The UK housing rental market could be about to crack

If you want to find out what’s going on in the financial world it usually pays to look at the bond market. Bond investors tend to focus more on the facts, and be less emotional than equity investors.

A great example is Bill Gross, one of the world’s best bond investors. In 1998 he wrote a great book, Bill Gross on Investing. It’s full of good advice. But for me, the best part of the book is Gross’s “plankton theory” and its application to the housing market.

“The plankton theory, like life itself, begins and ends in the ocean. Plankton, of course, are almost microscopic organisms that serve as food for higher life forms. Without plankton almost every fish and mammal in the sea could not survive, since most species depend upon other fish for their existence and plankton are the initial building blocks of the entire process.”

But what does this have to do with the housing market? Well, we’re getting to that…

“In the case of real estate, the plankton would be the first-time buyer (perhaps a young married couple) with a desire to own their own home but with very little capital to carry it off.

“When the time comes that they can’t pull it off… then the plankton would disappear and the rapid escalation in housing prices would ease as well. For, unless the current homeowner has someone to sell his house to, he’ll be unable to afford the house, and the process would continue into the echelons of Beverly Hills and Shaker Heights.

“In the end, the entire market would wither on the investment vine and home prices would stop increasing at the same rapid rate. So to gauge the health of the housing market, look first at the plankton.”

There’s a shortage of plankton in the UK housing market

So how are first-time buyers – the traditional plankton in the UK housing market – coping? The answer is not terribly well. Apart from a recent rush by some to beat a stamp duty holiday, first-time buyers have largely been priced out of the market.

To get decent mortgages, they need big deposits that are very difficult to save for with incomes under pressure. The government is trying to help with its New Buy scheme. This would allow first-time buyers to buy houses with 95% mortgages. However, many mortgage providers are setting rates for these schemes around 6% which is understandably putting many people off.

So if first-time buyers are no longer the plankton feeding the rest of the market, then who is? Look no further than the private rental market.

As with all markets, house prices are ultimately set by supply and demand. The 1990s UK house price crash saw high interest rates lead to a wave of repossessions.

This flooded the market with a supply of houses, pushing prices down. The banks are doing everything they can at the moment to stop this happening again. (Although see here for why we think this cannot last.)

Where does the private rental market feature in all this? Well, it is playing a part in both the demand and supply of houses. Frustrated would-be first-time buyers have been forced to rent, pushing monthly rental bills higher.

On the other side of the equation, more and more people are turning to property in search of higher investment returns than cash in the bank. This has led to a resurrection of the buy to let market.

On top of this, there has been a surge in reluctant landlords who either cannot or will not sell their homes and are choosing to rent them instead – keeping them off the market. But just how healthy is the rental sector?

Why the private rental market could crack

Despite last year’s rising rents and demand for housing, the rental market is showing signs of strain.

UK average rental yields

UK gross rental yields

Source: LSL

Firstly, average rental yields of 5.1% don’t look particularly appealing. Even the near-7% offered in markets like the North West of England are hardly stellar.

And this is not what typically ends up in your pocket. If you take into account letting management fees, voids and maintenance, then average actual net yields (before tax) would be at least 20% lower at 4% or 3.2% after tax. That doesn’t seem worth it given the risks you have to take.

With house prices unlikely to rise (because of a lack of buyers, or plankton in Gross’ terminology) renting out houses does not look like a good investment if you are looking at total returns. So investment demand could start to fall.

Of course, landlords who have owned rental properties for a long time will be getting much higher yields on their purchase cost, but are these yields going to rise from here?

UK average rents (£)

Uk average rents

Source: LSL

According to lettings agency LSL, average UK rents are falling (London rents are down slightly too) and are now sitting at around the same level as last summer.

Why? Because while there may be lots of people wanting to rent properties, having the money to pay the rent is another matter.

A recent survey by the Association of Residential Letting Agents (ARLA) showed that 41.2% of its members saw a rising number of tenants struggling to meet their rental payments during the six months to March 2012. More tenants are haggling over their rents, too, with landlords finding it harder to push through rental increases.

