Read the RICs report on the buy-to-let market.

Jan 2007

Rising interest rates slow buy-to-let

• Rising interest rates slow growth in new landlord instructions
• Strong labour market and migration keep tenant demand rising firmly
• Gross yields fall for first time in two years as house price rises accelerate

Tenant demand relects strong economy

Tenant demand for rental property remained solid in the quarter to October, according to the RCIS, although the pace of growth eased back slightly.

The strength of tenant demand reflects a combination of factors, including a strong economy which has generated 190,000 jobs in the year to September and rising migration levels due to the accession of central and Eastern European states into the EU.

Poor accessibility conditions continue to prevail for home-buyers in general but rental demand for flats has slowed, as a buoyant economy has helped some first-time buyers to climb into the housing ladder.

Manning Stainton Lettings does not foresee a significant rise in rental levels in 2007 due to a healthy number of new rental properties coming onto the market.  The crucial factor for Landlords is to provide ‘good quality tenants' with ‘good quality accommodation'.  2006 has seen the letting period for good quality, two-bedroom accommodation in Leeds taking between three and five weeks to find a suitable tenant. 

Instructions to let properties properties rose in the quarter to October - albeit at the slowest pace since Q2 2005. The slowdown in the growth of instructions reflects a deterioration in landlords’ margins as a result of rising interest rates and a renewed fall in growth yields. Indeed, property sales by landlords edged up in October, representing the second consecutive quarterly rise. However, landlords are still confident over market prospects, with the rate of property selling less than half that of July 2004.

Rental levels rose further in the quarter to October, but the pace was down on that recorded last quarter, which as the highest since Q3 2001. Tenant demand for property exceeded new supply for a tenth consecutive quarter, putting upward pressure on rental levels.

With instructions from landlords slowing, surveyors expect rental levels to rise further, though confidence has slipped a touch. Gross yields declined for the first time in two years for the October quarter, as house prices rose faster than rents, squeezing the net income of buy-to-investors.

Tenant demand remains solid

Tenant demand for rental property remained solid in the quarter to October, although the pace eased back slightly. Tenant demand has strengthened over the past few years in the wake of increasing migrant labour flows and a strengthening economy. 

20% more surveyors reported a rise in tenant demand than a fall for the quarter to October, down slightly from 25% on the previous quarter. The long-run average for the survey is 17%. Tenant demand remains strong in the North, London and the South East, while it picked up in the Midlands and Eastern region. In the South West tenant demand eased back.

Houses edge out flats in tenant preferences

The modest deceleration in tenant demand was skewed primarily towards flats, while demand for houses increased at around the same pace as in the previous quarter. The rise in tenant demand for flats is the slowest recorded since January 2005 as more would-be first-time buyers have been able to get on to the property ladder as the economy has improved.

For flats, 10% more surveyors reported a rise in tenant demand than a fall compared with 25% in the previous quarter and a long-run average of 18%. For houses, 22% more surveyors reported a rise than a fall, compared to 23% in the previous quarter and a long-run average of 14%.

By type of tenant

The make up of tenants is dominated by private households who constitute 80% of all lettings, which is slightly above the long-run average rate and up 2% on the previous quarter. The share of lettings to socially funded tenants increased for the first time in a year although it is still below the long-run average.

Lettings to the corporate sector fell by 1.7% after rebounding in the previous quarter and are now slightly below the long run average.

New instructions

Instructions to let properties continued to grow in the quarter to July although they increased at the slowest pace since Q2 2005 as rising interest rates squeezed landlords’ margins.

For the quarter to October, 6% more surveyors reported a rise in instructions than a fall, compared to 13% in the previous quarter. Instructions picked up in the Eastern region and South West, whilst in London they stabilised. In the north and the Midlands instructions strengthened, whilst in the South East instructions fell.

Flats and houses

The slowdown in instructions was skewed primarily towards flats, while instructions for houses essentially remained stable for the second consecutive quarter.

For flats, 9% more surveyors reported a rise in instructions than a fall, compared to 19% in the previous quarter and a long run average of 17%. For houses, 1% more surveyors reported a fall than a raise, compared to 1% more reporting a rise in the previous quarter and a long run average of 15% more reporting a rise.

Landlord activity

The share of instructions continued to be dominated by private investors, which made up 84.8% of the market in the quarter to October, up from 80.6% in July. This brings private investors’ share of instructions back to year ago levels, although they still remain slightly below the long-run average.

The share of instructions taken by institutional investors contracted for the second consecutive quarter to 7.6% in the quarter to October, which is back a year ago levels. Property companies’ share of instructions fell by 3.6 percentage points to 6% and is now at its lowest level in over a year.

Landlords find margins squeezed

The percentage of landlords selling their properties at the expiry of tenancies, rose fractionally to 4.8% I the quarter to October, up for a second consecutive quarter.

Landlord sales have begun to creep upwards in light of rising interest rates and falling gross yields, which are squeezing margins. However, landlord sales remain well below the survey high of 9.9% in July 2004, indicating that overall confidence of buy-to-let landlords in the residential property is still strong.

