Last year, well-publicised Treasury plans to allow residential investment property to be SIPP-protected were scuppered at the last minute, but surely it is only a matter of time before Britain’s love affair with real estate can also become a solid, tax-efficient, pension-planning platform. In the meantime, individuals who have decided to control their own destiny by investing in (mostly) residential property might be wondering whether the buy-to-let (BTL) market can continue to grow at such an astonishing rate, irrespective of tax breaks. The good news is that evidence suggests it will, provided they invest in the right areas.
According to the Association of Residential Letting Agents (ARLA), perfectly natural supply and demand features will ensure the BTL market slows over the coming decade, but their analysis indicates that private investor’s enthusiasm for investment property will sustain the market even when house price inflation periodically stalls.
The UK’s privately rented sector currently accommodates some 2.5 m households, approximately 12% of the UK total, according to government figures. However, Professor Michael Ball of Reading University believes the private rented sector is actually an amalgam of many different types of tenancy and landlord: “Buy-to-let may have become synonymous in the popular consciousness with private renting,” he says, “but it actually is a much smaller, if rapidly growing, part of it.” Professor Ball estimates that the BTL sector comprises “about 1.5 million properties, housing around 8% of all households.”
Mortgage company lending figures broadly concur with Professor Ball’s estimates. Earlier this year, one industry estimate suggested there were around 750,000 BTL mortgages with an aggregate value of £84 billion. The latest figures for which property values are available* showed that BTL investors owned property assets worth over £120 billion, a figure which has since appreciated by around 25%.
As individuals have increasingly lost faith in the Government’s ability to provide pensions, so the surge in BTL ownership has continued apace. A decade ago, less than 50% of privately rented dwellings were owned by individuals; today, that figure is almost 70%, with the majority of landlords owning one or two properties. An estimated 75% own four or less properties. On average, landlords expect to retain their BTL investments for 16 years and even for new entrants, the market’s long-term prospects are encouraging.
Youngsters priced out of buying
The sector’s attractiveness is a direct function of the UK’s changing demographic. Employment patterns, financial circumstances and entirely different lifestyles ensure that a significantly greater number of younger people now rent rather than own their property. In 1989, an estimated 40% of 20-24 year-olds owned their home; by last year, that figure had fallen by half. An increasing number of individuals are choosing to acquire their principal residence at least a decade later in life than they previously did. It follows that BTL tenants are predominantly young, mobile and in employment. According to ARLA, only 8% are students, although more than a fifth are under 25 and two-thirds are under 35. Would-be BTL investors should remain conscious of these characteristics before buying as they determine ongoing levels of tenant demand.
But has supply increased to meet this demand? ARLA suggest that between 1995-2005, the average rate of growth in assured shorthold tenancies, the letting agreement of choice for the overwhelming majority of landlords, was around 6%. The body expects growth to continue, but at a much slower rate, perhaps 2%-3%, for the next decade. Nevertheless, this represents an annual average increase of between 20,000-30,000 new tenancies to 2016.
Sub 5% mortgage deals still available
Furthermore, the body believes that entry to the market will be fuelled by the introduction of more competitive, lower-cost BTL mortgages.
Twenty years ago, arranging a mortgage on an investment property was an unnecessarily expensive, long-winded process, although matters have gradually improved since the first tax-efficient “Business Expansion Schemes” were introduced in the late 1980s.
Type in “buy-to-let mortgages” into Google and 1.63 million links immediately appear on your computer screen. Banks and other lenders appreciate that, given the demand side of the BTL equation is increasing, so the supply side, namely property, will rise to meet that demand. Accordingly, mortgage rates appear competitive: from Norwich & Peterborough’s 4.38% for two years, to Heritable Bank’s 4.74% and Bradford and Bingley’s 4.94%, but processing fees are expensive, ranging from 0.5% (N&P) to 2% (B&B). Nonetheless, last year, gross BTL mortgage advances represented 9% of total residential mortgages, although a sizeable proportion were remortgages.
