An introduction to the UK s buy-to-let sector

An introduction to the UK s buy-to-let sector

Contents 01 Introduction 02 The rise of a new market 03 A high performing asset class 04 Capital growth 06 Rental yields 07 Tenant demand 08 Tenant requirements 09 Forecast This report is intended to offer an overview of the UK s buy-to-let investment market. It charts the inception of the sector, before offering some insight into the current market conditions. 01

Buy-to-let the rise of a new market Buy-to-let a high performing asset class Buy-to-let is a phrase that was first coined in the mid-90s when it was used by the Association of Residential Letting Agents (ARLA) to refer to a new type of mortgage. The mortgage and the name were needed because ARLA s members had a shortage of rental housing stock and were consequently unable to cope with the rise in demand for rental accommodation from young people, migrants, the student market and from those for whom house purchase was not a realistic ambition. Of course, tenant demand for rental property far predates 1996 and since then, according to English Housing Survey statistics, the amount of properties the UK s private rented sector has increased from 2.4 million dwellings to 4.0 million a rise of 73.9%. Now, the term buy-to-let is no longer only synonymous with a mortgage, it is a distinct asset class. Trends in tenure, 1980 to 2012-13 16 14 12 To mark the 18th anniversary of the UK s buy-to-let sector this year, Paragon Mortgages assessed how a hypothetical investment would have performed since 1996. The Buy-to-let comes of age report stated buy-to-let has been the outstanding investment of the past 18 years, providing average returns that easily outstrip those of other major asset classes. How buy-to-let performed against other investments Buy-to-let, with a 75% mortgage 13,048 Buy-to-let, without a mortgage 4,791 UK commercial property 3,654 Equities (FTSE All-Share index) 3,082 UK government bonds 2,924 Cash 1,949 million households 10 8 6 4 2 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2008-09 2009-10 2010-11 2011-12 2012-13 The chart shows that 1,000 invested in an average buy-to-let property purchased with a 75% loan-to-value (LTV) mortgage in the final quarter of 1996 would have been worth 13,048 by the final quarter of 2013. This is a compound annual return of 16.3%, which outperforms an investment in UK commercial property (compound annual return of 7.9%), UK equities (compound annual 6.8%), gilts (compound annual 6.5%) and in cash (compound annual return of 4.0%). A buy-to-let purchaser buying entirely with cash would have seen each 1,000 invested grow to 4,791 by the end of 2013 a compound annual return of 9.7%. 14% of all mortages are buy to let owner occupiers private renters social renters 02 03

Buy-to-let capital growth The figures outlined by Paragon represent growth over the past 18 years, but what about the current market? How has property performed as an investment over the past 12 months? Global house price index In the third quarter of 2014, global property consultancy Knight Frank revealed that the UK property market is one of the strongest in the world. The Global House Price Index for the second quarter positioned the UK residential market in fifth place, behind Dubai, Turkey, Ireland and Colombia and ahead of 49 other countries. The list ranks house price growth over the previous 12 months and was compiled from government and central bank data and weighted by GDP. Even if the focus is narrow back to the UK, there is widespread disparity between geographical regions. At the start of the year, the UK s largest mortgage lender, Nationwide, revealed Best performing regional towns/cities a list of the best and worst performing UK cities over 2013. For comparison purposes, at the time, the average capital growth in the UK was 7.1%. Rank Country 12-month change 6-month change 3-month change (Q2 2013-Q2 2014) (Q4 2013-Q2 2014) (Q1 2014-Q2 2014) 1 Dubai 24.0% 7.4% 3.9% 2 Turkey 14.0% 7.9% 4.7% 3 Ireland 12.5% 5.4% 6.8% 4 Colombia 12.3% 6.3% 4.6% 5 United Kingdom 11.6% 5.8% 2.9% Rank Town/city Annual change Average price 1 Manchester 21% 209,627 2 London 13% 385,741 3 Brighton 12% 348,918 4 Leicester 11% 168,778 5 Birmingham 10% 151,793 On an international scale, Knight Frank believes the overall trajectory of the Global House Price Index is upward as 40 of the 54 countries either exhibited flat or rising prices over the 12-month period, while two years ago, the same could be said of only 31 countries. However, there appears to be significant variation, as a 30 percentage-point gap between the strongest and weakest housing markets has existed for the past two years. Worst performing regional towns/cities Rank Town/city Annual change Average price 1 Carlisle 1% 136,128 2 Edinburgh 1% 235,907 3 Newcastle 2% 169,395 4 Glasgow 2% 157,364 5 Coventry 2% 170,243 04 05

