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C

On The Threshold: London's buy-to-let market may not be the capital risk you think



By Alessandro Pasetti, 18 June 2018.

Tax, funding and regulatory constraints, in addition to the ubiquitous Brexit risk, have all been flagged as major hurdles for Britain’s buy-to-let market ‘over the past year, with some experts turning even more bearish since the turn of 2018.

Yet many observers have overlooked different sources of funding that can be deployed in a real estate market where buy-to-let could continue to flourish for years. Additionally, other structural and behavioural changes could combine to lessen prospects of the worst-case scenarios for the buy-to-let market.  

Landscape 

As with every investment, real estate is not immune to exogenous shocks, but many risks can be mitigated. Indeed, a strong rental market, one of the engines of growth for buy-to-let appetite, supports a bull case in which cash-rich buy-to-let investors should not be overly concerned about future events, although they might have to compromise on yields prospects.

Certain systemic risks associated to financial assets in the UK are more manageable than elsewhere in Europe – check out the latest swings in the value of financial assets in Italy, for example, driven by political uncertainty. Moreover, domestic real estate investments continue to be an opportunity for investors who are selective in their purchases. However, the sector must also be treated with care – trends in some London suburbs are a case in point, although there are signs a bottom for houses prices might be forming in some areas.

That said, the latest set of data concerning domestic housing rental prices was unequivocal – growth rates are still strong.

According to data released last week by the Office for National Statistics, “focusing on the English regions, the largest annual rental price increase was in the East Midlands (2.9%), up from 2.8% in April 2018. This was followed by the South West (2.0%), down from 2.1% in April 2018 and the East of England (2.0%), up from 1.8% in April 2018”. 

(Source: ONS)

(Source: ONS)

Only London is in “negative territory”, but even in the capital there are pockets of value, as we recently argued.

Bring into the mix house price trends over the long term and, frankly, the UK remains in a sweet spot against virtually all of its major European rivals (Germany, click here; France, here; Italy, here; Spain, here).  

Structural shift  

What’s also worth considering is that a structural shift is underway in the marketplace which plays in favour of buy-to-let investors.  As The Guardian wrote earlier this year, UK tenants paid a record £50bn in rent last year.

Look at the narrowing mortgage bill/rent bill spread in the UK.   

The British newspaper, which has historically closely followed the developments of the domestic property market – and, in my opinion, is a pretty good source in terms of accuracy – added:

 “Rents have doubled in a decade and could eclipse the entire sum paid for mortgages by homeowners.”

It noted that these figures “reveal the dramatic reshaping of the property market in recent years as home ownership levels have gone into reverse”. That has a lot to do with stricter capital ratios for lenders, but it’s not necessarily a bad thing. 

On the one hand, it could mean higher yields and lower capital appreciation prospects (or just the opposite), but on the other, capital appreciation itself could be preserved by the imbalance between supply and demand, so the impact here should be minimal. Different logic applies to different areas in a sector that mostly remains a buyer’s market across the key areas/segments covered by Inveztments.

Notably, as far supply/demand dynamics are concerned, we are at a crossroads, with recent data showing that the number of homes “coming on to the housing market is showing signs of positive growth for first time in more than two years”. 

Cash is king 

Talking of quality, I came across research published by Hamptons International (labelled “What next for buy-to-let?“) that is truly compelling. 

It may well be that the London-based estate and letting agent was talking up its own book, but hard evidence lends credence to some of the many nuggets of information contained in it.  

Firstly, it points out that despite changes in government policy, the private rental sector will continue to grow, and it “estimates there will be six million households renting by 2025.” 

Secondly, look at the chart below: cash owners are in the driving seat.  

Not only are they the largest of any tenure group, but also “their numbers have increased for 23 out of the last 25 years”. 

This research offers a balanced view about what it is going on in the background. 

Of course, in recent years the market has become less favourable for new landlords chasing yield, but we already knew that.

“Since 2013 house prices have consistently risen faster than rents, squeezing landlords’ yields on new purchases. The average investor buying in 2018 starts off with a rental return 0.6% lower than if they had bought in 2013,” Hamptons argues.

Yet behind the figures describing the ‘average landlord’, there are many investors outperforming their peers. This doesn’t just mean landlords are heading North for lower prices and hence higher yields – although many do. Even within a local authority the 10% of landlords achieving the highest yields earn 4.1% more than the average landlord in the same place. Conversely the 10% of landlords earning the lowest yields get 2.3% less than average, or £3,900 a year less in rental income.  

A landlord’s yield is the product of both market rents and house prices in an area.” (emphasis is mine)

Crucially, this is Inveztments‘ core business: working on your behalf to find hidden gems is not only a mission, but a way of living for its founders.

Finally, here’s one last piece of advice.

“Strong house price growth has shrunk yields for new buyers, especially in the South, but buying wisely brings benefits. Average yields in London are 5.4% compared with 7.9% in the North West, yet 20% of London landlords achieve higher yields than their North West counterparts.”

(This post was written by Alessandro Pasetti. Ale is the founder of Hedging Beta Ltd. He writes about investment strategy and assets valuation for European clients as well as Seeking Alpha, The Loadstar, Transport Intelligence and others. Based in London, he previously worked for about five years at Dow Jones/The Wall Street Journal, producing analysis for the IB community. Prior to that, he contributed to the launch of London-based Loan Radar, where he worked for three years. He had stints in equity research at Bear Stearns in London, HVB in Munich, and Unicredit in Milan.

It was edited by Gavin van Marle, managing editor of London-based The Loadstar. Gavin is also the author of the book Around the World in Freighty Ways: Adventures in Globalisation. He has won numerous awards, including the Seahorse Journalist of the Year 2011 and 2009, and Supply Chain Journalist of the Year 2010 and 2014.)