Rental Yields Move Towards 5.5%
Over the past 12 months the property market in the UK has seemed immune to the real-world troubles of Covid, war in Ukraine and rising energy costs. But with UK inflation projected to end the year at 10%, interest rates likely to rise further and the cost-of-living squeeze expected to hit hard this winter, reality is soon likely to hit home.
London prices remain attractive compared to other parts of the UK which have experienced double digit growth in the past 2 years and will inevitably slow down. While office workers have returned to the city in the first half of 2022, we believe there is more to come as people increase the number of days they spend in the office. This will support transaction volumes, underpin current sale prices and continue to drive rental values upwards.
We expect sales volumes to hold up in the second half of 2022 but would be surprised if prices continued to increase given the array of challenges facing the economy. It seems only a matter of time until the housing market loses some momentum, given what we’ve seen in the consumer sector and particularly following such a buoyant period across much of the UK over the past two years. Midtown, City and East London residential prices remain at attractive 2015 levels and for that reason alone with a shortage of supply we do not anticipate prices changing from their current levels in 2023.
The number of apartments coming to the market remains severely constrained by delays to fire safety remedial works. This issue will continue to over-shadow any block built within the last 30 years. There is now a window of opportunity for homeowners not affected by fire safety works to secures sales with less competition in the market over the next 6 – 18 months.
Landlords who were hit hard with reduced revenue during the first year of the pandemic are now enjoying an uplift in real income and we hope this will help to stem the tide of investors looking to sell their investments. Rents will continue to rise further in the second half of 2022 because quite simply there is not enough stock to meet demand. We expect rental values to rise by 10% in 2022 driven by reduced supply as more buy-to-let investors look to exit the market despite higher rents being achieved. A consequence will be stronger yields with gross returns moving towards 5.5%.
Increases to rents and the general cost of living are persuading renters to stay in their existing accommodation unless a move is necessitated by a change in their personal circumstances. Renewal rates of existing tenancies look set to remain high for the rest of 2022 and into 2023 fuelling further rental growth in parts of the market.
The Government unveiled a list of measures in the Rental Reform White Paper on 16th June designed to appeal to tenants including: greater rights to have pets in their properties with landlords having limited powers to refuse; a doubling of the notice for rent increases, a redress system for tenants, a new portal to help with disputes, a Decent Homes Standard (currently applied only to social housing) extended to the private rental sector; Section 21 eviction powers for landlords and their representatives will be scrapped and Section 8 eviction powers will also be enhanced. The government has pledged to give six months notice before transitioning to the new system of periodic tenancies.
It is our view that there will be increasing pressure on the government to support the private rental sector so that it can contribute to relieving the housing crisis. Although the current government favours home-ownership, it is not a viable option for many, especially in London and it is often not a desired option for those who prefer a flexible footloose lifestyle, particularly in the current environment where hybrid working presents more choices for young well-paid workers.
A recent report from Capital Economics suggested that London needs 85,000 new private rented homes to meet demand but the government’s own figures show that supply has been falling in London over the past 5 years. There needs to be a discussion about incentives that would encourage investors to return to the market, otherwise rents will continue to rise.
The demand for short lets remains strong, fuelled by flexible work patterns as people are more able to build long weekends into their working lives.
The Government has recently invited feedback on a proposal for a Tourist Accommodation Register which would help to regulate the short-term market including holiday lets and second homes, reacting to the rise in direct to consumer platforms such as AirBnb. The register would address issues around compliance, health and safety and anti-social behaviour. In our reports, we have consistently highlighted the importance of this market in London.
In the policy paper published in May, the Department for Levelling Up, Housing and Communities proposed a council tax premium of up to 100 per cent on second homes which remained empty after 12 months to encourage these empty properties back into active use. The application of this tax, if it became law, would be to the discretion of local councils. The department said this would “encourage more empty homes into productive use, while enabling councils to raise and retain additional revenue to support local services and keep council tax down for local residents”.
The June announcements of the extension of Right to Buy to housing association tenants (met with some scepticism) and, in this context, of encouraging home ownership through direct policy support, we would expect the Government to formulate other housing policies to encourage more renters to become homeowners, particularly as we move towards the leadup to the next general election.
Overall it feels like 2023 will be a much more muted year as a number of these economic factors catch up with the residential sector.