YIELDS INCREASE FOR INVESTORS
There will always be a strong rental market in central London. What has changed, is the rate of rental growth. The extraordinary growth that followed in the wake of covid subsided in 2023. There was the usual sharp upturn in the summer months driven by demand from students and particularly, wealthy overseas students, but overall, rents ended the year around 2-3% up on the previous year.
There were differences – East London had the strongest growth, reaching 5 or 6% for one and 2 bed apartments and one beds in the City also reached 5% but even these were modest compared to the previous 2 years.
Of course, a 2% rental increase looks tame compared the way rents performed in 2021 and 2022 but this growth is from a much higher base level and for some, rents have become prohibitive. Rents are now over 20% higher than they were in 2019 and almost 40% higher than in 2020. Renters who moved into our areas during covid, when landlords were willing to accept substantial discounts, have generally moved back out, taking some of the pressure off competition for homes.
Demand from overseas students settled back to a more normal level after the exceptional post-pandemic boom in summer 2022, caused by the backlog of students taking up university places in London. At the same time, the supply of homes to rent has been boosted by homeowners unwilling to sell at prices that do not meet their expectations. For all these reasons, the rental market has returned to a more balanced state and rental growth this year, at 2%, is much more in line with the long-term average.
International students at University College London and London School of Economics now make up half of undergraduate admissions in London. Overseas students who can pay up to £40,000 a year are essential in funding London’s universities and have grown at more than four times the rate of domestic students since 2015. While Chinese students are the largest in number the fact remains that London attracts students from over 150 countries and the capital is not reliant on one geographical region.
The delivery of more privately built student accommodation across the capital helps to manage the increase in demand but still the presence of overseas students in our markets is the strongest driver of rents and the reason that growth peaks during the summer months.
Although rents have risen more steeply in East London this year, the differential between our markets remains stark. The monthly cost of a 2 bed apartment in East London is less than for a one bed in either City or Midtown. In the same way, a three bed in East London can be rented for less than the cost of a 2 bed and only a little more than a one bed in Midtown. Renters with budget constraints do make these trade-offs and this has helped drive rents higher in East London and other London suburbs.
Overall, rents have settled at a new high. An investor measuring income return over the past 3 years (since covid) would be delighted by growth averaging 12% per annum but that does not reflect the longer term picture which is between 2% and 4% per annum.
The strength of rental growth over such a short period gives landlords more scope to be flexible and this year we have seen some willing to reduce asking rents in order to secure a good tenant for their property. Higher rents off-set the additional costs of service charges and, for those with mortgage debt, rising interest rates.
Despite the rental growth, there has been a sharp rise in the number of landlords choosing to exit the market. In our experience, they are not being replaced by new investors (see buyer profiles). 51% of buy to let mortgages in England were taken out between 1996 and 2007 and we recognise this demographic of landlords as our clients who wish to sell their properties and to use the capital in other ways (sometimes to help the next generation to buy). Rental supply in London has fallen year on year in response to rising costs, higher taxation and expanding regulation in the sector, which will soon include the Renters’ Reform Act, now expected in 2024, although the prospect of a General Election means the timing is uncertain.
There is no new policy designed to attract buy to let investors. Instead, the government continues to prioritise first time buyers. The exodus of buy to let landlords is clearly the outcome envisaged when George Osborne (then Chancellor of the Exchequer) announced a Stamp Duty surcharge for second-home owners and investors in December 2014.
Research conducted by Capital Economics on behalf of The Residential Landlords Association concluded that 735,000 homes could be lost from the private rental sector by 2027 if the Bank of England base rate remains above 2.5%. That would equate to one in 8, or 13% of all current rental stock. The researchers calculated that would mean a £1 billion loss of income and corporation tax revenue each year for the Treasury and higher rents for all.
There have been some concessions however. In October Michael Gove Secretary of State in DLUHC, gave assurances that the government would not implement the ban on no-fault evictions (Section 21) until court services had been improved. The improvements envisaged included digitising court processes, improving bailiff recruitment and retention and providing early legal advice to tenants.
The Government has announced that rent controls (like those in Scotland and under consideration in Wales) will not be introduced in England and that rents in the private rented sector should be agreed between landlords and tenants.
We are clear that for the private rental market to function efficiently landlords must be able to raise rents in line with market prices, but equally that proposing rent increases significantly above market rates, should not be used as a means of backdoor eviction.
All this is happening against a backdrop of improved returns for investors. The combination of rising rents and, at best, static prices, has led to a significant rise in the Gross Initial Yield in our markets which is now 6.25% for a one bed apartment.
At this level it compares well with many alternative investments and embodies the prospect of capital growth too – but the associated costs still weigh heavily on many investors, especially if they are carrying hefty services charges and interest costs. The yield is lower for larger apartments but remains over 5% for a 2 bed and just under 4% for a 3 bed. In other parts of the country, larger properties suitable for sharers tend to attract the highest yields but that is not the case in our markets where the values are so much higher.
There has been some renewed interest from overseas investors as yields have risen and we would expect that interest to continue in 2024 as London prices are now priced competitively compared to other international cities.