Newsletter June 2006

Landlords look to grow portfolios over the next 12 months - Undeterred by HMO licensing

Confidence remains strong among residential property investors. Latest research from specialist buy-to-let lender Paragon Mortgages shows that landlords have seen an increase in tenant demand and rising achievable rents over the past six months.

One quarter of landlords reported that tenant demand for residential property is currently increasing, with two thirds saying that it is stable. Buoyant tenant demand is having a knock-on effect on rents, with a substantial proportion of landlords (38.5%) reporting that rents achievable have increased over the last six months. On top of this, the survey shows a decline in average annual void periods, from almost 3 weeks on the occasion of the last two quarterly surveys to just 2.8 weeks now.

John Heron, managing director of Paragon Mortgages said, “Landlords are experiencing strong tenant demand, as reliance on rented accommodation continues to grow due to social and demographic trends. More young people see renting as a lifestyle choice, and in addition, there are an increasing number of students and immigrants who tend to opt for rented homes to meet for their accommodation needs.”

“These trends are clearly having an impact on landlords’ future investment plans,” he continues. “Landlords plan to grow the size of their portfolios from 10.8 to 11.4 over the next year. In value terms, landlords expect a higher level of growth in their portfolios than they have at any time for almost 2 years.”

The current average portfolio size of landlords surveyed is £1.31 million. Landlords are predicting an overall increase of 5.6% in the net value of their properties in the next 12 months. The majority of landlords (72%) currently achieve gross rental yields (based on market value of their residential property) of between four and seven per cent, with an average return of 6.3%. Respondents to the survey expected gross yields to rise to 6.4% over the next 12 months.

This strongly positive picture of the buy-to-let sector on the part of landlords comes despite some misgivings expressed over the new licensing of Houses in Multiple Occupation introduced on 6 April. Over a third of landlords said that this measure would make things more difficult.

John Heron concludes: “What comes over clearly is that landlord confidence is at a high level. With tenant demand remaining strong and future prospects rosy, they will take HMO licensing in their stride. They do need to make sure they familiarise themselves with the new rules, however, and make sure they are compliant before the end of the three month grace period.”

Investors continue to snap up properties at attractive prices    

As activity in the buy-to-let sector remains strong, the average price at which landlords acquire investment properties eased slightly in March, reflecting the sustained tenant demand particularly for properties at the lower end of the price spectrum and a surge in activity on the part of smaller scale investors. After three months of rising house prices, March saw a 1.5% drop in the average price paid by landlords, from £163,417 to £161,039. Nevertheless, property values are still 5.5% higher than they were a year ago.

John Heron, managing director of Paragon Mortgages, comments: “At the end of 2005 and especially the start of 2006, we witnessed a significant pick-up in activity in the buy-to-let sector, with professional and smaller scale landlords alike purchasing additional properties in response to identified demand from tenants. Since November, property values had been rising steadily, but this month saw an easing in prices paid. This reflects the fact that tenant demand is strongest for smaller homes, as singletons and young couples look for clean, simple rental properties to fill their accommodation needs. As serious investors buy in response to actual tenant demand, average prices paid have eased a little.”

In line with the easing of property values, rents are slightly lower, at £10,082, while yields now stand at 6.26%. “What is important,” continues John Heron, “is that at these yields landlords are confident to buy – and they are buying with a vengeance. Landlords typically have a 10+ year perspective on the market. Over the long term they are convinced that a combination of rental income and capital appreciation will make these additions to their property portfolios an attractive investment proposition.”

The London market, in particular, has enjoyed a significant boost – notwithstanding the fact that the Capital typically offers lower yields than the rest of the country. John Heron explains: “Regions, like London and the South East, where average property values are much higher tend to generate lower yields – hence in London yields are just 5.80%, based on an average property value of in excess of £293,600. Even so, landlord activity currently seems to be particularly strong in London and the South East. After a period of some uncertainty, economic confidence is back, interest rates look stable, there are plenty of jobs available in London and the Home Counties, and with this comes greater demand for rented accommodation among all categories of tenant. For investors this as a sure signal that the time is right to increase their involvement in the private rented sector.”

This month, the East Midlands has taken over from Wales as the region offering the highest yield, pushing the Principality into second spot. John Heron continues: “There tends to be an inverse correlation between property value and yield – so that lower value properties tend to generate higher rental yields. Thus, property values in both the East Midlands and Wales are well below the UK average, £136,403 and £133,297 respectively compared with an average of over £161,000.”

Looking at total returns (property appreciation plus rental income), the North offered the best return on a property bought 12 months ago, of 39.5%, followed by the West Midlands, Wales and Greater London (in each case approximately 29.5%).

In terms of property type, terraced homes continue to be the most popular with tenants and thus command the highest yield, of 6.65%, followed by semi-detached and detached at just over 6.4%.