Buy-to-let rental yields Buy-to-let tenant demand Yields are what distinguishes buy-tolet investments from regular property purchases. Providing a property can be tenanted, investors have the potential to receive regular monthly returns. The Paragon report found that over the past 18 years, the average buy-tolet investor with a tenanted property saw total returns that were 50% higher than investors relying on capital appreciation alone. Best performing regional towns/cities Worst performing regional towns/cities As buy-to-let investment becomes more widespread in the UK the locations that generate the highest yields is sought-after information. The most recent example of a buyto-let hotspot list was compiled by TotallyMoney.com in October 2014. Again, there is significant variation across the UK. Rank Location Average property price Average monthly rent Gross rental yields 1 Sheffield 69,995 645 11.06% 2 Aberdeen 138,000 1,200 10.43% 3 Bradford 60,000 459 9.18% 4 Manchester 134,950 980 8.71% 5 Southampton 181,000 1,300 8.62% Rank Location Average property price Average monthly rent Gross rental yields 1 London (Chelsea) 1,795,000 3,120 2.09% 2 Tonbridge 637,500 1,101 2.07% 3 Beaconsfield 1,475,000 2,496 2.03% 4 Dartmouth 385,000 650 2.03% As indicated above the private rented sector is four million dwellings strong and has increased in size considerably over the past few years. It could be argued that this growth can be attributed to the downturn of 2007 and 2008 and the associated clampdown in mortgage lending after the financial crisis. There is no doubt the inability of some young people to buy a property has swollen the private rented sector and housing affordability does remain a key factor in its growth. The significant property price increases detailed in the capital growth section above have outstripped increases in average salary. However, as the English Housing Survey statistics show, the expansion of the private rented sector far predated Generation Rent and the most recent recession. Population growth is certainly a contributing factor. Office for National Statistics figures show the UK s population has increased by approximately 5 million since 2001, and by more than 10 million since 1964. This growth easily outpaced the supply of new homes, resulting in a structural undersupply of accommodation across the country. The decline of homeownership and the expansion of the private rented sector cannot solely be attributed to affordability and population pressures however, as there is evidence to suggest that people are actively choosing to rent rather than buy. Knight Frank believes increased labour mobility has led to a rise in demand for rental accommodation among workers looking specifically for flexibility of tenure especially in urban centres. The property consultancy s Rental Revolution report highlighted that there was approximately a 6% increase in the number of people living in city centre rental accommodation between 2001 and 2011, while there was a similarly sized decrease in the number of urban homes owned with a mortgage or loan. Knight Frank also revealed that 50% of all households in the PRS are classified as high income. An increasing tenant affluence was also highlighted by HomeLet s Rental Index. The research, which is derived from the referencing of 350,000 prospective tenants each year, demonstrated that in the three months to August 2014, average tenant incomes had increased by 3.9% when compared to the same period in 2013. Furthermore, the private rented sector is also a young market. The latest English Housing Survey shows that of the 10 million people living in private rental accommodation, 50% are aged 34 or under. 5 London (Mayfair) 2,187,500 3,683 2.02% In order to secure future rental yields, an investor needs to ensure their property is tenanted. There are two factors involved in this process: the supply of tenants and the attractiveness of a specific property within the rental market. 06

Buy-to-let tenant requirements In order to generate long-term returns even in a soughtafter location within a city of high tenant demand buyto-let investors need to ensure that their property is both initially attractive to tenants and is well maintained. To give investors and landlords the ability to better assess the attractiveness of a specific property within a rental market, property experts Savills conducted research into the key value drivers for tenants. The What Do Tenants Really Want report found: Location 49% of respondents said proximity to work or university is the most important factor when choosing a rental home. Affordability Tenants are willing to spend 26% of gross income on rent a figure that only rises by one percentage point in London. Flexibility Buy-to-let forecast Although older tenants prefer the stability of a longer tenancy, this is not the case for tenants under the age of 24, who value shorter tenancies. Currently, 24% of tenants choose to rent for flexibility, although Savills believes this proportion could rise if the quality of housing stock was to improve. Designs and features This measure is the most open to interpretation and ultimately depends on the individual submarket of tenants in question. However, the research did highlight some general accommodation facilities that tenants are willing to pay for. Extra space is most important to families with children and they are likely to pay additional rent to have a larger property, but space is not as important to single occupants. The most affluent tenants are likely to pay more to have properties with an en-suite for every bedroom. Even if a property is initially tenanted, the longevity associated with a buy-to-let property investment is only realised if a property is continually let. Void periods have the potential to drastically lower total returns. Savills found that a quarter of tenants moved out of their previous rental accommodation due to poor management. For this reason investors must ensure they can commit to maintaining and managing their properties or pay somebody to do it on their behalf. Perhaps the most pressing concern to the future profitability of the buyto-let investment sector is potential for mortgage changes to affect the market. From March 2016, buy-tolet investors may be asked to pass new affordability tests that could result in them being denied loans or paying higher rates for mortgages. However, the remit of the new rules is to monitor how accidental landlords those unable to sell their current home or have inherited a property, for example are lent money. The new EU Mortgage Credit Directive could potentially mean mortgage providers would consider lender salary and spending habits as opposed to solely the ability of the property to generate returns before offering finance. However, a young existing tenant base, the potential to accommodate to an increasingly affluent customer, the growing importance of flexible tenure, and the sustained house price rise in the UK all suggest that buy-to-let returns will be attainable in the future. Knight Frank predicts that rental rates will grow by 2.5% in 2015 and 3.5% in 2016, 2017 and 2018. The consultancy also points out that there is an existing opportunity for investors and developers to brand their rental units, much like the hotel sector, allowing tenants to instantly recognise them as a reliable source of high-quality housing. 08 09

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