The dynamics of the housing market in terms of stretched affordability for first time buyers, localised supply shortages and rental growth has clearly grabbed the attention of large-scale investors who are re-examining the investment opportunities offered in the UK housing market.

But the investment market needs to be sure that these are long-term trends, representing more of a structural shift in the housing market than a short-term reaction to heightened mortgage constraints.

There are two key drivers that point towards increased demand for renting in the long-term.

1. Mortgage affordability

Deposit affordability is one of the key reasons why younger households are unable to access home ownership thereby increasing demand for private rented sector accommodation. The current first time buyer requires on average a deposit of £28,000 equivalent to four fifths of their annual gross income.

The size of this deposit undoubtedly reflects the current acute lack of mortgage availability in the wake of the credit crunch, particularly at high loan to value ratios.

As a result, we estimate that the number of private rented households across the UK rose by 1.15 million between 2007 to 2011.

In this period, the average first time buyer deposit rose from 10% to 20% of the purchase price. This compounded the effect on deposits of an increase in house price to household income ratios that had occurred in the previous decade.

Critically, this factor meant the issue of deposit affordability existed, but was less extreme, prior to the credit crunch.

In the 1990s, for example, when levels of home ownership were still rising, the average deposit for a first time buyer was 14% of their income. By 2007 it had reached 37% (equivalent to around £13,000). Consequently, the number of UK households in the private rented sector rose from 2.4 million to 3.6 million between 2000 and 2007.

Today, with 97% of mortgages currently taken out by first time buyers requiring capital repayments, their costs (that have also risen in line with house price to household income ratios) affect whether buying or renting is the cheaper option on a month to month basis. Our analysis suggests because of these costs buying remains 21% more expensive than renting.

So even if the brakes do come off accessibility to mortgage finance, first time buyers will still be hampered by deposit and capital repayment affordability.

2. Demographic pressure

There is also evidence of wider demographic drivers affecting the housing demand among ‘Generation Rent’ (20-34 year olds). Recent results from the 2011 census show that they have become increasingly concentrated in urban locations.

Map 1 shows the location of the 20% of local authorities where ‘Generation Rent’ makes up the highest proportion of the adult population. It also shows the extent to which that population has grown in these largely urban areas in the past 10 years.

Across these locations, 36% of the adult population is aged between 20 and 34, having grown by 19% in the past decade. No other age group has become so concentrated in specific areas.

Combined with a lack of house building, particularly that aimed at the lower rungs of the housing ladder in urban areas, this has created a supply demand imbalance.

Rental growth

Together these two factors are likely to underpin rental growth in the sector. The extent of that growth is likely to be capped by the affordability of rents. The recently published English Housing Survey indicated that across the private rented sector, rents accounted for 43% of the average gross weekly income spent on rent. This alone indicates that rental growth is likely to be linked closely to earnings growth.

Oxford Economics forecasts net disposable income per capita will rise by 19.2% over the period from 2011 to 2016, with growth of 1.8% in 2012 rising to 4.5% in 2016. Against this context we are forecasting rental growth of 20% over a five year period (see table 1), though there are likely to be variations between region, neighbourhood and sectors of the rental market.

Geographically, we expect rental growth patterns to follow economic growth prospects, with higher growth in London and the South East.

Sectorially, there is the prospect for our rental forecasts to be exceeded, where the tenant profile becomes more weighted to affluent renters. Conversely, rental growth is likely to be reduced in areas where there are high concentrations of tenants reliant on housing benefit.

Local markets

The findings of Rental Britain suggests there are significant localised variations in rental affordability, meaning the capacity for rental growth varies substantially within regions. Rents have already been pushed upwards in areas where there is a lack of supply and affordability is an issue. This has provided immediate investment opportunities in areas such as Oxford and Brighton.

Those that show capacity for rental growth need to be divided between those where there are the demographic drivers for growth and those where rents are low because of inherently low tenant demand.

In this respect population growth in ‘Generation Rent’ has not been universal across all urban areas. In the local authorities of Manchester, Liverpool, Nottingham, Bristol and Milton Keynes rents have risen by more than 20%, but in Warrington and Stockport it has fallen. Similarly in London, growth of over 50% in Hackney, Tower Hamlet and Newham, compares to falls in Sutton, Richmond upon Thames and Bromley.

Taken from
Spotlight: Rental Britain as an Asset Class