And, according to Templeton LPA, the number of tenants in severe financial trouble rose by 10.2% in the first quarter of this year. Just over 9% of all rents were in arrears.

And if people aren’t paying their rent, it becomes a lot harder for their landlords to pay the mortgage. Throw in the fact that many mortgage rates are going up, then we wouldn’t be surprised if buy-to-let mortgage default rates started to increase.

If the private rental market begins to crack, we could see a double whammy of lower housing demand and higher supply as more rental properties are put on the market. This could be the straw that breaks the camel’s back and triggers a long overdue correction in UK property prices.

  • MBUK

    Your charts stop at 2008. The rental market has improved since then. What you are Actually seeing are yields displaying a rising trend for the past few years, but the doom and gloom Moneyweek of course manages to spin a negative slant.

    I am guessing you would recommend we all buy gold instead :)

  • Lupulco

    I have four fears for the BTL Market.
    1] Rent controls being imposed.
    2] % rates riseing rapidly to support a fall in the £
    3] Impositition of a Property tax of some kind, on all properties.
    4] It is still on the statutes that a Local Council can force BTL landlords to acept tenants on empty property at a [fair rent?]

  • Boris MacDonut

    Your cynically manipulative chart shows rent at £705 a month in Feb 2008…..the magic date when the banks melted down. rents are still at £705 a month now, over 4 years later ,but house prices are down 13% so yields have grown.
    Aside from the offence of calling FTB’s plankton this article is simply wrong.

  • Phil Oakley

    Apologies

    The Charts are showing the right data, but the dates at the bottom are wrong. Feb 08 is actually showing data from Feb 12. I will get this fixed in the morning.

    It is not meant to be a manipulative chart, the dates have just come out wrong for which I apologise. Yields are currently 5.1% and rents are £705 the same as Jul 11 (chart says Jul 07).

  • Inflation Monkey

    Since the credit crunch started, most news commentators seemed to have forgotten that housing rents are governed by wages and house prices by the availability of credit and the monthly cost to service that credit. If rents go up too far people just default on their payments and landlords get a higher percentage of their tenants in rent arrears as mentioned in this article.

    Historically, UK housing rent growth closely matched salary growth since 1987 (Reference: see the housing rent vs. salary data from http://www.inflationaryPressure.com). There were short periods of time when rents grew faster than wages as in the 90’s, but they did not decuple for long or by a large margin. Why would anyone expect it to be different this time?

  • Myki

    cluching at straws!

  • Nick

    FTB buyers strike will continue.

    We are waiting…..

    As for rents, it is just a case of moving to somewhere cheaper…

  • Rajah Brookes

    We just got back from an extended period of travelling. Back in January (whilst still abroad) we had our eye on renting a three bed place in our village but Stags had persuaded them to jack up the rent to £950 a month from £850 last year. We spotted another house that has been for sale for over a year at over £800K, and made the owner an offer. We are renting that for less than £700 a month (on two months notice if he sells his house.) The original place still hasn’t found tenants. The greedy landlord has lost four months of rental income…the flexible reasonable one has good tenants.

  • Phil

    The problem is that rents are rising in areas where there are still jobs – i.e. London and the South East.

    People are paying a higher proportion of their salaries in rents. In addition, the high rents set by the Johnny-come-lately BTL crowd – required in order to cover their mortgage payments – have become the new normal across the board, even for properties purchased decades ago for peanuts.

    While QE and ZIRP continue, there will be no nominal correction in UK house prices. Real prices are of course 16% or more down on 2008 prices, but do you know anyone who’s had a 16% pay rise since 2008?

  • Chris

    He can’t be clutching at straws that much, I have 100 k, I earn 100k a year, and I am happy living with my family rather than paying 1600 pounds a month for a poxy 3 bedroom terrace in London’s suburbs, or 375 k to buy one.

    Yes I’m signed up to agents, and they use these stats to say that “We have a lot of interest”, but the fact is, with houses at 6-7 times average salary, I would sooner live in my Dad’s shed than have my eye ripped out by this false economy.