John Heron concludes: “We have identified a significant upsurge in landlords’ confidence and activity over the past three months or so. They are actively growing their portfolios and indeed in our landlord survey they tell us that over the next 12 months they plan to increase their property holdings by around 6%, on the back of growing tenant demand and an expectation that rents will rise.”

Buy to let booming, says Paragon Mortgages                             

The buy to let sector is booming, according to new figures from Paragon Mortgages. Rising prices seem not to be putting investors off from adding to their property portfolios, Paragon’s May Buy to Let Index shows.

Nationwide, sale prices have increased by 1.99 per cent since last month, generating a 4.7 per cent increase over the last six months.

Paragon managing director John Heron explained: “Residential property investors continue to build their portfolios in a buoyant housing market. We’ve seen prices at which they buy properties rise by almost 2 per cent since last month, contributing to a 4.7 per cent increase in the 6 months since October 2005.

“This pick-up is led in particular by strong property price inflation in the North, Greater London and the South East.”

He suggested that new entrants to the buy to let sector are not behind the current upward trend.

“There has been a resurgence of buy to let activity since last autumn, particularly among larger scale and professional investors. In all parts of the country, upbeat landlords are buying properties at higher prices, secure in the knowledge that there is good tenant demand out there for the right property in the right place”, Mr Heron stated, adding: “It is perhaps no coincidence that real estate investment is popular at a time of uncertainty in the equity markets.”

Paragon’s findings are consistent with recent studies from the Royal Institution of Chartered Suveyors and the Council of Mortgage Lenders, suggesting that 2006 is turning out to be a boom year for the buy to let sector.

Latest research shows commercial property debt has trebled since 1999

Bank lending to commercial property soared 16% to £156bn last year. More than £173.6bn of outstanding debt was recorded as at the end of 2005 across all property, including loans secured on social housing. Bank funding of speculative development - new buildings built without a tenant already lined up - and loan-to-value ratios are also on the rise.

The De Montfort University research shows that commercial property debt has more than trebled since 1999. There was more than £50bn lent in 1999 compared with £156bn last year, as borrowers have taken advantage of low interest rates and a continuing boom in property prices

The aggregate value of commercial property loans went up 16% between 2004 and 2005 - the largest rise since 2001. UK banks accounted for 45% of the money lent to property domestically and at the same time North American and German lenders are increasing their exposure to UK property. The six largest lenders were responsible for 58% of outstanding debt, although there has been an influx of new lending organisations.

New lenders contributed £62.4bn in debt in 2005, a 47% increase and the largest since research was first published.The rise in lending coincides with a record year for the securatisation of bank loans - where banks sell off the income streams from loans in order to recycle capital and increase lending to the property sector overall.

Last year, £12.6bn of debt was securitised, compared with a total of £31bn between 2000 and 2005. Loan-to-value ratios for prime retail, office and industrial properties at the end of last year were at their highest since 1999.

Spiralling prices in the investment market have also led investors to turn to riskier options in the development market. At the end of last year, 75% of loans are made for investments, against a rising 13% of loans on development. Speculative development lending jumped from £3.5bn in 2004 to around £5bn in 2005.

Retail continues to be the most popular asset class for investment, with 30% of overall outstanding debt and 17% of all commercial development lending.

Investors braced as roof set to cave in on property returns Leading commercial property investors are steeling themselves for a dramatic drop in returns from bricks and mortar.

Some fund managers driven out of the direct market by spiralling prices are seeking refuge in property equities. Others are renegotiating leases while circumstances are favourable. Standard Life has warned that while total returns from commercial property will hit 15.1% this year by 2008 they will have dwindled to just 5.4%.

Barry MacLennan, investment director at the Scottish insurer, said rental income would be crucial when capital rises tapered off and that he was currently renegotiating leases. He said investors need to protect themselves from a property slump that could strengthen the negotiating hand of tenants. The average unexpired lease on the IPD index is 9.3 years.

‘Clients and advisers should be looking for anything in excess of 10 years,’ he said. MacLennan also believes that property shares could benefit from an extended cycle after real estate investment trusts (Reits) come into existence next year.

Property equities are becoming an increasingly important part of Thames River’s £840 million TR Property investment trust (TRY) run by Chris Turner. Direct property makes up just 7% of his fund compared to normal weightings of up to 20%.

He said he had attempted to increase his weighting in direct property last year but ended up settling for just one purchase after being repeatedly outbid. But he believed that the majority of capital flowing into real estate was from investors with fairly long-term perspectives.

‘Nevertheless, we need to be wary. We think our investments in the leading UK property companies have above average upside potential due to the arrival of UK Reits and to the improved outlook for office rental growth in the UK.’

Peter Roscrow, managing director of Close Property Management, said a key way for investors to seek continuing returns in a slowdown is by getting exposure to development and trading opportunities. Among its current offerings is the Eighth Special Opportunities Fund LLP, a three to four-year property development fund.