Past rents/rent expectations

Rental levels rose in the quarter to October, albeit below the pace recorded in the previous quarter, which was the highest since Q3 2001. Higher rents reflect the impact of demand exceeding supply for the tenth consecutive quarter.

For the quarter to October, 28% more surveyors reported a rise in rents than a fall, down slightly from 30% in July, though this is still four times the long-run average for the survey. The slight easing in rental growth was skewed towards houses, thought the overall rise in rents was similar for flats and houses during the quarter.

For flats, 28% more surveyors reported a rise in rents than a fall, the same pace as in the previous quarter, while the long run average is 7%. For houses, 28% more surveyors reported a rise in rents than a fall, compared to 34% in July, and a long run average of 7%

Confidence in rental increases edged back after reaching the highest level in the survey’s history in the previous quarter. 26% more surveyors expect rents to rise than fall in the next quarter compared to 28% in the previous survey and a long run average of 10%. This modest fall in confidence comes amid the modest deceleration in the pace of rental growth for houses although it still remains very buoyant.

Rents and yields

The average rent in the country was £785 per calendar month in October 2006. Rent for a one bedroom flat in Britain was £593 pcm, a two bedroom flat £727, a three bedroom flat semi detached house £931 pcm and a four bedroom detached house £1,295. Excluding London, the average rent was £565.

The highest rents are paid in London and the South East (£1,798 and £774 respectively). The next highest are Eastern and the South West, at £587 and £584 respectively, Wales and Scotland have the lowest rents, at £397 and £410 respectively. In England, the lowest rents are in the East Midlands at £459.

Figures collected from RICS members indicated that average gross yields were 4.6% in October 2006 compared to 4.8% a year ago.

Gross yields

Gross yields fell slightly in the quarter to October, the first drop recorded in two years as house prices rose more quickly than rents. Yields on flats stabilised as rents continued to increase at the same pace as in the previous quarter, while yields on houses declined slightly as rental growth eased back.

Gross yields rose most in London (skewed upwards by rising yields on flats), while modest rises took place in the South West and the Midlands. In the North and the South East gross yields declined slightly, while in the Eastern region, marginal declines took place for the second consecutive quarter.

Regional results

North

Tenant demand for the three months to October continued to rise at the same strong pace as in the previous quarter.

Landlord instructions increased at the slowest pace since Q2 2005, as flat instructions eased sharply.

Rental growth remained steady, although the pace slowed for the second consecutive quarter, due to a deceleration in housing rents. Gross yields for both flats and houses declined for the first time since Q1 2005 as a result of rising house price inflation.

Midlands and Wales

Tenant demand for the three months to October increased at the fastest pace since Q1.

Landlord instructions increased in line with the survey’s long run average, although weaker than in the previous quarter, due to a sharp slow down in instructions of flats.

Rental levels increased at the fastest pace in the survey’s history, boosted by a sharp rise in rents for flats, while houses rents continued to increase at the same rapid pace. Gross yields stabilised for both flats and houses.

Eastern Counties

Tenant demand for the three months to October strengthened for the second consecutive quarter approaching the rapid pace recorded in Q1.

Landlord instructions increased at above the long run average after two consecutive quarters of modest rises.

Rentals levels continued to increase firmly although the pace slowed compared to last quarter, as housing rents moderated. Gross yields remained stable for the second consecutive quarter. House yields rose moderately while flat yields fell moderately.

South West

Tenant demand for the three months to October increased at the slowest pace since Q1 2005, as demand for flats stabilised and demand for houses increased only modestly.

Landlord instructions rose at the fastest pace since Q3 2003 after last quarter’s moderate fall.

Rentals levels rose at the fastest pace since Q3 2005 as a result of sharply accelerating flat rents. Rents in the housing sector continued to increase firmly although the pace slowed. Gross yields rebounded sharply after last quarters fall due to rising flat rents.

South East

Tenant demand for the three months to October continued to increase firmly although at a fractionally slower rate as demand for both flats and houses eased.

Landlord instructions fell at the fastest pace in the surveys history with both instructions for flats and houses declining sharply.

Rental levels continued to increase strongly although the pace slowed fractionally compared to last quarter due to a slightly deceleration in flat rents. Gross yields fell moderately for flats after last months rise, while they fell fractionally for houses, at the same as last quarter.

London

Tenant demand for the three months to October remained very strong, although it slowed moderately compared to the previous quarter.

Landlord instructions stabilised following last quarter’s heavy decline, due to stabilising flat instructions.

Rents continued to increase very strongly, at close to the fastest in the survey’s history. Rental growth was led by flats, where gross yields picked up strongly. Housing rents continued to increase quickly, although less so compared to last quarter, causing yields to decline moderately in light of the rapid house price growth that has taken place.

Scotland

Tenant demand for the three months to October continued to increase firmly at the same pace as in the previous quarter.

Landlord instructions also increased at the same rapid pace as in the previous quarter, only moderately below the record pace recorded in Q2.

Rental growth slowed compared to the previous quarter although in line with modest rises 6 months prior. Housing and flat rents both slowed by the same amount causing yields in both sectors to fall at the fastest pace since Q2 2004.

RICS, October 2006