With low funding costs and numerous income opportunities, the advantages offered from residential lettings are a tempting new market for banks to enter. However, several pitfalls remain.
In the post-Covid-19 age, banks are badly in need of new sources of revenue. Record-low interest rates, huge loan impairments, and a desire by consumers to pay down consumer credit has got many incumbents thinking about where to find new income streams. And with a new CEO, UK incumbent Lloyds Bank has decided to use its current saving glut to generate revenue by becoming a private landlord.
Historically, with such a small private rented sector and tax advantages for owning, this strategy was not a viable option in the UK. Private landlords have almost always been amateur property investors, and even in 2019, roughly 50% of landlords owned just one property.
However, with a growing private rented market, professional investors are beginning to take interest. For Lloyds, the sector offers good potential to create synergies with its current UK banking business.
For a start, private rented tenants are often just the sort of customer that banks are looking to attract: young with plenty of cross-selling potential – including mortgages – and living in an urban area with good future job prospects.
By forming a landlord-tenants relationship with them, Lloyds will be able to form regular contact with future potential customers, making it more likely for the bank to cross-sell a mortgage to them when the time is right.
The tenancy period would also act as a soft credit score, with Lloyds being able to see how reliable that customer is paying for housing on a regular basis before entering into a mortgage.
For the customer, Lloyds is bound to offer them a more attractive deal, such as lower rental payments by saving regularly, taking out and paying back loans, or spending responsibly to avoid loss of rent. And once a customer, the bank could then easily show creditworthy customers how they could reduce their housing payments by switching from renting to a mortgage instead, using a like-for-like comparison.
Lloyds may even take advantage of new reforms to shared equity mortgages, with the bank offering customers a chance to buy equity in their rented house, reducing the customer’s rental payments and helping the bank to sell a mortgage product incrementally. This would be particularly lucrative for the bank, as it would allow considerably more people to begin owning their own home and it would offer numerous chances to charge fees for associated services.
Furthermore, becoming a landlord might also help to lower risk while increasing returns. Since the late 1960s, a lack of available development plots has caused UK house prices to grow significantly faster than either wages or inflation. And while reform to the planning system is in the pipeline, the plans are unlikely to change the current dynamic of the housing market.
In the long-term…
In the long term, therefore, Lloyds would be able to benefit directly from a rising housing market, with lower interest rates and subsequent interest income offset by higher house prices. A new landlord business model would also allow banks to deal more effectively with repossessed properties, putting them on the market for rent rather than immediately disposing of them in a fire sale.
However, this strategy is by no means a risk-free option for the bank to take. For Lloyds, this idea, if handled badly, could be a PR nightmare. The thought of a bank turned private landlord vetting and refusing tenants, arguing over service charges or deposits, and making families homeless from unpaid rent is enough to terrify many bankers and give zeal to anti-bank politicians.
Critics may even cast suspicions of ‘unfair competition’ on individual landlords or the supposed monopoly power of banks. The strategy also ties up a lot of the bank’s capital in illiquid assets, a dangerous problem during episodes where both the property and financial markets freeze up, such as the last global financial crisis in 2008.
For banks considering the private renting sector, today’s market represents ample opportunity to generate new revenue streams, attract and retain customers to cross-sell, and lower idiosyncratic risk. However, for every few opportunities lies a pitfall that could cause major problems for banks long into the future and could even cause the next crisis if not careful.