Renting a home. When both residents and investors lose
Over the last few years, the rent of apartments, rental prices and the profit that can potentially be generated from renting have been a matter of much and heated discussion in both the media and around heavily-laden holiday tables.
Vaidotas Šumskis, Senior Economist at the Macroprudential Analysis Division of the Bank of Lithuania
Discouraged by low interest rates from depositing their savings in banks, which used to be one of the most attractive alternatives, the country’s citizens now appear inclined to invest in buy-to-let homes. There are several sources proving that this way of making savings work has become ingrained in the minds of Lithuania’s residents. For instance, the data from the Centre of Registers shows that the number of households with more than one home has been increasing steadily in the country in recent years, whereas second homes bought between 2015 and 2016 accounted for nearly one-seventh (13.8%) of the total number of housing transactions concluded in that period. The appetite of the Lithuanians for housing investment is also proved by opinion polls. For instance, a household survey carried out by the Bank of Lithuania in July 2017 revealed that one out of two residents identified real estate (RE) as the best current investment option. Moreover, brokers active on the RE market, as well as builders and bank representatives indicate that nearly one in three newly-built apartments in Vilnius has recently been purchased for letting purposes. In a survey, which was commissioned by UAB Inreal as far back as in 2005, i.e. well before the crisis, four out of five respondents said that RE would be their first choice of investment if they had any free cash available.
By buying buy-to-let apartments, residents promote activity all across the RE market. The growing demand for housing contributes to the employment of a wide range of residents, including housing builders, appraisers, sales agents and other professionals, and promotes growth of their income. On the other hand, attention should also be given to potential negative consequences, since such repercussions affecting the country’s entire population may result from over-optimism on the part of buy-to-let investors spending, with ease, their savings on residential property, in particular where these are coupled with borrowed money. So what would those negative consequences be?
The buy-to-let home buying frenzy may pose threats to the sustainable development of the housing market. Investors ploughing their savings and borrowings into apartment buying drive the demand, which, in turn, pushes up home prices. As a result, younger residents who want to buy their first home may have to shelve these plans for the time being and continue renting or staying cooped up with relatives. Hence the demand for rental housing is also growing, which may give rise to false expectations that apartment rents will keep climbing continuously and will be followed by growth in apartment selling prices. Given the excessive activity on the part of investors, builders may be unable to deliver a sufficient supply of new apartments to keep up with soaring demand, which may lead to an illusion that the stock of apartments available for sale will be depleted soon. Meanwhile, a sudden slowdown in economic growth would trigger opposite developments. It would not take long for the shortage of apartments to reverse into a surplus stock of homes available for sale and for housing prices to plummet. In this case, the biggest losers would be the least experienced investors who have bought buy-to-let homes at the highest price, often on advice from relatives, neighbours or taxi drivers instead of professional RE market participants.
Eventually, long-term and wide-scale buy-to-let home buying may further exacerbate the already noticeable income inequality and increase social exclusion. In most cases, buy-to-let homes can only be afforded by a very small group of more affluent residents and foreign investors. Thus a substantial share of the housing stock may become concentrated in the hands of a small part of the public and investors from abroad, which would see their assets and income grow even further, whereas large parts of the population would suffer from the lack of affordable housing. Moreover, lower income earners would have to spend a substantial fraction of their income on rent for a longer period of time due to a rise in home prices, which would undermine their possibilities for making savings. As a result, adequate housing may simply become unaffordable.
A glaring example of this is provided by the UK. The popularity of buy-to-let home buying and, at the same time, the demand for housing in this country was driven, inter alia, by the buy-to-let mortgages, which were introduced back in 1996. Since then, the number of rental homes has more than doubled. Moreover, a study carried out in 2014 by the Intermediary Mortgage Lenders Association found that rental homes were expected to account for more than one-third of the total housing stock in 15 years’ time. The same study also revealed that roughly half of all new homes built in the UK between 1986 and 2012 were rented out. However, according to the data from HM Revenue & Customs, persons generating income from rental properties accounted for a meagre 3 per cent of the population in 2015, which means that the owners of all rental homes represented a small percentage of the population. Moreover, low interest rates and favourable financing conditions encouraged the increasing number of UK’s residents to buy their own home. Given rapid growth in the number of both buy-to-let and first home buyers, housing prices in the UK grew at a substantially faster pace than household income. At the same time, investors grabbed up homes like hot buns thus fuelling a rise in the number of rental homes. In a situation of increased supply of rental properties, residential rents could no longer keep pace with home prices, powered by relentless demand. This led to a substantial decrease in home rental yields, whereas currently the country faces a serious shortage of homes.
It can be stated with a high degree of certainty that a substantial proportion of revenue generated from rent of accommodation is not declared. According to the data made available by the Lithuanian State Tax Inspectorate, only a meagre 0.3 per cent of the country’s residents declared income from the rent of RE in 2015. This proportion was nearly ten times smaller as compared to the share of residents that declared such revenue in the UK in the same time period. However, the popularity of housing investment in the UK is unlikely to be that much stronger. Tax evasion flourishing in the rental market leads, inter alia, to a lack of reliable data that could enable its regular and thorough monitoring.
Low interest rates, the growing activity in the RE market and the rising home prices underline the importance of close and regular observation of the processes ongoing in the buy-to-let market. The growing popularity of buy-to-let home buying may lead to a vicious cycle of renting. In a situation like this, home prices are rising at a rapid pace, supported by both profit-seeking investors and ordinary residents who are in a rush to buy a home before it gets even more expensive. Meanwhile, potential homebuyers find themselves forced to continue renting a home as they are hampered in their chances of saving up a down payment.
Various countries use different strategies to break these vicious cycles. Some of them choose to impose an additional tax on transactions or to tighten the requirements for buying second or subsequent homes. Experience has shown that these methods may be effective in mitigating the consequences that may arise due to excessive buy-to-let home buying on the part of investors whose exuberant behaviour may threaten to shake the foundations of the whole RE market and who may seek to secure their prosperity at the expense of other residents. Lithuania has resorted to the so-called Responsible Lending Regulations established by the Bank of Lithuania, which have been in force since late-2011 preventing the excessive and high-risk lending and borrowing behaviour from gaining ground in the RE market. At the same time, the Bank of Lithuania continues to closely monitor the market and has a wide panoply of other financial stability measures at its disposal and may use them if necessary.