by 30% over the last year. For seasoned observers it does look like the institutional penny has finally dropped and it will be third time lucky.

In the two previous big pushes (to borrow from “Blackadder Goes Forth”), which occurred in the late 90’s when a small number of funds were created and again in 2006 when REIT legislation was introduced, the advance was halted by a number of factors. There was one overarching factor, which was that developers could make more money – and faster – by selling to owner-occupiers or investors than by opting for the PRS route.

House prices are a major obstacle to get a foot on the housing ladder for many households with ratios of house price-to-earnings at all-time highs, reaching above 10 in all but one London boroughs and averaging over 7 throughout England [1] . Earnings of households are being squeezed full-stop at the moment.

The taxation of buy-to-let investors is also restraining demand for residential and a critical look at the provenance of foreign money and higher stamp duty at the top-end have also dampened demand. There are therefore significant barriers to a rapid resurgence in demand for unit sales. Surely this leaves the playing field clear for Institutions to invest at good value for the long term, especially as they may be wishing to reduce their exposure in other property sectors?

I would offer some significant caution:

Firstly (and hopefully obviously), until many large blocks or portfolios have fully stabilised their income profile, the value of assets will continue to reflect the underlying unit values first and foremost. This means investing in assets which have all the correct infrastructure, amenity and local economy is paramount. However, the local markets also have to perform. With house price growth outstripping household earnings growth in Britain it is safe to conclude that at some point there has to be some sort of reversal, with either earnings catching up with house prices or house prices falling. This will therefore affect the value of PRS residential properties too.

Secondly, it is crucial to make a proper assessment of rent and operational cost. We constantly hear the rules of thumb applied to new developments of Build-to-Rent (‘BTR’), saying it is 25% loss of income to operational costs but I would be concerned about three things:

• Who is assessing the rental level;
• Have realistic assessments been made for rental premiums as well as for costs?
• Whilst 25% gross-to-net loss is appropriate in London with relatively high rents, this can still be true in regional locations where rents are much lower but boilers and light bulbs cost the same.

Thirdly , UK BTR buildings are being acquired with a view to NOI and the comparison with risk-free rates. In the US, as 10-year Treasury pricing rose to 3%, multifamily returns came under pressure. The listed sector lost 5% in the 1st quarter of 2018, making it one of the worst performing sectors. This is a warning for what might happen in the UK.

So as the new wave of Institutional PRS units are being created, as identified by the BPF, I believe there will be winners and losers and 2018 will be a seminal year. I think 2018 will begin to show if the appraisals are correct.

Let’s hope there are more Blackadders than Baldrics in the trenches and that the generals in head office have their eyes on the ball. We are all rooting for the successes of all the new PRS schemes as this will lead to an ever wider pool of investors, and we should see the market mature and properly establish itself.

PRS goes forth!