What does the growth in the rental market mean for house prices?

Rental demand is a real indicator of the fundamentals of underlying occupier demand. Nonetheless, prices in the lower tiers of the market are likely to be increasingly driven by the value of property to investors rather than owner-occupiers, with rental growth and yield the key factors.

Given our robust forecasts for rental growth, price falls will only occur if investors are no longer willing to accept current yields. Gross yields average 6.7% for one-bedroom properties and 6.1% for two bedroom properties, looking increasingly attractive against savings rates. Such yields will put a floor under residential real estate values and confound the sceptics who believe that UK house prices will suffer a significant double dip in nominal terms.

Where are best investment prospects?

Our forecasts suggest the best medium-term investment prospects are in urban areas in London and the South East where there is a growing population in the 20 - 34 age bracket and an under supply of rental stock. These markets have seen the strongest levels of both rental growth and capital growth. Looking forward they offer the prospect of a balance between income yields and capital growth. (See Graph 5.2 which shows how deposit costs are pushing first
time buyers into renting).

In London alone – the real pressure cooker of demand – the number of households in the private rented sector has risen by 90% over the past 10 years, while the population of 20 - 34 year olds has grown by 18%. At the same time, the average first time buyer deposit has risen from £12,000 to £58,000.

In other markets, income yields are typically higher, but capital growth prospects lower. These offer a different type of investment opportunity, one that is likely to be based on longer term income streams.

What are the challenges for policy makers?

One of the biggest challenges the government faces is how to meet the housing needs of Generation Rent. The DCLG, the government department responsible for housing policy, has recently opened a consultation on the regulatory requirements in the rental sector.

There is a real need to address the issues causing concern (such as tenant choice and rental affordability), rather than their symptoms. Realistically, this means more investment from institutions is needed to deliver substantially increased levels of supply. This will require incentives to encourage the provision of well-managed, affordable rental accommodation.

Taken from
Residential Property Focus Q4 2012