  • Qadeer

    Must confess I don’t know where Phil Oakley have been last couple of years, the rental demand is very high at present. Simple fact is if people can’t buy they rent. As for arrears thats part and parcel of the animal, besides as rental markets grow so do arrears, law of averages.

  • Elvis Presley

    An 800k house achieving a rent of £700/month – great return of around 1%; methinks he asking too much.

  • marcus

    this is the reason why i have stop my moneyweek its just slopy and cheap I like some of the guys but there not on enogh,if i may i am starting shares mag .

    wake up moneyweek and i might come back.. 30% need to be saked for right uter rubbish

  • Arthur

    We are in a situation where high order capital goods such as housing will fall in value, while low order capital goods like energy are rising in price. This is why we have an anomaly of high petrol prices and weak, falling property market. It will continue for some time, and so Moneyweek is right to suggest gold.

    Further, we now see the Chinese paying Iran for oil in gold rather than dollars, because the US has imposed a freeze on other countries using the SWIFT system for international money transfers. This is very positive for gold and will see its price in dollars/euro/pounds rise significantly.

  • Chas

    It will be interesting to see the effect of reductions in housing benefit will have on rents. If landlords refuse to reduce rents for HB tenants, then therewillbe be increased supply for open market tenants, and if they accept reduced rents for HB tenants then this will tend to reduce rents, it will probably take 12 months or so to wash through.

    Btl market is kept afloat by savings cash seeking a better yield

  • Daisy

    Interesting article. The first I have read that really comments on the impact BTL has had on house prices during the last two decades. I have always believed that BTL has really priced FTB out of the market.

  • Steve Lynham

    The renter getting an 800K property at £700 pm rent (1% yield) is a special situation … the owner gains something rather than leaving it empty (and it is better for a property’s condition and security to be lived in) … and the renters agreed to a 2 month notice period …. so no point in critiquing this arrangement ‘Elvis’ (anyway, thought you were gone). A very astute move by the renters and one we should all follow. My landlords do nothing for me but I cannot move at present due to uncertainty in my future and so not wanting to commit anew for 6 months (a rule I think should change to give the option of a lower notice period for the renter, but not the landlord; maybe with a small fee if the option is used).
    There is so much at stake in the housing market that I am not sure the government could allow any significant fall in prices; they will just allow inflation to do it. Our economy is still so dependent on services that people cannot be allowed to feel poor.

  • Andy

    Chris, couldn’t agree with you more. I’m in my mid thirties and also earn very well through my business, and have around 120k saved and invested, increasing at a rate of around £30k per year.

    I’m hardly struggling yet even to me property seems crazily overpriced. Looking at value I resent paying £250k for a mediocre house round here (South Manchester) that when you check the property history on Mouseprice, you see that the seller paid around £100k for just 10 years ago. Yet it’s still the same crummy house – no improvements made.

    If that’s not a bubble that’s about to burst then I don’t know what is! I certainly won’t be buying until some vale returns to the market. I’ll continue to invest wisely and when house prices drop I’ll be in there – hopefully mortgage free. The longer this takes then the better off I will be.

  • Steve Evans

    I live in that area known as the ‘rest of England’ Here in the real world the only people that live in £800,000 houses are Lords and cute property investors. We wouldn’t dream of letting them out.We can buy 10-16 3 bed houses for this price and let them for £7k each[return £70-108K,a damn site more than 1 or even 3-4 %].
    The returns we get on HMOs I will not even disclose.Buy all the gold you want,and leave us to enjoy our incomes well into our retirements .
    Steve Evans [Hard up property investor in the midlands]

  • charlesdb

    Patient landlords and negative equity mortgage payers will be rescued by a combination of a rigged market and QE leading to high inflation. Everyone is looking for an inflation hedge and investment in housing is one option. This is not America or Spain. We’re an overcrowded island with a high demand for housing.

    The cost of housing in this country is a disgrace, but from a London perspective, which is where I live, I don’t see any sign of the market cracking. Rental yields are a result of high prices, but I guess many Landlords are now inthe game as a future inflation hedge.

