Buy-to-let: It’s not all about capital growth

Tracking the affordability of rents can be complicated

The stability of rents against average incomes makes for an attractive proposition.

The UK – and London in particular – has been the beneficiary of large inflows of global capital into property in the last few years. While most of these funds have flowed into commercial real estate, a growing proportion is being directed into residential assets.
This should be seen as welcome news, as fresh sources of investment are needed to support an expansion of the delivery of new housing. Some of the largest new housing schemes around London are underpinned by commercial investors developing homes for rent, while in Manchester the local authority pension fund is actively investing in rental schemes.


But aside from being attractive to institutional investors, the residential market also offers private investors assets that can deliver a stable and robust income stream.
When it comes to investing in residential property, the general assumption is that all investors are chasing capital gains from an under-supplied market. The reality is somewhat different. While investors take comfort from the prospects of capital growth over the long run, it is the income profile from investing in UK housing that is the real attraction. There is strong investor demand for assets that can deliver robust and stable cash flows which track the growth in earnings over the long run. This is as important to a private investor investing for retirement as it is for a pension fund looking to match its future liabilities.


Over the last decade, we have seen the rise and fall of many housing-related indicators – from house prices, which fell 20 per cent and have subsequently bounced back by the same percentage, to private house-building, which is still 40 per cent below its 2007 levels. The one measure that has hardly budged has been the proportion of average earnings accounted for by private rent. This measure has tracked in a consistent, narrow range of 31 per cent to 37 per cent, and has averaged 33 per cent since the fourth quarter of 2004. The stability of this measure is particularly attractive to investors.


Across the UK, rents as a proportion of earnings are at the lower end of the affordability range, suggesting that there is potential for rental growth as the economy recovers and incomes start to rise. In inner London, however, the ratio is much higher as a result of higher rents. Accurately tracking the affordability of rents in London is made more challenging by the trend towards higher occupancy of rented housing. To pay higher rents in a central area, more tenants are sharing. The rent is paid for by more than a single earner, thereby making any assessment of affordability more complex.


Half of all private rented homes in London are now fully occupied. It’s a growing feature of a market under pressure, and presents management and design challenges for the new breed of investor looking to develop rented accommodation. It is nothing new in the US, however, where so-called multi-family housing accounts for a significant amount of institutional investment.


The greatest challenges for investors will be to compete for land with speculative developers, and to ensure that rents are pitched at the right level to ensure sufficient demand and a steady income. Affordability pressures put a cap on how high rents can rise, and investors will need to be realistic on rental values. Greater focus on delivering supply in the most desirable locations with the right range of services will be important as supply expands and the choices for tenants increase.
Richard Donnell is director of research and insight at Hometrack.

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