Newsletter January 2007

Rental market provides increased capital values and steady returns even as bureaucracy and EU referencing are troublesome.

Capital values have increased and returns in the private rented sector have remained largely unchanged this autumn but bureaucracy is driving landlords who own Houses in Multiple Occupation out of their market. This was revealed in the latest quarterly survey of ARLA member letting agents published today, December 6.

The survey also showed that immigrants from the new European Union states are making less demands on rented property stock than many believe but obtaining references on these prospective tenants is proving to be a major problem. Commented Adrian Turner, Chief Executive of ARLA, "The mainstream rental market continues to flourish. It is only at the margins that trouble could arise if these two problems are not addressed swiftly."

Overall, the average asset value of houses to rent has increased by 7.4% in the last three months as a result of rises of 11.4% in prime central London and 21.3% in the rest of the UK. By contrast, the average value for houses in the South East outside prime central London fell by 4.4%.

In the same period, rented flats rose by an average of 4.7% for the country as a whole with increases in prime central London at 3.5% and the rest of the UK outside the South East increasing by 16%. In the rest of the South East, the value of flats fell marginally, by 0.3%.

Returns on asset values have changed little in the past three months, although achievable rent levels have increased overall. In the last three months rents have increased in prime central London but have remained largely unchanged in all other parts of the country.

The latest three-monthly survey shows that well over half of those landlords who have disposed of properties used as Houses in Multiple Occupation have done so because of bureaucracy and too many new regulations. These factors are just as likely to have influenced decisions to abandon that part of the market as the additional costs of licenses and alterations.

On the question of immigration, the majority of letting agents describe incoming tenants from the new EU countries as only having some effect on the rental market. Just one in twenty believe that EU immigration has made any dramatic impact on the market.

The most significant problem for the private rented sector caused by the new immigration is the difficulty in checking references. One in twelve agents say it is proving impossible to get references on prospective tenants who come from the new EU accession states.

Unsurprisingly, immigrants have had the least effect on the rental market in prime central London. They have had the most effect away from the South East.

In London and the South East, the balance of supply and demand for rental properties has continued to improve. More than seven out of ten ARLA agents in prime central London report that there are more tenants than there are properties. This is an increase of ten percent over the previous three months.

Agents throughout the South East who also report more tenants than properties have increased from 34% to 37%. However, there is a small drop in the rest of the UK, with the number of agents reporting more tenants than properties falling from 34% to 32%.

Compared to the third quarter, the average void period has fallen from 26 to 25 days. This reflects properties remaining empty for shorter periods in both prime central London and the rest of the South East.

Once installed, tenants are staying put for an average of 15.7 months. This is up marginally from an average duration of 15.6 months reported at the end of the last quarter. "These lengths of tenure suggest that the private rented sector is providing the sort of property that people want to live in as well as giving them choice and flexibility," Adrian Turner pointed out."

Another buoyant year for Buy to Let

Residential property investors remained active throughout 2006, benefiting from an uplift in capital values, stable rental yields and a consistently positive economic backdrop. Demand from tenants has remained strong, with particular growth from inward migrants to the UK.

Over the past 12 months, the average buy-to-let property has risen in value by 5% or £7,736, according to latest figures from Paragon’s Buy-to-Let Index. This compares with an uplift of 0.8% or just £1,277 over the previous 12 month period.

Nigel Terrington, chief executive of specialist buy-to-let provider Paragon, comments: “In terms of capital appreciation alone, the average buy-to-let investor has made over £7,700 this year just by owning a rental property. On top of that, he has generated almost £10,000 in rental income, an excellent total return on investment of £17,700 or 11.4% over the past 12 months. 2006 has definitely been a good year for most buy-to-let investors.”

Recent government statistics provide further evidence that the private rented sector will continue to grow apace.

According to HM Treasury estimates, new immigration will continue at an annual rate of between 185,000 and 190,000 over the next three years, higher than previously expected, on the back of which the estimate of sustainable growth has been increased from 2.5% to 2.75% from 2007 onwards.

Nigel Terrington says: “Inward migration is a key driver of tenant demand. We know that less than 20% of migrants become home owners within five years, which means that a net influx of people, particularly from Central and Eastern Europe, will have a direct impact on the private rented sector.”

“Indeed, recent research of our landlords indicates that almost a third believe that tenant demand is either growing or booming, and the majority believe it is stable.”

