The private rental sector (PRS) is growing at a remarkable pace. Overall the value of the sector swelled to £990 billion in March, up 11% year on year. This month it will have crashed through the £1 trillion threshold for the first time.
The long-term driver for this strong and sustained expansion is the growing number of households who rent. The total number of privately rented households grew by 150,000 over the last year, to a post-war high of 4.8 million; 18% of all households in the country. Owner occupation is falling and as social housing provision remains limited, the private rented sector is absorbing the vast majority of newly formed households. Indeed, a staggering 77% of all new households created in the last year were in the private rental sector.
There has been a shift in attitude towards long-term renting as a lifestyle choice, and we can’t ignore the economics that make it the only reasonable option for many given the underlying strength of the property market.
Historically low levels of lending to first-time buyers is a key indicator of growing tenant demand. In the five years before the credit crunch, 2.4 million new buyers got on the housing ladder with the help of a mortgage. Fast forward to the last five years, and just half that number have bought their home with a mortgage. Much has been made of the various reforms designed to support homebuyers, but the Help to Buy Scheme and amendments to stamp duty are tinkering at the margins in the context of rising house prices.
First-time buyers face the need for large deposits, and while the availability of high LTV lending has improved, it is still relatively expensive to borrow beyond a 90% loan. With wage increases relatively muted since the recession, LTVs relatively high, and house prices rising, it’s very hard to save a deposit fast enough to keep up. And even then, the new, stricter affordability assessments in use since April 2014 might stand between you and the home of your dreams.
More homes in the PRS couple with higher house prices to drive the value of the sector higher. Furthermore, landlord interest in the sector is driven by the lure of growing tenant demand and house price growth. Those seeking capital appreciation will no doubt have been happy to see buy to let properties increase in value by 7.5% in the year to March, but we’re starting to see this inflation show signs of moderation, falling from annual rate highs of 10.9% in September, through 9.6% in December, to the levels seen at the end of the first quarter. More importantly for the sustainability of landlord finances, the 4.8% yield on property is high compared to other asset classes.
We cannot, however, ignore the overwhelming issue driving growth in the PRS, which is, of course, the systemic shortfall in house building in the UK. We need 243,000 new homes every year to meet the UK’s growing demand, but in the last year just 141,000 have reached completion, a long way shy of the target, and a third fewer than the amount created in the year before the credit-crunch2. So long as supply lags demand, house prices will simply get further and further out of reach for prospective first time buyers. By contrast, landlords are able to exploit rising capital values to build portfolios by extracting equity from properties they already own.
The housing market is cyclical: interest rates will find a new normal one day, and affordability cannot be stretched indefinitely. That means house price growth will moderate, and from time to time may even fall. However, the UK has a growing population, set to be the largest in Europe by the middle of this century, and for housebuilding to catch up requires a spectacular and unlikely transformation from today’s position. The PRS will almost certainly keep growing in size as a result. For landlords, the key is not to gamble on capital growth. Focus on property with a yield well in excess of mortgage interest, and consider any capital gains a welcome bonus.
John Eastgate is sales and marketing director of OneSavings Bank