Recent interest rate rises have failed to dampen landlord enthusiasm for BTL, although most lenders believe that should base rates rise above their socalled neutral level (5.5%), this could begin to act as a significant drag on the mortgage market, not least because property yields remain relatively stagnant in what are considered the best areas to buy.
The two key considerations when buying
According to property consultancy Hometrack, there are two principal factors to consider when identifying the best places to buy. First, investors should examine the volume of properties already let in that locale and second, they should accumulate as much demographic data as possible. In “prime” areas, a high proportion of the employed population is aged between 18-30.
By these measures, the firm has established what it calls Britain’s rental hot spots for 2007 (see below right), although the anticipated increase in property supply in these areas will, naturally enough, fail to boost yields. Indeed, there is anecdotal evidence to suggest that some private landlords have liquidated their property assets and switched back to the stock market, where average yields at blue chip companies such as Lloyds TSB and Vodafone can exceed 4%.
By contrast, average annual BTL returns are more muted in the most popular areas. In London and the south east, for example, wannabe landlords can expect yields of between 3%-4% against a national average of between 4.5%-5.5%. In other areas, such as the north east, yearly returns can still exceed 7%, although capital growth prospects are less favourable.
Nonetheless, there are several longer-term factors that appear to favour the BTL market, not least changes in planning policy, which virtually guarantee a flow of relatively small newly-built apartments, ideal for tenants and easy to maintain. Provided maintenance and management costs can be controlled and void periods, i.e. the time a property is empty, are kept to a minimum, BTL landlords have every reason to be optimistic.
That most BTL owners are in for the long term is indicative of two things: first, that they adapt a Warren Buffett-style approach to investment – get rich slowly – and second, that they appreciate their ultimate capital gain, against which all manner of tax relief can be given, is (or should be) akin to a lump sum pension payment.
Net immigration forecast fuelling long-term demand
Tenant demand for clean, well-maintained properties looks unlikely to spread much outside of its current core client group of younger households. According to Professor Ball, “Household projections, including net immigration, suggest that numbers will grow by almost a quarter in England between 2003 and 2026, which translates into a 209,000 annual increase. [This] highlights the substantial growth in housing demand that is going to affect the country.”
If there is to be a threat to private landlords, it can be expected from residential property companies and investment funds. The two are often inextricably linked and many have sizeable portfolios comprising fewer and fewer properties bound by regulated tenancies. Increasingly, often following extensive refurbishments, they will be able to offer units at competitive rentals.
Moreover, in several instances, investments in them are eligible for inclusion in SIPP portfolios, an advantageous benefit not yet extended to the “pure” BTL market.
Announcing plans to increase the State pension age from 65 to 68 by 2046, John Hutton, the Work and Pension Secretary, said, “If we aren’t prepared to increase the state pension age, we will pass an even greater and unsustainable burden to our children and grandchildren.” Mr Hutton failed to address just how the Government plans to fund public sector pensions, for which no assets have been set aside and which actuaries estimate will cost taxpayers £960 billion in the decades ahead.
Property investors have long seen the writing on the wall. Few consider BTL as some form of get-richquick scheme, but it is not unusual to hear private landlords refer to their property portfolio, whatever its size, as “my pension”. Given that the Government will, frankly, be unable to provide a State pension to all but society’s poorest within a couple of decades, investors who make their own pension provision cannot start the process too early. Those future economic historians will almost certainly admire the foresight of these folk.
*Latest figures are to 31 Dec 2003.
Hometrack’s top 10 rental hotspots
|
City |
% of 18-30 year olds |
|
Birmingham |
23 |
|
Brighton |
26 |
|
Bristol |
59 |
|
Camden, London |
30 |
|
Edinburgh |
29 |
|
Leeds |
25 |
|
Liverpool |
24 |
|
Manchester |
30 |
|
Wandsworth, London |
37 |
|
Westminster, London |
30 |
Peter Sharkey is a company director and writer on commercial and offshore financial matters.
P.S. If you enjoyed this article then we encourage you to sign up for the free Fleet Street Daily eletter. Learn what you can expect from today's markets -- and how to prosper in the face of uncertainty. You won't find more thought provoking writing anywhere on the Internet.