A recent survey of a thousand UK landlords has indicated growing confidence within the buy-to-let market, particularly amongst landlords who maintain portfolios of five or more properties.

The specialist lender, Shawbrook Bank, reports that 88% of portfolio landlords have made new acquisitions in the last six months. Looking ahead, one in four (25%) reportedly intends to buy one additional property within the next year, and one in five (22%) is looking to purchase multiple units.

The results suggest that despite the gloomy headlines in a number of tabloids, those who are most seriously committed to the sector recognise that prospects for investors are improving steadily. In this article, we’ll examine why that’s the case.

Short-term Versus Long-Term

Property investment should always be regarded as a long-term undertaking. The market will inevitably see short-lived fluctuations, but what has made British property such a reliable investment asset for so many decades is the fact that the long-term capital growth trend has remained robustly positive.

HM Land Registry records show that since 2000, average UK house prices have risen by nearly +250%, from £84,620 in January 2000 to £292,882 in August 2023. That’s far in excess of the rate of inflation over the same period, and that’s after taking account of occasional downturns, such as during the global financial crisis. Viewed over the longer term, residential property has clearly been producing real-terms gains.

Whenever average asking prices start to decline, as they have for some of 2023, there’s a temptation to conclude that the market is somehow “in crisis” and entering an unstoppable downward spiral. The immediate, knee-jerk reaction might be to sell up and abandon the sector but this is often little more than a panic response born of inexperience. The fact that such a high proportion of seasoned, larger-scale investors are expanding rather than shedding their portfolios supports the argument that the present conditions are creating a time of real opportunity.

Prices and Portfolio Building

For those investors who regard investment as a longer-term venture, occasional dips in asking prices are largely irrelevant. That’s because they will be intending to retain their properties and use them to generate a regular rental income. Capital values really only matter when it comes to selling up or, of course, when it comes to making further acquisitions.

For those who intend to buy additional property, a short-lived dip in values is decidedly good news because it enables investors’ budgets to stretch further. It means that they can buy bigger, more modern or better-located units than they could have done if values had continued to rise.

This is the situation that we face now. Some house price indices have shown modest, year-on-year contractions in asking prices. Those contractions have been far smaller than many industry commentators had predicted at the start of 2023 but, nevertheless, prices in some regions are lower now than they were a year ago.

In its latest House Price Index, ONS noted that “average UK house prices decreased by -0.1% in the 12 months to September 2023.” To put that in terms of pounds and pence, the average residential property would have cost an investor £291,716 in September 2022, whereas that same property would have cost £291,385 a year later. That isn’t a big difference but, when we factor in the ongoing effects of inflation, it means that the real-terms cost of investment property has fallen more sharply. And over the same period, average earnings have been rising by +7.7% per annum, so real-terms affordability has been improving too.

In short, the combination of increased earnings, unusually high inflation and a negligible change in average property values has amounted to a readjustment in the market; one that has made property more affordable for homebuyers and investors alike.

Property Prices and Yields

For investors, lower asking prices don’t only mean an increase in purchasing power. They also make it easier to achieve stronger yields. This is because “yield” is an expression of annual rental returns as a percentage of the initial purchase price. We’re witnessing a time when rental returns have been rising at around +10% per annum (according to the most recent indices from Home, Rightmove and Zoopla) and asking prices have remained essentially static. Consequently, it’s no surprise that average UK yields have been rising strongly.

The latest Rental Trends Tracker from Rightmove estimates that annual gross yields are averaging at around 6.4% across the UK – ahead of the current rate of inflation – and that they have grown by +0.4% year-on-year. The Q3 Rental Market Barometer from Fleet Mortgages estimates the average at 6.9%. This, it reports, is “up from 6.3% in Q2 and 1% higher than levels seen in the same period over 12 months ago.”

Trends in Capital Values

The current market conditions are already enabling investors to make affordable acquisitions and to enjoy strong yields but it’s fair to say that if a downward trend in capital values were to persist for a protracted period, investment prospects would look less attractive. Fortunately, however, the longer-term outlook appears decidedly positive.

