Residential Property Focus

Residential Property Focus 2015 Issue 2
 
What's Driving Residential Investment?

24 June 2015, by Neal Hudson

The housing market remains an attractive investment opportunity, but risks need consideration.

 

Owning a home is well within affordable levels for many existing homeowners thanks to low mortgage rates. The problem is that actually buying a home has become far less accessible. A housing market with high prices relative to incomes inevitably requires large deposits. Help to Buy 2 has increased the availability of higher loan-to-value mortgages that eases this problem, but they generally carry an interest rate premium that makes them more costly to service.

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FIGURE 8

Cost of owning vs Cost of buying (first-time buyers)

 
Figure 8

Source: Savills Research, CML

A split market

The market is therefore split between those who can raise a deposit and those who can’t. For those who can, the stability and security of home ownership is the reward. For those who can’t, the private rented sector is often the only option.

The UK private rented sector does a fairly good job of offering a short-term flexible tenure for the traditional students and young professionals. But there are increasing numbers of other household types living in the sector, including 20% of all children.

Policymakers need to recognise that private renting is no longer just a stepping off point on the way to home ownership. For many households it is increasingly the only long-term housing option. However, getting the right balance of policy to meet the needs of those who require long-term stability and those who value short-term flexibility will be difficult. Policy will also have to balance the needs of typically younger households against the substantial political power of the older property-owning generations.

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FIGURE 9

Key market considerations

 
Figure 9

Source: Savills Research

Buy-to-let

The emergence of buy-to-let mortgage lending at scale during the early 2000s provided an easy route to property investment for many of those lucky enough to have been born in the right decades. Coinciding with a period of substantial house price growth, the buy-to-let lending created for many an easy route to wealth generation far in excess of what can be earned in even a relatively high paying job. It also meant that small-scale investors own the majority of homes in the private rented sector, with 60% of properties owned by landlords with four or fewer investment properties.

The small-scale nature of the market means there are massive inefficiencies in the management of the sector. Large proportions of income are lost to third party management firms and other costs. Many investors also underestimate the amount of time and emotional energy required to manage their own property. To date, the returns so far have generally counterbalanced the difficulties.

The buy-to-let mortgage market is now coming under greater scrutiny but it remains to be seen whether its regulation will be brought in line with the wider mortgage market.

Equity rich investors

Buy-to-let mortgage lending may have tripled since the depths of the downturn but remains 40% below its 2007 peak and accounts for only 8.5% of current transactions. With access to equity the key to buying a home, people buying with no mortgage debt now account for 36% of all transactions (440,000 per year). A small proportion of these will be overseas buyers in central London but most will be (typically older) home movers or investors who have built up sufficient equity thanks to the rapid price growth of the last 20 years.

Pension reform

With gross income yields averaging around 5.5% across the UK and the prospect of further capital value growth, the housing market remains an attractive investment opportunity for many. Anticipating the recent pension reforms many speculated that a large ‘wall of private money’ was going to hit the market. The reality is that although people aged 55-64 have defined contribution pensions totalling £120 billion, the median pension pot is only £25,000.

The distribution of pension wealth is such that only the top 7% of these pension holders could afford the average priced UK house. Factoring in the propensity to actually invest in property, we estimate that the pension reforms will only lead to an additional 10-20 thousand transactions per year.

For those who do decide to invest their funds into the market, there are risks. House price growth is likely to be more limited in coming years than that seen over the last 20. Mortgage market regulation will limit the capacity for price growth to run ahead of incomes in all but the highest demand markets. As such, higher income yielding markets may appear more attractive to investors.

It is worth noting the associated risks in higher yielding rental markets. Higher yields will already reflect a greater incidence of voids and other risks. Many of these high yielding markets have high proportions of housing benefit recipients living in the private rented sector.

A reduction to the overall benefit cap will hit that housing benefit disproportionately. This could leave some households unable to pay existing rents, leading to increased arrears, evictions and possibly lower rents.

Possible solutions

Further investment is urgently required in the private rented sector, but needs to go hand in hand with making the tenure a better place to live. Recognising the private rented sector as more than just a temporary stop between leaving home and buying a first home would be a good start. Greater enforcement of existing regulations would help, but rent controls would not. Increased investment from institutional landlords has the potential to make a substantial difference, though cannot offer a short term fix. Best of all would be to build more homes of all tenures starting in the most unaffordable of markets.

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