In this environment of growing tenant demand, investors are expected to channel significant additional investment into the private rented sector over the coming months. Paragon’s latest landlord survey indicates that investors expect to grow their portfolios in numerical terms by 6% over the next 12 months.

“Many of them see residential property as a good investment class for long term retirement provision. They like property because they understand it and they can control the outcome – unlike stock market investments.”

Indeed, another recent survey indicated that eight out of ten mortgage brokers expect to see an increase in buy-to-let lending in 2007.

“With tenant demand set to remain strong and investors continuing to be confident about residential property investment, 2007 is set to be another busy year for buy-to-let,” concludes Nigel Terrington.

NAEA predicts a steadier year for house prices

The National Association of Estate Agents (NAEA) is predicting a steadier year for house prices across the UK in 2007, with regional variation being a key characteristic of the market as property supply continues to be an issue in many places. Interest rates will have a vital role to play in ensuring that struggling areas are able to weather the difficulties. Meanwhile, the proposed HIPs legislation presents huge uncertainty for the market.

Average house prices

Following a difficult year in 2005, the majority of 2006 has seen a healthy market with average house prices having risen around 9 per cent since January. This positive trend is expected to continue in 2007, but at a slower pace with the NAEA forecasting rises of around 5% over the year.

Regional differences in supply and demand

While the market has always been subject to regional variations, these are likely to become more pronounced in 2007 as the issue of property supply comes to the fore. The latter part of 2006 has seen the gap between areas struggling to find property and those where supply is not such an issue widen markedly.

Shortages in the South East have led to high prices and a high pace of activity, which is distorting figures on a national level. While the overall picture may look positive, a number of areas across the UK have been experiencing a much flatter market. These regions have not been helped by two interest rate rises over the last four months.

Interest rates

Following the increase of interest rates to 5% in November, leading economists are now divided over the movement of rates in the early part of next year. While the recent rises may help to calm house price inflation in London and the South East, there are a number of already underperforming areas across the rest of the UK that are likely to suffer further if there is another rate rise.

With this in mind, the NAEA is warning the Bank of England not to be governed by the London market when making decisions on interest rates next year.

Consumer confidence

Consumers have demonstrated a renewed confidence in 2006 and the NAEA expects this to continue into 2007.

With many set to take advantage of the higher lending multiples now being offered by banks, some could run into problems if there is a significant rise in interest rates. The NAEA is advising home buyers to plan carefully and be realistic about what they can afford in 2007.

First time buyers

Although NAEA estate agents have reported an increase in the number of first time buyer sales recently, first timers are likely to continue experiencing difficulties next year if issues such as affordability and stamp duty remain unchecked. The NAEA urges the Chancellor to seriously consider these when looking at his budget for the next financial year.

HIPs

The proposed HIPs legislation – due to come into effect in June 2007 – looms as an unknown factor when making predictions for the coming year. With June usually a busy time for estate agency, it is uncertain what effect the Packs will have. The usual trends of supply and demand are likely to be severely disrupted with buyer reactions hard to predict.

Peter Bolton King, Chief Executive of the NAEA, comments: “In what is likely to be a quieter year than 2006, we are expecting to see modest price rises and a continuing rise in consumer confidence. I firmly believe, however, that it is going to be increasingly difficult to make generalisations about the market as we see the gap between under-performing areas and those holding steady widen even further.

“While it may be a quieter year for prices, the housing market itself could be facing significant change with the proposed HIPs legislation. This is creating huge uncertainty for the market and is a situation we will continue to be watching closely moving into next year.”

Strong growth in output and employment feeds above trend property demand

Overall demand for commercial property grew at a rate above the long term average and ahead of expectations in the last six months, according to the latest survey of property trends published by property advisers GVA Grimley and the CBI.

The above trend growth in demand for property has been driven by higher than average business output growth and strong increases in employment.

Companies are even more positive about their demand for property over the coming six months. In fact, the factor they now fear will constrain their expenditure most is a lack of suitable property. By contrast, access to and cost of external finance comes bottom of their concerns.

The twice-yearly survey of occupiers - which takes in offices, shops, factories and warehouses - shows that over the last six months +31 per cent of respondents increased their property holdings while +11 per cent reduced them.

The rounded balance of +21 per cent is higher than expected and shows a pick up in growth since the summer's survey (+7%). A balance of +25 per cent expects the amount of property they occupy to increase in the next six months.

