Are private rents sustainable?

The point to watch is when the gap between mortgage payments and rent evens; we are someway off this but we can start to see the shift happening

In our series on property we have considered different aspects; from property as an investment to whether the market is overheating. One aspect that seems harder to quantify is the rental market.

The data on this is much harder to ascertain but in this blog we want to consider some aspects of the rental market, and whether we can learn anything from this.

Supply / Demand

There are four main providers of property in the UK:

  1. Owner occupied
  2. Private rental
  3. Housing association
  4. Local authority

Government statistical data from 2005 to 2013 shows some interesting figures:

  1. Owner occupied – down 2.30%
  2. Private rental – up 65%
  3. Housing association – up 30%
  4. Local authority – down 22%

The number of dwellings has gone up 6% during this period.

On its own this doesn’t tell us much but actually there is perhaps more than meets the eye.

House prices

House prices started to hit a peak between 2005 and 2007. By the end of 2005 the inflation adjusted price of a house reached £208,365 and by the end of 2007, £224,853. At the same time we saw two things happen; firstly the house price to earnings ratio breached 7 times’ earnings, and secondly monthly mortgage payments as a percentage of income breached the 50% mark.

Both of these are important but the 50% figure is the part to focus on.

At the peak of the last housing bubble mortgage payments peaked at over 50% of earnings. At the same time rent as a percentage of income was 17.5%. It made sense to rent.

As house prices dropped the affordability of mortgage payments dropped to below 20%. At the same time private rent (as a percentage of earnings) was about the same. Effectively once the market bottomed and people felt confident to buy they moved from being renters to owners.

2014

At the start of 2014 the index of affordability showed that mortgage payments had fallen from a high of over 50% to just above 30%, but this is expected to rise to 40% when interest rates go up.

At the same time private rent affordability is about 26% of earnings.

The gap between buying and renting is too wide particularly when you consider the deposit needed.

Is there a rocky road ahead?

We know what has happened in the past. In 1989 we hit a peak in house prices and then the market dropped 60% from peak to trough.

Jump forward to today, house prices have dropped from their peak in 2007 and if history repeats as house prices fall the affordability gap narrows.

The point to watch is when house prices fall such that mortgage payments vs rent are about even (as they were in 1996). At that point (and if interest rates start to fall) then we could see a shift away from private rental to owner occupier.

We have already highlighted the challenge for landlords especially in a falling property market, but if we get to a scenario where the affordability of rent and mortgages is the same and individuals start to move out of properties then landlords will face void periods.

Two things for landlords to consider, firstly at the moment the market is their favour. This is likely to change over the next few years to favour the renter. Secondly, for those heavily indebted landlords this is a worse scenario because their costs increase, potentially making them forced sellers where they can’t meet the costs and they can lose money if they have to sell at a low point in the market.

Will rents decrease?

Over history there is no evidence of rents decreasing, in fact between 1995 and 2002 rents went up 3.85% p.a. above inflation, and between 2003 and 2013 they went up 2.60% p.a. above inflation.

In reality although rent seems to be increasing above inflation, it is starting to slow.

This is where we go back to 1995; between 1995 and 2000 rent went up 1.83% p.a. but inflation averaged 2.60% p.a. It shows that at the time of the housing recovery, rent increases were actually below inflation; in real terms they dropped. However between 2000 and 2003 went up over 10% a year, so well above inflation (as we started to see the gap between cost of renting and mortgages widen).

Looking at the figures, rent in 2012 averaged £723 p.m., in 2013 this was about the same.

But in 2012 inflation was 2.8%, 2013 2.5% and 2014 1.5%. This would suggest that rent increases have already started to fall behind inflation.

In summary although rent is unlikely to fall in monetary terms, when you factor in inflation we could be seeing negative real increases. What this does is that it starts to bring down the ratio between costs of rent as a proportion of earnings (there was a slight drop in 2013).

Many factors

Going back to history; from 2002 onwards we saw rent breach 20% of earnings and this peaked at 27%; this has started to fall. It appears that rent is now increasing at below inflation rates, and this brings down the affordability of rent in real terms.

If we are hitting the peak of the housing market then house prices will start to fall when interest rates rise. The point to watch is when the gap between mortgage payments and rent evens; we are someway off this but we can start to see the shift happening.

For landlords this is more worrying because if rent is not keeping pace with inflation at a time of rising interest rates and potential falls in house prices, their finances could be squeezed. If we get to a point where it is affordable it moves in favour of buyers then voids will be become more common.

Conclusion

In conclusion there is no evidence that private rents will fall but there is evidence that they are starting to slow. There is also evidence that when there has been a crash in the market that during a period of recovery rent increases continue to fall behind inflation. This means it is good news for those renting because it becomes for more affordable to buy but not such good news for landlords (who have been very much in control in recent years).

Of course much of this is theory and speculation and there are regional differences. You could also argue that this time is different but history does show trends and perhaps shouldn’t be ignored!

Source: The information for this blog has been sourced from various places. The key sources include; Bank of England Interest Rate Database and Inflation Calculator, MeasuringWorth.com Earnings Database, Independent Article ‘Interest Only Mortgages A Million Face Payment Problems Yet Lenders Are Still Pushing Them’, York University Research on Rent, Government Data Statistics on Dwelling Stocks and Private Rental Market Statistics, EconomicsHelp.com data on housing market. Telegraph article ‘Buy to let returns beat all other mainstream investments’, HousePriceCrash.co.uk indices from Nationwide, Nationwide.co.uk article comparing Stocks and Shares to Buy to Let

Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.

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