As we approach the dark days of winter, I thought I’d have a look at the prospects for those considering investing in the UK’s private residential sector.
Will the housing market recover or are we in for a double dip? Is now the right time to invest? What are the long term prospects for investing in private rental property?
Demand vs supply
Firstly, the facts are that we all live in a market economy which seeks to balance demand and supply.
Buying an asset that is in limited supply where there is heavy demand for means that ultimately you should see the value of that asset rise in value over time. Guess wrong; and you could watch your hard earned cash wither on the vine.
So let’s have a look at some of the key stats that define the UK housing market and the likely direction of travel for investment returns in the medium & long-term.
UK housing demand
1. We live in a country with a growing population. Recent forecasts from the Office of National Statistics (ONS) indicate that the UK’s population is expected to grow from 60.5m (2006) to 71.1m by 2031. However, the Coalitions recent immigration cap may reduce this. The forecast is for an increase of 17% in population.
2. Single people who make up a sizeable proportion of the private rental sector are projected to increase from 6.8m in 2006 to 10.9m in 2031. (source: Communities & Local Government (CLG))
3. The number of households is on the rise. In the UK its expected to rise 29% from 21.5m in 2006 to 27.8m in 2031 (source: CLG)
4. The increase in households is particularly pronounced for London & the South East. Households in London are forecast to rise from 3.2m in 2006 to 4.4m in 2031. In the South East the increase is 3.5m to 4.8m in the same time period. (source: Experian)
Looking at these figures it’s clear that there is increasing pressure on the UK housing stock. But will housing supply keep pace?
Supply of new housing
The UK has been characterised by a change in the type of housing provision over the last 30 years with the private sector now being the dominant provider of new housing. The proposed public sector cuts mean that this looks set to continue.
1. There are approximately 22.5 million dwellings in England. Private sector housing supply has consistently failed for the last several decades to meet the requirements set by Government. The Government predicts that the housing industry needs to build 240,000 new properties each year. Even in the boom years the industry has not built more than 200,000 and recently following the financial crisis this figure dropped below 100,000.
2. The planning system seems hell bent on not allowing these targets to be met. The reality is that despite each government claiming that they will make the planning system more responsive they then lump a whole load of extra regulation on it to make it harder & more expensive for builders to get planning permission. The latest political sop to the Liberals and the Nimbies is the localism agenda. This can only make things worse.
Shortfall of supply
It looks from a simplistic analysis of this information that too few houses are going to be built. However, what does this mean for the rental sector?
The reality is that the UK is still a population of aspirant homeowners. However, this ambition is being curtailed by lack of finance and affordability.
The latest statistics on mortgage lending indicates that total lending in 2010 is set to reach £140 billion. This remains at about half the £250 billion that was considered normal in recent years according to Council of Mortgage Lenders figures.
That means that many first time buyers are struggling to buy, mainly because they are unable to raise the large deposits required by many lenders. Latest stats show that the average 1st time mortgage by a first time buyer is an incredible £34,000.
Added to this is the fact that the main source of first time buyers have been traditionally new graduates or newly qualified professionals. However, with half the population going on to do a degree but then being landed with an average of £25,000 of debt the chances of the new graduates being able to afford to buy quickly, even if they are the lucky ones in getting a job are going to be small.
Signs of growing demand for rental accommodation
It’s not therefore that surprising that many in the know are forecasting a new paradigm in the size and the scale of the private rental sector. Savills’ the upmarket surveyor has predicted in their latest research on development and property investment released in September that the private rental sector could easily grow from it’s current 14% of the share of total households to 20% by the end of the decade.
This structural shift in demand is starting to be reflected in rising rents as more & more potential purchasers defer their purchasing decision in favour of renting. The latest stats from the likes of the Rent index and Propertyfinder show that rents are hitting record levels.
Rising rents are all good news for landlords who assuming that house prices do not rise should see their rental yields increase.
Will rising rental yields attract more investment?
In theory, rising investment yields should encourage more landlords into the market to buy more investment property. However, the elephant in the room with this theory is the concern of many landlords that house prices could dip lower. This in my view is curtailing many landlords from entering the housing market to make a new investment purchase or to increase the size of their investment portfolio.
We all know that a property investor takes a huge risk if they gear an investment and then asset prices fall. Even where in the current low interest market many landlords are making good income returns. These could all be wiped out in the short term if house prices then take another nose dive. US investment bank Morgan Stanley predicts that UK house prices could fall by up to 18% by the end of 2011. Extreme pessimism I know, but a significant risk for landlords none the less.
Added to this is the very high price of obtaining mortgage finance compared to recent years. In order to obtain a buy-to-let loan many landlords are faced not only with paying very high real interest rates but also excessive set up fees and charges that can easily add several percent to the cost of their investment.
Will & should landlords respond?
So will landlords step up to the plate and provide the increased amount of residential investment property being demanded? I think the answer will be yes. What we do need is to be convinced that we have a stable housing market. Prices don’t need to be shooting up; but we need to be convinced that they are not going to lurch downwards again either. Also, we need the lending market to become more competitive. There was encouraging news this week that Paragon; one of the biggest lenders in pre credit crunch days were going to re-enter the market.
Finally, what landlords need is the surety from the Coalition Government that we face a stable and benign regulatory regime which is not going to impose more costs and complexity in the letting process. What we also don’t want is legislation that favours institutional investment in the private sector at the expense of smaller independent landlords.
If these conditions prevail I think that private landlords will respond to the challenge and fund the massive increase in the private rental sector at no cost to the taxpayer. If only we could say that about other parts of the UK economy!
Do you have a view on the prospects for the private rental sector? Posts your comments here.
Good article at a higher level. However fails to address local trends that are significant.
If you take Newport, South East Wales there has been a massive about of new build. This has caused over capacity and rents of new flats have fallen from £600 to £500 per month on the last year. This has had the effect of bringing down the other older property prices.
Yet in a nearby town this is not an issue as they are in a different situation.
Also some landlords have lost their shirts on new build as they would have paid up to £180,000 for flats that are now selling for £82,000. This means some people are trapped. However the people buying now have a good return and can cope with lower rents.
So you need to be very careful about what is being built as it will affect an area is there are a lot of them. Even if you think it is not the market you are in the effect of lower rents will come through.
The LHA effect.
Just as the first time buyer is the foundation that the property price ladder sits on then the Local Housing Allowance is the base which supports the housing rental rates in many of the less prosperous areas of the country. The change from 50 to 30 percentile points will reduce many LHA rates by £25 to £50 pounds per month. This does not sound a lot but if you are benefit rich, cash poor then it certainly is. The most likely outcome will be for singles to consider HMO's and studio's and couples to downsize from 2 bed to one bed.
As 2 bed houses are the majority of my portfolio, I may see longer voids and no rent increases, an income reduction I can accommodate. However I think that flats with high service charges will cause some headaches especially for the more highly geared investor. If you factor in future interest rate rises then the new flats market will not be a nice place to be.
The suggestion that LHA along with other specific benefits may be abolished and replaced with a single payment to the claimant is scary. At the moment the council tells the tenant that so many pounds is for the landlord so there is a good chance that will be paid on. If the claimant is told that this is a single payment for his needs, then the rent payment will have a lower priority.
I cynically assume that the present unjust system will continue were the social landlord will get direct payment of the rent and the PRS landlord will have to rely on the honesty of the tenant to pass the payment on. Why as a one man band am I exposed to this risk when big organisations are protected against it?