February Month End Thoughts: Residential Lettings Market

Posted on Wednesday, March 9, 2022

Updated on

As people seek to improve their living environment, there will be continuous demand for residential property. Investment in real estate markets should have reasonable prospects in the long run” - Li Ka-Shing

This month, we want to focus on the residential lettings market.  We have all seen the cost of renting property increase dramatically over the past 8 months in London so we sought to understand why and to see if there was a way for our clients can take advantage of this increase. In this paper we will take a flying tour of property investments and we will conclude that there are parts of the market where pricing discrepancies provide value to a BTL landlord.

Turning first to commercial property. Taking some altitude (as this is not our area) Covid has created a very different landscape for this asset class, with some elements benefiting from the pandemic (distributions centres) and others suffering (retail, hospitality, and office).  It is difficult to see how this asset class will fully recover with consumers now so use to shopping on-line and offices having to be re-organised to make them attractive for workers to return, including (if refurbished) pandering to the expensive ESG requirements of many corporates, necessary for landlords to implement to achieve the highest rents.  Even if refurbished, many employees currently retain the option (either from goodwill of the employer or contractually) to continue to work from home. However, in our opinion, workers will return to offices because, to ensure the continuity of any business, knowledge needs to flow from the senior to junior workers and that can only really be done when all are working in close proximity.  This will lead, in our opinion, to an increase in demand in traditional smaller (1-2 bed) buy to let properties in the rental market.

Turning to residential property, the old rule of thumb was that the market would grow concurrently with economic growth.  This, of course, is now outdated thinking as property prices have become decoupled from economic growth, increasing not only because of quantitative easing but also very low long-term mortgage rates.   Covid however provided for a sustained fall in prices according to data from Rightmove noting year on year falls in Kensington and Chelsea in (for example) July 2020 of 36%, August 2020 of 34% and this fall continued until July and August 21 when we saw Y.O.Y. prices increase 44% and 51% respectively.   However there has been some discrepancies in the properties where price increases have occurred: Family homes have increased in price dramatically whereas a 1-2bed apartments have languished somewhat. (Both might well be “buy-to-let” but a standard 1-2 bed is the more staple component of the Private Rental Sector in London).  For example, in January 2022 the 1 bed flat stock available for sale in London was down 24% Y.O.Y. but prices only increased 2% in the same period.  For a 4-bed family house, the stock available for sale is down 42% Y.O.Y and prices are up 10%. (Source: Rightmove).  Our takeaway here is that people are looking more carefully at their living environment and seeking to improve it.   This has led, in our opinion, to a disconnect in pricing between what use to be seen as rental stock and what is seen to be family homes, and this is supported by the significant price increases in those family homes as noted above.

Rents have also increased dramatically and as we have seen this has not been driven by marked increase of applicants, which are now at pre-covid levels, but rather because of a decrease in the rental stock in Private Rental Sector. In Prime and Prime Central London, data provided by Lonres suggests that there are 29% fewer rental properties available now compared to prior to the Pandemic.  At the same time, we have noted a larger number of what can only be seen as suitable buy to let properties come to market for sale.  We hold the Government to account for this, as years of increasing taxation (SDLT), the inability to deduct mortgage payments before tax, the inability to claim for certain capital expenses and the very difficult mortgage applications for BTL investors has made the Sector much less attractive. However there exists value:

If we take the Marlborough, which is a purpose-built block of flats in Walton Street, Chelsea, as our example, we note:  In 2015, a one-bedroom flat would have attracted approximately £950,000 at sale (to include SDLT).  At the same time, the gross rental income was £500 per week.  This provides for a gross yield of 2.7%. Today the same property will cost approx. £775,000 (to include SDLT) and the rent has increased by 10% to £550 per week providing for a gross yield of 3.7% with the added benefit of a potential gross capital uplift of 16% should prices return to 2015 levels for this property. (We do have a property coming on to the market shortly, with a tenant in situ which evidences this).  In our opinion this property (and there are others) are now offering potential returns worth considering.

To conclude, we are not involved in the commercial property market so whilst we may have a private view, it is not qualified (although we do have a large contact list of city office workers who were renting prior to Covid and who are currently not renting in London). We do however have a qualified view on our residential market, where we have seen sales prices of family homes increase and we have seen corresponding rents increase because of a lack of stock.  As and when workers return to offices, we believe that the 1-2 bed flat market will become more popular with increases in both sales and rental prices. In our opinion, there are mispriced opportunities in this market, and these are likely to quickly disappear. If you would like to know more, please do give us a call.   

  

We would like to caveat this paper by stating that we are not investment advisors, and the above is our opinion.  If you would like to know more, please do take professional advice as part of your own research, as everyone’s circumstances are different and please note our disclaimer below.