A key reason for the recent hiatus in market activity has been unusually high rates of interest. The Bank of England has sought to control inflation by raising the base rate of lending and, initially, lenders responded by raising the rates on their mortgage products. After many years of exceptionally low rates, this brought an unwelcome increase in repayment costs for households and investors. It also coincided with a sharp rise in taxation and the war in Ukraine, which drove a sharp escalation in the cost of fuel, energy and certain staple foods. Seeing their household budgets strained, homebuyers were forced to rein in their ambitions, either by staying put or haggling down the price of their intended purchases. The result, ultimately, has been a year of slower sales activity and a much more price-sensitive market.

Looking ahead, however, those economic constraints are losing their grip. The latest inflation data from ONS shows that the Consumer Prices Index fell to 4.6% in October as wholesale energy costs fell sharply. CPI inflation will take time to fall back to the Bank of England’s 2% target but there’s a broad expectation that it will gradually decline. That, in turn, will give the Bank more confidence about lowering the base rate and easing the financial pressures on mortgage-holders. As it does, so market sentiment should improve and property values should slowly return to growth.

Even ahead of that, mortgage rates have been falling noticeably. Driven by stiff market competition and growing optimism about longer-term market conditions, lenders have been introducing lower and lower rates on their fixed- term products. Many are now available at well under 5% - which some market commentators have previously regarded as the ‘magic’ threshold, below which homebuyer confidence would start to return.

More generally, average earnings are continuing to rise faster than inflation, so people should slowly start to feel that they have more money to spend. The change won’t be immediate or dramatic, but it’s another trend that should gradually help to boost market activity. Historically, there have been close parallels between average earnings, sales volumes and asking prices, so if we take past trends as a guide, a return to capital growth looks almost inevitable.

And finally, of course, the most fundamental market forces – supply and demand – are still working very much in favour of investors. Demand is extremely strong, both for both rented property and homes to buy, while supplies remain severely limited. Shawbrook reports that rental demand is +51% higher than the 5-year average, while the number of available homes is -30% below.

The statistics vary by source and by season, but that same striking imbalance has been a feature of the UK residential sector for decades. It has been a powerful driver of long-term price growth. As other affordability pressures abate, it should continue to exert upward pressure on both rental and capital values.

Rental Supply

The results of Shawbrook’s latest survey suggest that experienced investors are very much aware of all this. Conscious of the present downturn but anticipating a return to growth, they are building up their portfolios while prices are still comparatively low.

By contrast, a number of less experienced landlords, perhaps frightened by newspaper headlines, have been selling up. Some of their properties will have been purchased by professional investors and fundholders but others will have moved into private ownership – i.e. out of the rental sector entirely. If this shift results in a decline in the total supply of rental property, then competition amongst tenants is likely to increase still further and that could push asking rents even higher.

The irony here is that the departure of less experienced investors could provide those who remain with even stronger returns.

Professional Investment

There is no doubting the important influence of supply and demand. However, as 2023 has proven, these are not the only forces at work. Investors are focused on profit, not absolute returns, so it’s vital to consider the cost-side of the equation.

Mortgage costs are one obvious factor, but another has been the way the government has changed tax liabilities. In recent years, it has introduced a series of measures that have eroded profitability for many individual landlords. For example, it changed stamp duty thresholds for investors and ruled that from April 2020, landlords would no longer be able to deduct their mortgage interest costs from their rental income. This regulatory change has driven increasing numbers of landlords to invest via a business rather than in their own names. Investing via a limited company offers a number of tax-saving advantages, in most cases at least, and recent estimates suggest that over 75% of new property investments are now made this way.

Changes to taxation and other regulations have also tended to squeeze out ‘accidental’ landlords – i.e. people who choose to let out homes that they have acquired through inheritance or cohabitation. Those who became landlords for reasons of convenience rather than as a result of a considered financial decision may have struggled with these many changes, and selling up may have felt like an easier option than staying abreast of the changing regulatory landscape.

Against this background, it makes sense that the majority of new property investment is now coming from businesses and professional investors. It is part of an ongoing transition that many in the industry will welcome, not least because it should help to raise standards and ensure more stringent compliance with building and safety regulations.