  • PV70

    At the end of the day, rental market works exactly like sales market. A house / flat is worth exactly what someone is willing and/or able to pay for it.

    Even in some areas of London there are plenty of properties to let. If the price is right they go quite quickly but some keep on staying on the market for months – almost like sales market where some properties remain unsold for years.

  • Tony

    We should take the rental prices seriously. It is very much a dynamic supply and demand market, and prices reflect what people are prepared to pay. You cannot borrow (much) to pay your rent. So it represents real time what people can afford.

    FTBs are in short supply, because they have to be older and richer. The more numerous young can no longer afford to buy.

    On those that think that asset debt can be inflated away, this requires wage inflation which isn’t happening.

  • Rob

    Oh dear Moneyweek journo’s really are getting desperate aren’t they. Over the past few years you have persistently pinned your badge to gold going up and property going down but you have been just plain wrong.

  • P Hamilton

    23. Rob

    I think you need to look at the Gold and UK house prices over the last few years and then reread your post.

    In 2008 I decided against buying property and stuck much of the saved deposit money into gold. Since then house prices have fallen 15% in my region and my deposit fund had nearly doubled.

  • Moleman

    Has anyone added in a shortage of students living away from home next Autumn when the student fees go up to £9000.
    As a parent of a student living in the Midlands who is paying £1260 a month(4 bed x4 students) without bills for damp, cold accommodation with mildew, I know that my younger daughter will have to study and live at home, so that she doesn’t end up with a £50K debt on graduation.
    The rental market looks set for a decline when this factor is included

  • Noneleft

    Rob, have you ever looked at a gold chart ? Gold price over years has taken off like a scolded rabbit. Real property values on the other hand (after rampant inflation) have slumped. Someone is plain wrong alright, but it aint moneyweek.

  • Ruby THS

    Buy where you know the market. The ‘rest of England’ looks interesting but SE England is expensive and one can’t help feeling student rentals are going to fall. However, on a long view, I would rather invest in BTL property for retirement rather than risk money with underperforming retirement funds or where you have to buy a ridiculous annuity. The returns on BTL may not be eyepopping but if you pay off the mortgage by the time you retire you have a nice little income – and something to leave to your children.

  • clive chafer

    Another interesting and thoughtful article from Moneyweek so thanks, Phil. People don’t think house prices are falling on average purely because their headline value is pretty static while inflation is rapidly bringing down the real value. This illusion is actually a problem as our money stretches much less far when buying essential items.
    Therefore, it would actually be far better to bite the bullet, let house prices find a more sensible level naturally and keep inflation low. However, I’m sure the present arrangement suits politicians because people notice house price falls quickly when inflation is low.

  • HL

    Noneleft and P. Hamilton are spot on.

    Isn’t it surprising how many people think like Rob ? They desperately want property prices to rise (but not any other prices) and they seem to get upset at the mere mention of gold. Yet it is gold that has performed well and property that has fallen.

    Ah, well . . .

  • Boris MacDonut

    The social cleansing of London by limiting the Government subsidy to BTL’ers to £400 a week will impact the Southeast, but may help the rest of the UK. London Borough Councils can afford to pay a bit more to house their unwanted lumpen masses in the sink estates of Stoke ,Rotherham, Middlesboro etc….

  • Rob2

    @Rob
    Err, how can you say it has been wrong to think that gold would go up and property down. Gold up 550% plus since 2002. Also up 11% in 2011. House prices down 11% nominal since late 2007, and only propped up by low Bank of England base rates and quantitative easing (new mortgage rates are referenced off gilt yields). Sorry, but you are very wrong here.
    http://housepricecrash.co.uk/indices-nationwide-national-inflation.php

  • Boris MacDonut

    #31 Rob2. It is easy to get bogged down in “good as gold”statistics. To give a sense of proportion the gold price is up from $616 to $1700 since 1980, that is 175%. House prices in the same time rose by 810%. Try to think long term, most of us get to live for 80+ years now. Those that do not intend to spend the grandkids inheritance must be hoping to accumulate wealth over a 60 year adult lifespan. So go back and look at 1952 before denouncing our present era.

