Monday, April 23, 2012

Hometrack looks beneath the headlines of the rental market

Its key findings show:

• two very distinct markets - one in London and another for the rest of the UK, with rents in London broadly double those for a comparable property elsewhere. With the exception of London, rental growth in 2011 was lower than in 2010 across all regions. Rents in London were up 9.6% in 2011 and, although growth has slowed since Q3, it remains stronger than the rest of the UK. The continued growth in the capital's rents reflects the sheer size of the city, the high cost of buying and the corporate rental sector which drives some of the highest rents in the country. In contrast, demand across other cities is largely domestic, driven by those unable to access owner occupation.

• that affordability pressures on tenants mean that rental growth is expected to remain relatively subdued. On average Hometrack expects rents to rise by 2-3% in 2012, pushing gross yields slightly higher towards 5.5% by the year end.

• a highly segmented sector where typically the bottom 25% of the market comprises private tenants in receipt of housing benefit; a larger 'core' rental market, where households are unable to buy outright or who wish to maintain flexibility and at the top end, a rental market driven by corporate lets but subject to the volatilities of the wider economic cycle.

 - In London 22% of lettings are over £2,000 pcm for a typical two-bed property whilst outside London just 4% of lettings are over £1,000 pcm.

- The core London market, where tenants typically pay between £1,000 - £1,500 pcm, accounts for 37% of the private rented sector. Outside London, rents in the core market are typically set between £500-750 pcm - representing some 50% of the overall lettings sector.

• the profile of lettings and voids risk varies across rental market by location and value band. The prospects for rental growth in sectors reliant on housing benefit will for example, be influenced by new benefit caps imposed by the government as part of their welfare reforms. The core market offers prospective investors and lenders the deepest pool of demand and even if mortgage availability improved this market would not erode significantly.

• the dynamics of renting versus buying vary across the country. On benchmarking the cost of renting to an 80% loan to value (LTV) first-time buyer mortgage, a clear north/south divide emerges. Renting is only cheaper than buying in cities such as London, Bristol, Oxford and Cambridge, where the cost of getting on the property ladder is prohibitively high.

• in lower capital value markets tenants are paying a premium to rent over the cost of buying an equivalent property.

• local market dynamics dictate the sustainable LTV that an investor is able to withstand for a given level of rent. Assuming a 5.5% interest rate for a buy-to-let loan and rents equating to 125% of the interest payments rates on the mortgage, the maximum sustainable LTV in high capital value areas is less than 75%. In London the maximum LTV stands at 55.4%, in Edinburgh 66.8% and Oxford 67.6%. In other areas of the country, the maximum sustainable LTV is much lower - 91.5% in Birmingham, 88.4% in Manchester and 87% in Southampton.

• European Union plans to introduce new regulations for the buy-to-let sector could limit the scale of future expansion.

• regulations aside, affordability factors will continue to limit rental growth. The majority of renters are would-be first-time buyers but as tenants - rather than owner occupiers - they have not felt the benefit of lower mortgage rates on their household budgets. Furthermore renters are more reliant on unsecured loans and borrowings where interest charges have risen in recent years. The net result is that renters are price sensitive and there is a maximum level to which they can afford to pay for rent versus other living costs.

• London data from the English Housing Survey reveals a clear trend towards greater sharing and cohabitation as a means of meeting higher rental costs. Rather than simply renting a two-bedroom flat and retaining a spare room, couples are choosing to let their spare room to a third tenant. Analysis of renting as a percentage of income needs to take this trend into account.

Commenting on the Insight Paper, Richard Donnell, Director of Research at Hometrack, said, "The rise in private rents has been driven by growing tenant demand and a shortage of supply. With no major improvements in mortgage availability likely in the near future so rental demand is set to remain strong. There is however a limit as to how high rents can go as affordability constraints continue to squeeze household budgets. Increased occupation of rented housing through greater sharing is one solution to affordability pressures - especially in London. Although less prevalent elsewhere, increased sharing could help absorb further rent rises and become more commonplace in future. Put simply, with household incomes under downward pressure rents are doing well to rise. Looking ahead, Hometrack expects the overall rate of rental growth to moderate over 2012."