For property investors, 2017 was a challenging year that saw a marked change in investment patterns. A proportion of small-scale landlords left the market in response to a number of 'anti-investor' tax changes which began to have an effect this year. Conversely, many professional and institutional investors now report growing optimism.
A few short years ago, property investment was widely regarded as a sure-fire win. Across the country, thousands of new investors jumped at the opportunity to make quick and substantial profits. Many, of course, did just that; the UK property market certainly produced a good number of winners in the aftermath of the global financial crisis. However, government policy turned increasingly against landlords last year and, weighing the likely impact of measures such as increased stamp duty, reduced mortgage interest relief and the scrapping of the wear and tear allowance, some investors chose to sell up. In June this year, the Council of Mortgage Lenders reported that the number of properties bought by landlords had almost halved in a year - a trend it attributed to the new taxes and regulations.
There is no doubt that government policy has at least partly succeeded in eroding profits in the private rental sector, but recent measures have not produced any mass exodus from the market. Indeed, some big institutional investors see important opportunities ahead.
Given the uncertainties surrounding Brexit and its consequent dampening effect on the British economy, it might seem strange to be talking in terms of rising optimism. However, there are solid reasons for regarding property as a reliable and attractive investment vehicle. To explain this, let's look at some of the key factors affecting the sector.
One of the best reasons to stay serious about property investment is the absence of better alternatives. Buy-to-let continues to outperform the majority of asset classes, and with inflation now outpacing savings rates, money in the bank is losing value all the time. The stock markets are volatile - particularly while Britain's relationship with Europe is still in doubt - so property looks to be a decidedly more reliable option than most. It has delivered respectable capital growth this year, and average rental values continue to rise.
According to the Halifax, Britain's largest mortgage lender, average residential values rose by 3.9% in the year to the end of November. That alone is comfortably ahead of the rate of inflation and, on top of that, most landlords have also enjoyed a regular monthly rental income.
According to the ONS Rental Index, average rents have risen across all the UK regions - most notably in the East Midlands, which saw values rise by 2.9%. According to Landbay’s National Rent Review, the average monthly rent now stands at a record £1,196.
What's more, rental demand is still strong across the UK and, with no signs of a major house-building boom, renting property will continue to be the only viable option for millions. Demand will therefore remain very healthy, despite forthcoming cost pressures that may force landlords to raise their prices. That being so, Knight Frank forecasts that rents will rise by a total of 14% over the next five years.
Although some landlords left the market earlier this year, rental demand stayed strong and, of course, someone had to take up the slack. In many cases, this fell to the larger, more experienced investors who, quite rightly, continue to regard BTL as a long term venture. As a result, the market as a whole has by no means contracted. According to the latest edition of Kent Reliance’s Buy to Let Britain report, the value of the sector increased by 6.4% year on year, reaching a total figure of £1.4 trillion. Over the same period, it records that average rentals rose by 4.2%. In other words, the market is not dwindling but rather re-shaping itself. The phenomenon was explained recently by Andy Golding, chief executive of OneSavings Bank, who said: "A fundamental shift in the landlord population is now underway, as buy-to-let moves from being a popular pastime for hundreds of thousands of amateur landlords, to the preserve of committed long-term investors with experience and expertise."
A viable investment?
The readiness of experienced investors to remain in the market suggests a strong faith that, as a long term proposition, BTL still offers exceptional value. Looking at market forecasts, key commentators expect that buoyant housing demand and continuing affordability pressures will underpin BTL returns for many years to come. In addition to predicting continuing rental growth, Knight Frank also expects to see average property values rising across most regions. After constrained growth in 2017 and 2018 (1.5% and 1% respectively), the company is forecasting average price growth as follows:
Over the 5 year period, that equates to cumulative price growth of 14.2%. Importantly, however, it does not expect that pattern to be evenly distributed. Some regions are expected to fare considerably better than others.
Knight Frank forecasts that, over the next five years, the leading regions will be the Midlands, the East of England and the North West.
London has endured a rather woeful time in 2017 as average property values began their return to more sensible territory. New buyers and young professionals in particular had seen that at least half their average incomes were destined to be spent on accommodation if they remained in the capital, and so large numbers of them left the city in favour of destinations offering better standards of living. Manchester, Sheffield, Bristol and other growth areas were some of the biggest beneficiaries.
Due to its size, London understandably remains in the top charts for rental demand, but it is seeing increased competition. In December 2017, property marketplace, TheHouseShop.com published a list of the top five UK cities for tenant demand. After London, the other sought-after rental locations included Birmingham, Bristol, Leeds and Manchester. Amongst these, Bristol attracted the highest number of millennials, Manchester saw greatest demand amongst the 35-50 demographic, and Birmingham attracted greatest interest on the part of those aged 51 to 69.
The falling popularity of central London can quickly be appreciated when one considers the cost of making a home there. According to a recent National Rental Survey by Landbay, "41% of millennials do not expect to ever own a home of their own."Those that rent up to to the average life expectancy of 82 will pay an estimated "£1.1m on rent if they live outside of London, and a staggering £2.6m on lifetime rent if they live in the capital." These figures may seem daunting, but there is similar price disparity when it comes to buying a property. According to the ONS, the average house price in England was 5.11 times average earnings, and by 2008, the ratio had risen to 7.14. In 2016, it reached 7.72. However, affordability was considerably worse in London, where the price to earnings ratio rose to 12.88.