Output rose over the last six months for a balance of +41 per cent of property holders, the fastest rate since November 2000 (+44%). This growth in output is expected to slow next year to a balance of +31%, in line with the long-term average.

Meanwhile, employment increased for a balance of +38 per cent of respondents. The rate of growth was particularly strong in banking and finance, where a balance of +42 per cent took on more staff. Overall employment growth is expected to moderate in the coming months, though the balance (+23%) is still well above the long term trend (+8%).

Demand for retail property grew for a balance of +18 per cent, a little above the long-term average of +13 per cent and slightly up against the last survey six months ago (+15%). Healthy demand is expected to continue for this sector, with a balance of +19 per cent expecting it to grow.

Office property was broadly stable, with occupiers expecting demand to rise over the next six months. The balance of +1 per cent for the past six months was slightly below the average for this sector (+5%) and a +6 per cent balance now expects demand to grow, driven largely by the banking and financial sector.

The balance in the manufacturing sector of zero per cent shows demand for factory space neither increasing nor decreasing overall. The balance for the next six months is slightly lower at minus two per cent, the only negative balance in the survey for expected demand.

Optimism about the general business outlook remains essentially unchanged from the last survey, with a balance of five per cent marginally above the long term average (+4%) but slightly lower than six months ago (+6%).

Stuart Morley, National Head of Research at GVA Grimley said: "Above trend growth in the economy, reflected in the rise in business output and employment seen in this survey, is pushing up demand for commercial property. If anything, the biggest concern is that there aren't enough suitable properties to satisfy demand. This is particularly true for parts of London and the South East but the outlook nationally is upbeat for the commercial property sector. A slight slowing in business output over the next six months, in line with the expected slowdown in the world economy, is not expected to hold back growth in demand for offices, shops and warehouse space."

Doug Godden, CBI Head of Economic Analysis said: "Demand for property has been robust in the retail sector in the last six months, while office property holders are optimistic demand will increase over the next six, having been reasonably stable recently. With manufacturers continuing to shed jobs, they have not increased demand for factory space and they do not expect the next six months to be any different.

Looking forward, the rate of employment growth is expected to slow overall, and the rate at which manufacturing jobs decline is expected to moderate over the next six months. "The commercial property sector has benefited from the recent healthy economy and continues to look forward to a buoyant half year. Whether that continues beyond this depends not just on domestic conditions but also on the impact of any US economic slowdown on the UK's economy."

Demand for commercial property sees value of vacant buildings soar

Attractive yields and healthy rental growth have helped to make commercial property one of the strongest performing investment options available and recent years have seen unprecedented levels of demand, particularly in the offices sector.

Moreover, due to the sheer weight of this demand, there has been a significant step change in terms of what constitutes a good investment. According to South Wales property adviser GVA Grimley, one of the most noticeable effects of this trend has been the rise in value of vacant office buildings.

Traditionally, compared to buildings with existing tenants and the accompanying rental revenue they bring, vacant buildings have been regarded in almost all instances as less desirable by investors. But this is no longer always the case, as Stuart Ramsey, regional head of offices and development for GVA Grimley in Wales, explains:

"In the past, the office market has been driven by occupier demand, with leases put in place to drive value and profit to those implementing development. More recently, however, the phenomenal demand for commercial property has shifted the emphasis towards owners, who are benefiting from rising capital values without occupier demand running alongside.

"As a result, we are seeing untenanted properties achieving values which would have been virtually unheard of twelve months or so ago – particularly in locations such as the Valleys with good road transportation links to the M4 motorway."

The growth in capital values for these types of properties is also based upon anticipated uplifts in tenant demand and consequential rental growth – with the demand for commercial property unlikely to abate any time soon, owners are confident that their investments will continue to pay dividends well into the future.

The market is also being fuelled at the smaller end by the ability of individuals to place commercial buildings into SIPPs (Self Invested Personal Pensions). Stuart Ramsey continues: "The Government’s U-turn on permitting residential property to be placed into SIPPS has added to demand, steering money and finance towards the commercial sector. With excellent returns on commercial property of all kinds, individuals looking to secure their retirement funds are just as likely to consider untenanted buildings as any other."

Vacant buildings then, once the white elephants of the property industry, have now become a much more viable proposition for investors. Their rise in value is testament to the exceptional levels of demand the UK property industry is currently experiencing and which will surely continue for the foreseeable future.