Even though we have long been advocates of residential property investment in the private rented sector, this has until recently been predicated chiefly on the expectation of increased capital value.

Now, in the face of increased rental demand, a shortage of property to rent is currently pushing up rents at a rate faster than capital values across the UK. According to Findaproperty.com, asking rents rose by 4.6% in the year to the end of September, while the LSL buy-to-let index suggests rental movements of 3.5% over the same period (see Graph 'The Rise In Renting').

There is a growing demand for rental property as more newly formed households look to rent, more first time buyers choose to delay or are prevented from making a purchase and economic constraints push more people from home ownership into rented accommodation. This scenario is unlikely to change for as long as mortgage finance remains scarce and first time buyer deposits are unaffordable.

The rental sector

The recent low levels of investment in the residential sector mean available property to rent is scarce. Demand for mortgage finance among buy-to-let investors is rising, but the level of new lending in this sector remains heavily suppressed. In the second quarter of 2011 gross buy-to-let mortgage lending was just 28% of its level at the peak of the market. (see Graph 'Rental Affordability').

Large-scale portfolio investment, which has the potential to significantly expand the rented sector, has garnered significant interest; but is yet to bear fruit. Much of this comes down to investors’ views of income yields rather than the positive look for cash flows.

Sticky supply side

In London and the South East, where capital values remain relatively high, the supply-demand imbalances between renters and available property to rent are greatest. Higher yielding properties favoured by investors are simply in lower supply there.

This sticky supply-side is key to our prognosis that rents will rise by over 20% across the country as a whole over the next five years. Were it not for the constraints of affordability, this forecast would be even higher.

This level of rental growth has the effect of maintaining average UK rents at 38% of net disposable household income, which is slightly higher than their 10-year average but in line with where they were at the turn of the millennium. By this yardstick, rental ‘affordability’, a term which we expect will assume increasing significance, will not worsen under this scenario.

Upward yield shift

Rental growth of this level would see the headline gross yield on residential stock increase from 5.0% to 5.7%. In areas of weak owner-occupier demand, where yields start from a higher base, we expect an even greater upward yield shift.

This means one and two-bedroom properties in secondary and tertiary locations should begin to stand up as income yielding investments, when compared to alternative asset classes over the next five years (see Graph 'Rental Markets').

Taken from
Residential Property Focus, Q4 2011