With the increase in mortgage interest rates putting a squeeze on rental returns, some people are questioning whether it’s still worth investing in Property. In our latest article, we discuss why interest rates have increased, what it means for us as investors and what you can do to take back control.
It’s no secret that house prices have been increasing rapidly. As it stands, the average house price in the UK is £286,000.
However, all this may be about to change, because of rising interest rates.
What are Interest Rates?
Interest is essentially the cost of borrowing money and an interest rate tells you how high the cost of borrowing is.
From a property perspective, the mortgage interest rate will be the rate that you pay for borrowing the money against your property and it is useful to note that there is a difference between the Bank of England base rate and the mortgage interest rate that you pay, but that they are both correlated.
But, why are interest rates increasing in the first place?
Well, to understand this, we first need to understand what inflation is
What is Inflation?
Inflation is the general increase in the price of goods and services over time.
The Bank of England’s only role is to keep inflation at a target level of 2% and it uses monetary policy by rising and lowering the interest rates to do this.
Currently, the inflation rate is 9.9%, so the Bank of England needs to increase interest rates to get inflation back under control.
Why does Increasing Interest Rates Work?
Increasing interest rates works because it reduces the amount of disposable income people have in their pockets, which then reduces spending. As well as this, increasing interest rates also means that people make more interest in the bank, which encourages people to save rather than spend. Because there are fewer people buying, the price of goods and services fall, reducing inflation.
Why Have Prices Increased?
No doubt you will remember the various lockdowns that were imposed during the COVID-19 period. During those times, people couldn’t go to work and this caused massive supply chain blockages, with some people paying as much as £5 for a toilet roll!
As well as that, with people being told to stay at home to avoid spreading the bug, the Government had to provide ‘a stimulus package’ (or more commonly known as ‘money’) to people to make sure they could still afford to eat and heat their homes.
All that extra money in the economy was just printed out of thin air and without an increase in productivity, this naturally lead to an increase in the price of goods and services.
And as if that wasn’t bad enough, over the last 2 years, energy prices have sky-rocketed and because you need energy to make or transport almost all goods and services, the price of those goods and services has also increased.
What Does All This Mean For Property Investors?
Ultimately, increasing interest rates reduces your rental cash flow. However, on a positive note, the potential of reduced cash flow creates less of an appeal for potential investors and therefore, an opportunity to purchase properties at a discounted price as the demand for BTL starts to slow.
We expected that price reductions may be more prevalent in London, where rents may not be able to keep up with mortgages. However, in places like Leeds and Sheffield, there is a larger buffer between the rents and the mortgages, meaning there is scope for a better return during these times.
When Will This Begin To Affect Property Investors?
One thing to realise is that there is going to be a time lag between when the rates increase and when these impacts take place.
With the rate increases we have seen in 2022, they have only just started to impact the property market with fewer people buying and more people starting to accept slightly lower offers. In fact, it usually takes 12-18 months from a rate increase to when the full impacts can be felt in the market.
The demand for properties has started to reduce, but will become more evident when the cold weather hits and the cost-of-living crisis starts to really bite.
The other point to mention is that the prices of properties is not only affected by interest rates, but by consumer confidence and by the availability of mortgages in the market.
At the moment, consumer confidence is waning and there are few good mortgage rates available in the market
We expect that as soon as confidence starts to return to the market, which it may start to do soon, now that we have a more credible Prime Minister in power, inflation will begin to come down and in turn, so too will the mortgage rates.
Here’s What We Think Will Happen
Interest rates are going to steadily increase. They are currently at 2.25% but we think that they will increase to 3% in November and then maybe to 3.5 or 4% early next year.
This will continue to decrease the demand for properties nationwide, which should in turn reduce prices. In places like Leeds and Sheffield, we expect prices to stagnate or maybe dip by 5-10% in the short term.
Inflation should start to come down next year and so interest rates should do too, ending the year at 2.5%-3%. Once rates start to normalise at that level, we expect the demand from BTL property to increase once again.
After 2023, we expect this 3% interest rate level to remain in place. While 3% may seem like a high rate of interest compared to what we have been used to, it’s important to remember that they have been much higher in the not-too-distant past. For example, in 1991, interest rates were as high as 15%, so 3% is not as drastic as it may initially seem.
What Should You Do About Rising Interest Rates?
1. Get your mortgages on a fixed or tracker rate
First things first, if you are on the Standard Variable Rate or are worried about your payments, you should speak to a Mortgage advisor to find out what options you have.
Rates are expected to be relatively high for the next few months but will come down in the short to medium term, so in some instances, a tracker may be a better option.
Because of increasing mortgage rates, if you have any buy-to-let mortgages, or a residential mortgage that are on the Standard Variable Rate you should get them on a fixed rate deal or tracker rate (depending on your attitude to risk) as soon as possible. Especially if you can get a good Product Transfer rate with your existing lender
2. Invest in property as soon as possible.
Property is a stable and inflation-proof asset class because the prices of property increase in line with inflation. While the interest rates are going to start eating at your rental returns, there is a real opportunity to save tens of thousands of pounds by buying when no one else wants to. Over the next few years, the rates will come down and things will return to normality. Knowing that, why not take a short-term sacrifice on the rental income for a much larger pay-off in the capital price?
3. Don’t panic
For the financially aware, a recession is a golden opportunity to make generational wealth and financial security. Despite the doom and gloom you may hear in the news, it’s important to remember that a recession is just a change in the market and it’s normal for the economy to go through a period of boom and then a period of bust.
As investors, it just allows us to have a reset and reconsider where everything is and allows us to move forward from there, evaluating how to make the most returns from our investment.