  • dr ray

    @boris
    So your thesis is that house prices have increased in value at a faster rate than gold or wages or indeeed population growth for a generation and you use this to support your belief that they will continue to do so, maybe for ever.
    Most sensible people would see a rise in prices which outstrips the ability of people to pay those prices as evidence of a bubble which will, sooner or later burst and reestablish the link between price and earnings.
    The old expression is that a fool and his money are soon parted. In your case it would be deserved.

  • Boris MacDonut

    #33drray. As usual just insults and attempts to put words in others mouths. I have no “thesis” that house prices will continue to grow as they have in the recent past. I have only ever said if they stay at the usual ratios they will rise by about 22% by 2020.
    Prices have not outstripped the ability to pay,they are almost exactly on the long term average ratio. As for Gold vs Houses. Since 1960 Gold has risen in value by 4,500% and houses by 6,500% and people are relatively 3 times as well off.
    Your groping to regain the halcyon price to earnings ratio is charming and quaint, but naive in the extreme.

  • dr ray

    @ boris

    The more you post the more confirmation we get that you are delusional. The game is up for ever increasing house prices. If we go into a prolonged period of slow growth and minimal wage increases house prices will fall in real terms for the next 20 years. Increased household income in the last generation required the wife to go out to work. Unless the kids are going to be sent to work too household income cannot be increased again

  • dr ray
  • Noneleft

    Can’t win with Boris – he continuously adjusts his argument and selects history in a misleading way to suit, but ignores reality.

    #32 Boris compares gold v house prices. Arbitrarily he starts at 1980 (a multi year peak for gold) in order to ‘prove’ that houses rise more. In other posts he berates people for not going longer term, so lets go further back to 1972 (the first year gold floated freely after Nixon ‘closed the gold window’), gold was just $50 (yes fifty dollars). Rerun your percentage rises from that date Donut Boy, and see what you get. Using volatility/lag/out of trend data to suit your argument is desperate and easily discovered by anyone who actually knows history, rather than just cherry picking from it.

    #34 here Boris picks a start date of 1960, when gold still had 11 years of government pricing before market price discovery began, so comparisons are therefore meaningless. I wonder why 1960? A historic low for property perhaps?

  • Ed

    If you’ve got money to burn burn it in property in hong kong. There’s a smarty pants.

  • Boris MacDonut

    #37 Noneleft. I am not selecting history in an arbitrary way,just using it to show reality. History is/was reality in that it is what actually happened as against speculating on an uncertain future. I choose 1980 to illustrate the point as most people today can expect to be an adult for 60 years. 1980 is about half an adult lifetime ago. Since 1972 Gold has risen 17 fold $50 to $1650. Houses rose 32 fold from £6,000 to £190,000 or more.
    1960 was not anjistoric low for house prices, 1946 was. From 1946 to 1960 HP’s more than doubled.

  • Nev

    I remember the 60s, just about. Young couples used to save with Building Societies from the age of 16 or so. Because the B S s would only lend to long standing savers. And they would only lend 3.5 times the husbands income. Women could not get mortgages, unless a male relative guaranteed them.
    Expecting house prices to return to 60s multiples is unrealistic. The world has changed. Do we expect it to change back because we do not like the effects?

  • Truth be told

    What a shame that Donut boy keeps spamming these otherwise well-informed housing threads.

    If he is not firing off insults at Merryn he is desperately ramping his dream of endless house price inflation contrary to all the grim economic evidence. Obviously worried that his BTL empire will soon be bust!

  • Christopher

    Dodgy sums. $50 up to $1650 is actually a 33 fold increase.

  • Boris MacDonut

    #42 Christopher. Thank you, I stand corrected. That was a dodgy bit of maths brought on by haste and the Saturday rush to get to the chip shop. What is funny, having checked the DCLG site is that house prices are up from £6,000 to £212,000,which is still slightly better than Gold at 35 times. But we have to say over the long term both are broadly in line ……..whereas the Stock market….

