UK to see massive surge in demand for rental properties in next five years

One in five households in the UK could be renting a property by 2016 resulting in a requirement for an additional 1.1million rental homes, according to a new report from Savills and Rightmove published today (Tuesday 27 March).

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Some £200 billion investment will be needed to provide the homes required, but only £50 billion of this is forecast to come from buy to let funding, says the report Rental Britain.

It estimates that there are 4.8 million privately rented homes in Britain, up from just 2.5 million in 2002. In London, private renting already accounts for 27% of all homes, some 900,000, having overtaken social renting in 2010, which now accounts for just 24% of tenure or 783,000 homes.

‘Meeting the growing demand for private renting and the changing profile of tenant demand are perhaps the greatest challenges facing both the housing industry and policy makers,’ said Lucian Cook, director of Savills residential research.

‘The dynamics of supply and demand make a great case for investment in this sector, and rising rents and lower capital values have begun to attract private investors back into the market. Investment returns relative to other asset classes will dictate the pace of investor entry to this sector,’ he added.

The situation of first time buyers unable to access home ownership has been well documented but they are now joined by a new generation of more mature renters, particularly families.  Rightmove estimates that these ‘trapped renters’ now account for over half of the UK rental sector, and over a quarter of these are aged over 40. Such renters will require a different type and size of rental product, catering for longer term lets.

Rent increases over the past year have averaged 5.2%. Savills forecast 20% rental growth over the next five years with 3% in 2012, while research from Rightmove indicates that almost two thirds of tenants are expecting their rents to rise over the next year.

‘This illustrates that the shortage of supply is creating severe upwards rental pressure. This could lead to an over stretching of tenants’ finances or a rental bubble in some locations,’ said Miles Shipside, director of Rightmove.

‘A shortage of supply is making the situation worse. Our analysis shows that search activity has more than doubled over the last two years while stock available for rent is down by nearly 10% even though there has been no reduction in stock posted,’ he added.

Rental values vary enormously across the UK and regional averages can mask highly localised variations. Proximity to London tends to equate to higher rents, with an average of £10,300 for a two bed property in the South East compared to £6,170 in the North East. In London rents vary from a low of £9,980 per year in Bexley in the south ease of the city to a high of £48,230 in Kensington and Chelsea.

And there is a real North/South divide which is shown by the rents across the 30 largest rental markets outside of London. The five highest value locations Elmbridge, Oxford, Brighton and Hove, Woking and Reading, are all located in the South East and have average rents over £10,000 a year. The lowest value markets including Bradford, Kirklees, Warrington, Sheffield, Coventry, are all in the Midlands and North with average annual rents in the £5,700 to £6,700 range.

Affordability appears most stretched in London at 53% and the South East at 35% compared to the most affordable, the East Midlands and North East, both at 25%.

In locations where affordability is most stretched landlords will face a trade off between pushing for higher rents, thereby risking arrears and voids, or opting for a lower rental growth but a more secure income, and renters will face the possibility of long periods in shared accommodation to make renting an affordable necessity.

The research has found that individual investors have clearly begun to re-enter the market, but any increase in traditional buy to let stock since the credit crunch has largely been funded by cash investors, a source of new supply that clearly cannot keep pace with demand.   Large scale investor activity is long awaited.

‘Low yields have been the biggest barrier to much needed long term investment, but as yields move out there are early signs of changing investor behaviour. The challenge for the industry will be to attract the £200 billion investment needed to supply forecast demand over the next five years,’ explained Cook.

Until peak of the market in 2007 the growth in private rented stock was roughly matched by increases in new buy to let mortgage lending. In the past 10 years £380 billion has been invested in buy to let but only £140 billion mortgage funded. Last year, when buy to let lending fell to its lowest level for 10 years, private rented stock increased by 250,000 units, well above the flow of new stock seen at peak from a combination of private cash buyer and corporate investment.

‘Estate agents report an upturn in buy-to-let investor activity, driven by frustration with poor returns from cash in the bank. It remains understandably patchy however, depending on whether capital values have fallen enough, or rents have risen enough, to offer an acceptable return. The consistent message from lettings agents throughout the country is there are not enough existing landlords expanding their portfolios, and not enough new landlords entering the arena, to satisfy the growth in tenant demand,’ said Shipside.

Lower prices and rising rents have pushed out income yields to a point that may just act as a trigger for such investment at scale. Such investors would be expected to achieve bulk discounts of up to 25% on vacant possession and there are signs that this may just trigger investment in the right opportunities in the right locations.

The new analysis finds that yields at a regional level can disguise a wide range of localised variations, with further variations for different types of property. At a UK level, yields range from 7.8% for the top performing 10% of properties to 4.4% for the bottom 10%, with the highest yields achieved for the lowest value properties. At a local level, London has the greatest extremes, with the top performing 25% of locations yielding an average 7.0% gross, while the bottom 25% yield just 3.9%.

Average yields for a one bed unit are 6.7% compared to 4.3% for a property with four or more bedrooms, but there will clearly be a place for larger properties in a balanced portfolio and strong demand from families and sharers seeking value. Higher capital growth forecasts mean that London and the South East are likely to be the focus for investors. The top and bottom performers will be in a tighter range over a 10 year period and relatively low value locations such as Greenwich, Tower Hamlets and Newham, are expected to offer the best total returns.

The report concludes that rapidly rising demand will need rental stock to be delivered by the new build market, in volume and at a discount to provide the yields to attract vital corporate and institutional funds.  Meeting need in volume will require the planning system to formally recognise the need for private rented accommodation to a greater or lesser extent interchangeable with affordable housing provision.