Friday, 4 May 2012

Which way next for the buy-to-let market in the UK?

In an earlier blog piece, “Which way next for the Residential Property Market in the UK?”, I looked at the long term relationship between house prices and average earnings and drew the conclusion that, in my opinion, it seemed unlikely that house prices could make substantial forward progress in the absence of growth in average earnings.

It was interesting, then, to see a number of articles highlighting the attractions of the buy-to-let property market, which has prompted me to fire up my abacus again and consider this more fully. The website has composed the Rental Index using a statistical methodology developed by Calnea Analytics, the company who produce the official Land Registry house price index. This seems like a reasonable place to start to consider what kind of rental yields are available across the UK. As importantly, it also gives some idea about what direction rental yields are moving in. This makes very interesting viewing.


Rental yields across England and Wales would seem to average around 4.5% whilst in London and Scotland this figure is around 5.5%. Moreover, London aside, rental yields look, at best, flat and, most importantly, below inflation. Unfortunately longer term information on Rents (which form part of the Retail Price Index) only goes back as far as 1987, but, as you can see from the chart below, they do show a strong correlation with average earnings.

Source: Brewin Dolphin
This should be no surprise, but it does call into question the idea that rents will carry on rising, especially in an environment in which average earnings are not. So, we have already seen house price moves fail to keep pace with inflation over the last two and a half years and we should add to this a letting market that, outside London, has seen little in the way of rental growth.

Of course, for the individual who is looking at the paltry returns available on cash deposits and government bonds – traditional “low risk” investments for those seeking income, the attractions of property are clear. It is a solid asset that, on the face of it, is easy to understand. The market in London, too, is distorted by clear demand and supply issues, coupled with a “safe haven” status for both domestic and international investors. However, property must, in the end, be affordable and this link of prices to average earnings will have to reassert itself in one way or another, either through lower prices or higher earnings.

Investors should be aware, too, that the current ultra low interest rate environment will not be with us forever. While we do not anticipate this happening in the near future, at some stage rates will rise at which stage property investors will be reminded of the fundamental illiquidity of residential property. Add to this, for the individual investor, agent fees for managing the property (for those who do not want to be woken up at 2am to deal with a faulty boiler), void periods, refurbishment costs, government stamp duty, estate agents fees on disposal, income tax due on rental yields and a likely flat property market, I would question whether even 5% property yields are particularly attractive.

For this reason, for investors looking for longer term, real (i.e. inflation adjusted) returns, should consider a well diversified portfolio which, depending on your individual circumstances, may contain a substantial equity content.

Rob Burgeman
Divisional Director

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