Banks and owners stalling in buy-to-let sector

With the budget around the corner, we are hearing soothing noises all round about the economy.

We are to be grateful that in an inversion of the biblical reference 1 Kings 12:11, we are not to be beaten with the scorpion of €3.1bn but merely with the whip of €2.5bn in cuts. Hooray…

We also see the ESRI coming out very bullish on the economy, particularly with regard to employment.

How much of this is a dead cat bounce and how much a sustained improvement, we will see, but one thing is clear, we are by no means out of the woods. At best, we have worked out on what side of the dead tree we should look for the lichen to aid us to get out.

The budget will act as a drag on the economy. What remains to be done on the fiscal side is, by comparison to what has been done, small (but still painful). We are still, however, looking at a structural deficit — that is to say that abstracting from interest payments on debt, we are still running a deficit. Until we are in structural balance, we are still liable to fall into fiscal wardship.

For many persons with mortgages, particularly buy- to-let mortgages on investment properties, the next few years are likely to be the most difficult of all. We now know the buy-to-let market is in the horrors. Of 150,000 mortgages out- standing, 40,000 are in arrears.

Buy-to-let (BTL) mortgages in the boom were typically on an interest-only basis. Thus the mortgagee repaid interest and expected that in 20 or 25 years time the capital value of the property when sold would meet or exceed the initial sum borrowed.

50% of a sample of recent BTL investors noted that they were not getting rental income sufficient to cover the interest. Thus, in addition to these mortgages slipping further into arrears, there is a growing cohort of investors who are building up further arrears on capital. The same investors do not see the property market recovering, in the sense of outperforming for its level of risk, in the short or medium term.

Despite all that, a large percentage of these investors refuse to sell for less than the price at which they purchased. In the face of a 50% fall in capital values where there is likely to be at best modest nominal increases in value in the medium term, this is while understandable from a psychological perspective simple delusion from an economic perspective.

The banks refuse to engage with this problem either. With 150,000 mortgages of whom 40,000 are in arrears, we have a paltry 500 in repossession. There are 10,000 buy-to-let mortgages in arrears of over two years. These are never going to be repaid. The €700m of accumulated arrears are gone. The €3.3bn of mortgage value is impaired by at least €1bn. The banks refuse to move to write down these loans, repossess and move on. This is down to their petrification that when they start to do this, to repossess investment properties, they will cause a cascade. Part of that cascade will be that as repossessed houses come onto the market, this will further depress the prices which, Dublin aside, remain in decline.

A more worrying element is that there are an unknown, but presumably non-trivial, number of these which are cross secured on residential properties. While there is some faint appetite for repossessing investment property there is much less for principal private dwellings. So despite rents beginning to rise, which would make these properties more attractive for banks in their capacity as landlords, there remains a massive blockage. At the bottom of an interest rate cycle, with a depressed economy at best recovering very haltingly, with little prospect of fiscal loosening in the medium term, the outlook for these BTL investors is bleak as it is for the banks.

Sitting on the problem and hoping that it will go away will not work for the BTL investors. Nor will it for banks. While individuals may be excused for anchoring to past prices there is no real excuse for a large commercial organisation to do so.