Rental growth remained subdued in the second quarter of 2015 in the prime residential markets of London. Average rents rose by just 0.5%, leaving annual growth at 1.5%.

This means that over the past five years rental growth in the prime London market has struggled to keep up with the underlying rate of inflation. While rents in the prime London housing market have risen by 7.7% over this period, the Consumer Prices Index has grown by 12.1%.

Focus on Prime North and East London

Prime rents have only risen in real terms in the belt running from Canary Wharf, through Wapping and up to Islington. Here a mix of UK and international tenants, from a range of employment sectors have supported demand.

While the financial & insurance sector employment market has been subdued, these locations have been well positioned to benefit from the growth in both the information & communication and the professional scientific & technical sectors in the past ten years.

Figures from the Office for National Statistics (ONS) based on VAT and PAYE records, indicate significant new business activity in these sectors in the past years. Across the boroughs of Hackney, Tower Hamlets and Islington the number of these businesses has risen by 39% over the past five years. This has contributed to 26% growth across all business sectors, compared to just 6% across the borough of Westminster.

Competition & Supply

Across the remainder of the prime London market, rental growth has been held back by the high level of new stock being brought to the market by investment buyers of both existing and newly developed properties.

With a significant development pipeline of new stock over £1,000 per sq ft likely to provide further competition over the next five years, landlords will need to take informed decisions regarding their stock selection, the needs of their target market and how they present their property to the market to maximise their returns.

Market realities

Current market conditions require landlords to consider how far rents can be stretched within a submarket and the consequences for returns and investment decisions. This is likely to mean that benchmarks such as rental value per sq ft become more important.

Source: Savills Research

For example, in the context of prime central London our analysis shows that:

■ Whereas rents average £59 per sq ft, that average is closer to £75 per sq ft in Belgravia, and £50 per sq ft in Marylebone and Chelsea

■ Only 15% of the prime central London prime lettings market achieves rents of more than £75 per sq ft

■ Those properties in an immaculate condition average £70 per sq ft while those in a moderate condition average 30% less by this measure

■ Like the sales market there is a premium for scale (albeit not as large) with rents for properties over 5,000 sq ft averaging £74 per sq ft

Figures for other areas of prime London generally indicate less capacity to stretch rents, without the same rental premium for scale, though the condition in which a property is presented remains an important driver of rental value.

Source: Savills Research

Similarly, landlords are likely to pay attention to the yield fundamentals, recognising that while gross yields average just 3.25% across prime London housing, 23% of stock yields over 4.0% gross – most typically the smaller units outside of prime central London.

Source: Savills Research
NB: These forecasts apply to average prices in the secondhand market. New build values may not move at the same rate

Beyond the capital

Rents in the prime regional markets rose by a more healthy 1.6% in the quarter to June 2015, contributing to annual growth of 2.4%. Three bedroom stock has seen the strongest annual growth, with an increase of 4.7%. City locations such as Cambridge and Winchester have fared particularly well.

By contrast, demand for the largest houses has remained subdued, with a much smaller pool of big budget tenants meaning that rents for homes of five or more beds have risen by just 1.3% over the year. As a result on average, they remain -2.8% below their 2008 peak.

Source: Savills Research