  • Manny

    gold in gbp in 2005 = £250 ish today £1000 per ounce
    rise started around the time all this nonsense in support of the uk housing market
    gold in usd in 2005 = $420 today it is around $1600 per ounce.

    gold will be the bubble of all bubbles before this nonsense ends. It is going to the moon
    It will stop going up when BoE raises interest rates and that will be never.
    No politician or bureaucrat has the courage to do the necessary.. meanwhile the market will enforce interest rate rises and mortgage providers will squirm out of trackers by hook or crook

    uk housing will settle -70% from peak in 2007, 200k to 60k

    I keep posting my -70% in these comments, please remember you heard it here first

  • Le Brit

    Elvis he is just covering his mortgage costs, probabaly bought the house for £400k a few years ago and is on an ultra low 2 and a bit% deal. House prices are built on hype and greed not true rental values. Just wait until the capping of housing benefit kicks in then landlords will have to thinking about housing as an investment. By the way when is Graceland going to be put up for sale. Its now or never.

  • Boris MacDonut

    #44 Manny. Your spurious predictions are quite absurd. For house prices to fall 70% from the 2007 peak they’d have to reach just £62,000. A level last seen in 1991..They would then be at just 1.9 times income or less than 40% of the long term rate.
    I have to say you are over-egging the pessimism pudding.

  • William Davison

    I think Phil Oakley is right, when I was looking for some where to rent a year ago there was no shortage of supply and a year later the identical house next door was rent out 4% lower. Which if you take into account inflation means the rent has fallen about 8% in real terms.

  • Boris MacDonut

    #47 William Davison. No. Rent has fallen 4%. Pound notes are real not dubious inflation linking. If I had a pound for every time a pessimist used the fatuous line “in real terms” ………
    The man was shot through the head and is dead in real terms. The car exceeded the speed limit by 20mph and the driver is jailed in real terms. I’m a posh kid with three C grade A levels and I didn’t go to Oxford in real terms. In real terms means did not happen.

  • doddy

    I am old enough to remember the 60’s/70’s. I got my first house in 73 and – contrary to above, mortgages were quite easy to obtain.
    Brokers asked how much you wanted to borrow and worked backwards from there. Nobody seemed to care and that seemed to be the start of the house price boom – albeit with many setbacks. House prices will rise slowly over the next decade, but nothing like we have seen before – people simply can’t afford to “get on the ladder”. QE will eventually cause inflation, which will lead to the rise. As we all know, this “rise” is not real, as wages 40 years ago were a fraction of what they were then. It is ability to repay the loan that is/was/will be the main criteria for house price growth.

  • Christina Latham

    The rental market is becoming forever difficult. For first time buyers, whom it can take on average 37 months to save a 10% deposit, they have no choice but to rent. However, because many first time buyers need to do this, it has the domino effect of rental prices rising. Overall, the current situation is not a ‘plankton’ friendly market. First time buyers are majorly out-priced. They should seek advice from professionals. Many large property agents are not just about selling but employ research teams who can give you an in depth insight into the market and how this effects you. One agent that does this is http://www.chestertonhumberts.com. However, there are many more in and around London. Save yourself some time and ask an expert!

  • fawad

    pakwatanproperty.com offers ,property in pakistan,house for sale,plot for sale,property for sale,house,plot,shop,plaza,land,agriculture land for sale,property for sale in all cities of pakistan,like(Karachi,Lahore,Rawalpindi,Islamabad,multan,Abbottabad,Faisalabad,Gujranwala,Hyderabad,Peshawar,Quetta,Sialkot, Taxila,Mirpur Khas,Gujrat,Abbottabad,Gwadar,Jhelum.

  • Steve

    I couldn’t agree with you more about the fact that London has slowly becoming an impossible place to stay for not so well-off people. In fact i knew some people who left and settled somewhere, Asia and some other 3 third world countries. At least its more affordable in there. But on the brighter side, there still a few accommodations that are relatively affordable. I have know a few but i can recommend one for you and for the rest of your readers since i for sure know you have hundreds of followers here. Look at Flats to rent in Camden, see the prices and you will be surprised.

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