However, it’s also important to recognise that entering the market as a new investor is still relatively easy. It’s important to take advantage of the best possible advice, of course, but there are few practical barriers.

A Professional Mindset

Successful property investment does not require a massive budget nor, necessarily, years of experience. What it does demand is a serious business mindset. In other words, investment properties should be chosen on the strength of detailed local research and with an understanding of what each local market demands. That, in turn, demands flexibility and a readiness to invest where the market conditions look most favourable.

The survey by Shawbrook notes that amongst those intending to increase their portfolios, 39% were intending to diversify by location and 37% were considering different types of accommodation, including conventional assured shorthold tenancies, student property and retirement housing. The point here, is that successful investors do not abide by rigid preconceptions or personal preferences about style, type or location; they choose their properties primarily on the basis of their ability to generate a good financial return.

Property Type

When making an informed investment choice, energy efficiency is a crucial consideration. Energy prices and the cost-of-living crisis have undoubtedly shaped people’s preferences about the kinds of properties in which they want to live. Ordinary tenants and homebuyers are prepared to pay more for energy efficient homes, and this shift in demand is affecting the returns that different types of property are likely to deliver.

On the one hand, more modern, energy efficient homes are holding their values better and, in several regions, they are appreciating much faster than the local competition. Moreover, they typically command higher rental values, they see fewer void periods and they benefit from greater loyalty on the part of tenants. By contrast, older, poorly insulated homes have been more prone to depreciation, rental arrears and void-related losses and, unsurprisingly, they often expose investors to considerably higher maintenance costs.

This is a point underscored by the Shawbrook survey. The company’s Managing Director of Real Estate, Emma Cox, said: “whilst the property market remains challenging, it’s encouraging to see professional landlords continuing to invest and seek opportunities to diversify. Our research has shown that a significant number of landlords have taken proactive steps to expand their portfolios while responding to demand to add quality, energy efficient rental stock to the market for renters.”

Location

Throughout this article, we have used average figures for the whole of the UK. However, investment professionals will seldom confine themselves to just one location when seeking to acquire new properties. They will invest wherever the conditions are most favourable.

At present, the UK’s more affordably priced markets appear to be the most attractive. There will always be considerable variation at the very local level, but on a regional basis and by most criteria, the best results are typically being achieved in Northern England and Scotland.

A clear North-South divide is apparent when it comes to house price growth. The November House Price Index from Rightmove reports positive year-on-year growth the North West (+2.5%), Scotland (+1.9%), the North East (+1.3%), Yorkshire & Humber (+0.2%) and Wales (+0.1%). Elsewhere, average values have fallen – most noticeably in the South East, where asking prices dropped by a significant -2.8%.

Other sources offer different figures but that same regional split is clear. Home.co.uk also lists the UK frontrunners as Scotland and the North West, whereas ONS reports the strongest gains in Scotland and the North East. All indices report poorer results further south.

On the measure of rental growth, there is a similar pattern, except that London has also performed well. Nevertheless, if we take an average of all rental indices, the North West and Scotland still come out on top.

When it comes to gross yield, that same North-South divide is again apparent. The affordably priced North East has performed best overall (8.5% according to Rightmove), with Scotland, Wales, the North West and Yorkshire & Humber following close behind.

Summary

No one will look back on 2023 as a heyday for property investors, but then the best investment opportunities arise when the market is in a trough, not when it’s close to its peak. Right now, capital growth rates appear unimpressive but they also look set to improve, and that could give rise to some very valuable opportunities.

Key economic indicators, such as inflation, mortgage interest rates, average earnings and the continuing imbalance between supply and demand all point towards a slow return to growth. That growth won’t be as dramatic as it was during the Covid pandemic but it should quickly begin to outpace inflation and deliver respectable real-terms returns. In the meantime, investors with well-chosen properties in the country’s more affordable regions should also be able to count on continuing rental growth and inflation-beating yields.

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To find out more about investment opportunities in residential markets across the UK, please call our advisory team on 01244 343 355.

Growing Confidence Among Investors