In London, the result of this overheating market has been a rebalancing of prices - in other words, a drop in average rentals. According to the Mortgage Industry Advisory Corporation, rents fell by an average of 0.83% in London, while outside the capital, landlords did rather better. Overall, according to MIAC figures, rents rose by an average of 1.27% over the course of 2017. This figure is less than the 4.2% cited by Kent reliance, but all reliable sources agree at least that rental values are continuing to rise.
What seems unarguable is that some of the best property investment opportunities are now to be found well outside the South East. In December, Knight Frank published its Private Rented Sector Update, which stated: "Whilst much of the regional PRS appetite to date has focussed on ‘best in class’ city centre assets in key cities, an increasing number of institutional investors are now looking beyond these, to more secondary cities and to well-connected satellite towns... where superior affordability ratios offer greater potential for rental growth, whilst still providing secure income with strong rental demand."
In November, Savills expressed a similar sentiment with respect to capital growth, stating: "Price growth will be most sluggish in areas where affordability is most stretched; particularly London and the commuter belt. Affordability in the capital is already more stretched than the rest of the UK, putting a brake on growth. But areas beyond the Home Counties have potential for growth: incomes have grown more in line with house prices, aiding affordability. That’s why we expect the North to outperform London and the rest of the country. The North West, in particular, has a robust economic outlook and strong employment growth. And house prices sit at a modest multiple of average incomes: 5.6 times in the North West, compared with 12.9 times in London."
Forecasting prices, rental growth and economic performance is notoriously difficult, particularly at a time when Brexit is casting such a long shadow. However, many commentators seem to feel that once some kind of exit arrangement has been reached with Europe, Britain will begin a process of recovery.
Supply and demand are key to the way that prices will change next year, and several important factors will affect this.
On the supply side of things, house-building is not expected to see a major surge. Indeed, a recent survey of house-builders showed a marked fall in the rate of construction since June 2016. Most believed that the industry would fall well short of the targets set by government - i.e. one million new homes by 2020. If that trend continues, then the private rental sector will remain the only logical alternative provider of accommodation for the foreseeable future and, accordingly, rental demand should hold strong.
The departure of some landlords earlier in the year will have released a certain amount of stock into the housing market but much of this is likely to have been acquired by other, larger, more experienced investors. Likewise, there is a possibility that new minimum energy efficiency standards in 2018 will see a number of BTL properties being sold off by cash-strapped landlords who cannot afford the costs of refurbishment. Again, however, many of these will be bought back into the private rental sector. In any event, the number of such newly marketed properties is unlikely to make a big dent in the UK market as a whole.
For the moment, the biggest constraint on market growth is regarded by many to be Brexit. In November, Savills wrote that the main thing holding back growth was uncertainty. " With the UK’s future relationship with the EU up in the air, we’ve seen the UK’s credit rating downgraded, the pound weakened, and the economy subdued. Inflation has cut into people’s earnings, with the ONS reporting that incomes fell by 0.4% last year in real terms. Against this economic backdrop, there are no strong drivers for house price growth over inflation next year." However, once the dust settles, Savills expects successive years to offer better prospects, saying: " We expect the market to return to growth in 2019-20, as employment growth, wage growth, and GDP growth swing back towards trend levels."
In short, the Brexit question may cause some short term turbulence, but strong demand and a shortage of new housing continue to provide firm foundations for the BTL market as a whole.
2017 saw the first interest rate rise in a decade as the Bank of England finally chose to push up the cost of borrowing. However, just as it had signalled, the rate rise was very small - a minimal 0.25% - and the Monetary Policy Committee has said that any future rises will be small and incremental. The Bank is wary of making sudden changes, so the market is unlikely to face any big shocks, and the base
rate itself is expected to remain well within a historically acceptable range. As Knight Frank reported: "The UK may now be entering a period of interest rate rises but, even so, we expect rates to be low compared to long term norms."
2017 has seen a shift in the structure of the private rental sector. Some landlords operating at very narrow margins have left the market but the shortfall has largely been made up by professional investors who remain committed to the BTL sector and the impressive returns it still promises. The sector has taken a number of knocks this year but the market fundamentals remain strong and promising. Demand is healthy; supply is short. That's invariably a recipe for sustainable prices.
2018 will inevitably see further uncertainty, but this should diminish as the country gains more clarity on how its relationship with Europe will evolve. With greater clarity should come greater market confidence and an improvement in economic performance. Once average wages recover lost ground against inflation, this should provide fuel for price growth in the housing market, whilst also alleviating cost pressures on paying tenants.
Forecasts are generally promising, but they vary considerably by region. The North West and the Midlands are widely regarded as offering some of the greatest potential for investors. These are markets that we ourselves have been looking at very closely and we'll be featuring them in some of our blog posts in the coming year.
Until then, have a very happy Christmas and a prosperous New Year from all of us at Residential Estates!