Peter Dawkins:
Welcome to the Industries in Motion Podcast from RBC Capital Markets, where we take the time to explore what's new and what's next in today's fast-moving industries to help you stay ahead of the curve. Please listen to the end of this podcast for important disclosures. I'm Peter Dawkins, product manager at RBC Capital Markets. And today, I am joined by Benjamin Toms, a director on our European banks team. Ben has been with us since 2015 and is responsible for coverage of UK and large-cap Spanish banks.
Ben joined us from Barclays, and prior to that, worked with Deloitte where he qualified as an accountant. Firstly, I just wanted to thank you again for your time today. And we are delighted to have you as our speaker as I really do feel that the subject matter for today's chat is the most topical that it's been in years, and that's the buy-to-let market. I know you've written on this topic extensively over the past year. So I think it's best for us to just get straight into it and discuss really to start off with, what topics have been the key focus areas for your clients over the past few months?
Benjamin Toms:
Hi Peter, and thank you for having me. Well, landlords, they've been experiencing higher remortgage costs over the last couple of months. And the market for housing has started to turn. So I think that the investors have been really been focused on the outlook for buy-to-let volumes and also the potential for a decline in asset quality. If you go back to 2008 in the financial crisis, buy-to-let volumes came down sharply and cost of risk increased. So investors have been worried that history could be repeating itself in that respect.
Peter Dawkins:
Well, I think if you're, you've painting that picture of 2008, that sounds quite ominous. What are we thinking then in the context of this current market? Are you looking at a similar environment in 2023 as we saw in 2008?
Benjamin Toms:
I think broadly speaking, we do think that 2023 will be a tough year for buy-to-let lenders. In terms of house prices we think that they could come down 10 to 15% and the volumes for buy-to-let could be relatively thin. However, we do think the pain will be focused on amateur landlords rather than professional landlords with any decline in the professional market rebounding in earnest in 2024. For landlords and tenants, I think the narrative is going to be more focused on significant rental increases. We think about at least 10% and what that means for affordability for the consumer. Whilst there may be a decline in asset quality, we do think that's relatively contained and will be manageable for the banks.
Peter Dawkins:
So you said declining housing prices, lower volumes, hit to rents and affordability. What would that then mean for your projections for loan growth, vital net loan growth in 2023?
Benjamin Toms:
We often are asked the question about whether we think the loan growth will go negative for next year. In short, we don't. The environment will be tough for volumes, particularly if there's a large house price correction, but we still expect the buy-to-let stock in the UK to grow in 2023. And I think a key factor here to consider is that the remortgage market is much larger than it was in 2008. So today it's about 60% of volumes. 10 years ago it was about 40%. Therefore, when landlords stepped away from the market in 2008, the hit to volumes was much larger than we think we'll see next year. The other element to think about here is deposit funded lenders are also likely to win market share as non-bank lenders suffer from higher wholesale funding costs and struggle to fund themselves.
Peter Dawkins:
Okay, that's great. I think if we shift gears here slightly, it's been very difficult to avoid mentions of higher interest rates, higher mortgage rates, higher mortgage costs in the media, and so I think a lot of us have been thinking about that impact on borrowers. What will be the ultimate impact on landlords in this kind of environment?
Benjamin Toms:
So we have no doubt in our mind that consumers who have a mortgage [inaudible 00:03:56] over in the next 12 months are going to feel a real squeeze, and that's a combination of the fact that their mortgage costs could be up to 30% higher, but also they're going to have higher energy and food costs. And that means many consumers will struggle to balance their books in 2023. Now, landlords aren't immune from these higher mortgage costs, and actually the increase will be even higher amplified by the fact that landlords are on interest only mortgages in general. However, relative to residential borrowers, landlords do have the major advantage that they can pass on higher mortgage costs to their renters.
Peter Dawkins:
Well, and I think that's a great thing in theory, to what extent do you actually think landlords will actually be able to pass along higher mortgage costs to their renters, just given everything you just mentioned about cost of living and energy costs and the wallet being hit in so many different directions at once?
Benjamin Toms:
Well, actually it's interesting. The supply and demand economics of rental pricing are currently very much in favor of landlords and of higher rents. Over time, we can see there's a correlation between high rental levels and wage growth, and we're currently seeing significant upwards pressure in that area. And also the rental market tends to be quite countercyclical, and we're seeing currently that there's demand for rental properties growing from first time buyers really struggling to get into the market. Additionally, there's also a structural shortage of rental properties, and that's following years and years of outflows from the sector. That means your only real options as a renter are either to pay the higher rent, downgrade your property, or move back in with your parents. Now affordability will become an issue at a certain point, and it will bite, but we think there's room for much higher rents before we reach that juncture.
Peter Dawkins:
That's interesting because it does really seem like there's an emerging pressure point on both landlords and the tenants, but if you do say there's room to grow, how far do you think rental yields can go for buy-to-let landlords in this kind of environment?
Benjamin Toms:
I think it's useful at this point to maybe add some numbers to the conversation. So we think the gross yields professional landlords, they've been on the rise for a couple of years and we think they're currently around 5.5%. Net yields pre house price movements, they're much lower than that, so around nor 0.5%. Whilst landlords will be able to pass on some of the higher mortgage cost to tenants, they're not going to be able to pass on all of those higher costs and therefore those net yields are going to get squeezed over the next couple of years. Particularly if you take into account the fact that landlords are also in part of a cycle of upgrading energy efficiency of their properties to comply with EPC efficiency regulations. However, critically here, what we think is that net yields will remain positive with buy-to-let mortgages remaining a pretty good way to gain exposure to house price movements. So whilst 2023 may be tough for buy-to-let, we expect the [inaudible 00:06:50] will bounce back in 2024 once house prices have stabilized.
Peter Dawkins:
This has been great, Ben. Thank you so much for your time today. I'm sure our clients will really appreciate hearing from you on this subject in what will probably be a very tumultuous and impactful 2023. So just thank you again for your time. What else lies ahead in today's ever-evolving markets and industries, we will be keeping track right here on Industries in Motion. If you'd like to hear on more subjects like what we've discussed today, please make sure you subscribe to Industries in Motion, wherever you listen to your podcasts. Thank you for listening to today's episode.
Speaker 3:
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