RENTAL RETURNS CONTINUE TO RISE
In recent weeks, media attention has focused on interest rates and speculation about how soon the Bank of England might decide to reduce the base rate from its 15-year high of 5.25%. These are certainly important issues, but it’s worth noting that they have drawn attention away from other interesting developments in the sector. Most significant amongst these is the rate at which rental returns have been improving.
At the time of writing (i.e. early August 2023) the Consumer Prices Index stands at 7.9% but, for some time now, rental values have been rising considerably faster than that. An average of all the major rental indices for July suggests that, UK-wide, rental returns have been increasing at just over 10% per annum. In other words, investors’ rental incomes have been doing much better than simply keeping pace with inflation; they have been delivering substantial real-terms gains.
That’s been the case for a number of months now and while the inflation rate continues to fall, it seems that rental returns are continuing to improve.
To illustrate that, let’s look at the most recent of the country’s rental indices – the July Index from Goodlord. It declares:
“July was a record-breaking month... The Index, which analyses tens of thousands of completed tenancies each month, saw the highest average rental costs since the Index’s launch in January 2019. As rents soared, void periods also dropped dramatically. This set another record: the shortest void periods ever recorded.”
Its most striking finding is the monthly rate of growth. Over the course of July alone, rental values reportedly soared by nineteen percent. That’s an astonishing figure; to put it in context, Goodlord remarks that until now, the average month-on-month gain for 2023 has been +1.3%.
In practical terms, that means that in July, the average cost of rent in England reached £1,367 per calendar month. That figure is +9.4% higher than the previous record, set in September 2022. It also means that, on an annual basis, average rents have risen by +10.4%.
Major indices seldom produce exactly the same figures but, in this case, 10.4% seems to be something of a consensus. It’s also the figure quoted by Homelet (June index) and in Zoopla’s Rental Market Report for Q2 2023.
In addition, however, investors have also been benefiting from record levels of occupation. That is to say that their properties have actively been producing income more consistently and more efficiently than at any time on record. Goodlord writes:
“As the cost of rent spiked, voids headed in the other direction: dropping by 44% to hit an average of just 9 days... This is down from 16 days in June and is the lowest ever void rate recorded by the Index. The previous record was set at 10 days in July 2022.”
With records being broken on rental values, rental growth and void periods, a typical rental property is now delivering more income for investors than ever before. What’s more, since the imbalance between demand and supply shows no signs of changing, the same trends look set to continue for years to come.
In the notes accompanying the company’s rental index, Goodlord’s CEO William Reeve said:
“This month’s numbers are quite staggering. In July, we usually expect to see an increase in rents and a reduction in voids - and all indicators pointed to a particularly red-hot summer for the rental market, if not the weather… Traditionally, rental costs continue to increase until September before cooling off in the autumn, which could mean these aren’t the last records we’ll see broken before the year is out.”
Of course, data from a single source can always be misleading, so it’s important to take note of what other agents and lenders have been saying. But when we do that, a surprisingly consistent message emerges. In its latest quarterly rental report, Zoopla states:
“Rents continue to register double digit growth for the 15th month in a row... An ongoing chronic imbalance between supply and demand continues to push rents higher across all parts of the UK. This is set to continue into H2 2023 as we approach the usual seasonal upturn in demand over the summer and into the autumn.”
Later in the same report, it adds:
“Rental inflation will only slow if we were to see a material increase in supply or weaker demand. The latter seems unlikely given rising mortgage rates impacting first time buyers, the strength of the labour market, high immigration and upcoming busiest period for rental demand – between July and September. The level of homes for rent remains stuck 20% to 40% below pre pandemic levels in most regions. This means more renters chasing fewer homes, adding extra impetus to rental inflation.”
There must, of course, be a limit on how quickly rents can continue to rise. Affordability pressures mean that they cannot rise unchecked forever. However, supply and demand are fundamental market forces and, as such, they have a powerful effect on prices. They mean that, in all probability, rental returns will continue to rise at well above the rate of inflation.
For investors, it is not the absolute pounds-and-pence value of rents that matters so much as the gap between rental growth and inflation. That determines the real-terms value of their return on investment. Thus, if the rate of inflation falls (and the Bank of England currently expects the CPI rate to fall to 5% or below by the end of 2023), investors can afford to see rental growth drop back too, so long as it remains ahead of that crucial CPI figure.
Looking ahead, Zoopla expects annual rental growth to average around +8.0% by year-end, a figure that would be 3% greater than the rate of inflation (if the Bank of England’s own forecasts are accurate.) That would amount to an even greater real-terms gain than we see now. The current gap is 2.5% (i.e. 10.4% rental growth minus 7.9% inflation) so those forecasts point to improving rewards for investors.
Other sources offer similar views. In its Q2 Rental Price Tracker, for example Rightmove states:
“Despite quickly rising prices, rental homes are continuing to let at speed and many landlords are still being met with long queues of prospective tenants wanting to view and rent their property… Tenant demand continues to exceed even last year’s frenetic levels and is currently 3% higher than at this time in 2022 and 42% higher than June 2019.”
Likewise, in its June rental Index Homelet states that “there seems to be no sign of a slowdown in the continued growth of rents across the UK.”
In short, rental growth looks set to continue strongly this year and beyond. Tenant demand is unlikely to waver and there is no credible reason to expect a sudden increase in housing supply. Consequently, the only factor that could realistically constrain that growth is affordability. That might conceivably dampen the rate of growth next year but high employment rates, relatively strong wage-growth and a falling rate of inflation should all help to ease those affordability pressures. On balance, continued real-terms rental growth looks set to continue for the foreseeable future.