Residential rents across the prime property market in London rose by just 1.3% on average in 2015, while those in the commuter zone increased marginally by 0.6%, new data shows.
In London this reflects relatively high levels of supply coming into the market, not just from investment buyers of an increasing volume of new build stock but also from the re-emergence of accidental landlords, who reflect a more heavily taxed and generally less active sales market, says a new report from international real estate firm Savills.
Behind the headline figures, however, there are a number of submarket trends seen in previous years, the report points out.
In the prime housing markets of the commuter zone, rental values of prime properties in urban locations performed much more strongly than those in other locations, showing annual rental growth of 3.1%.
In London smaller properties were by far the best performers. For example, while rents for one bedroom homes rose by 3% in the year, those for four bedroom houses barely increased at all rising by just 0.1% on average.
‘From an investment perspective, this meant smaller, less expensive properties clearly delivered the best returns. In addition to stronger rental growth, they offered better income yields and capital values proved more robust given less exposure to higher rates of stamp duty,’ said Lucian Cook, director of Savills residential research.
He also pointed out that the impact of tax policy on the rental market has undoubtedly become a very hot topic. There is the progressive restriction of tax relief on mortgage interest payments meaning that by the 2020/2021 tax year, only basic rate tax relief will be given to private individuals, and more recently the imposition of a 3% stamp duty surcharge on the acquisition of so called additional homes, the purchase of which completes after 01 April 2016.
Cook gave examples of how these changes will have an impact. He examined the economics behind the purchase of three different prime London properties in 2015; a one bedroom flat in the east of City market, a three bedroom house in south west London and a four bedroom house in central London.
In each case it was assumed that 60% of the total purchase cost, including stamp duty and miscellaneous additional costs of purchase, is funded by cash and 40% by debt. At current interest rates, with full tax relief on the corresponding interest payments each makes a reasonable cash surplus for a private investor. That surplus varies between 21% of gross rent for the most expensive property in central London that has the highest stamp duty liability and delivers the lowest income return and 28% of gross rent for the smallest, highest yielding property in the east of City market that carries the lowest stamp duty liability.
‘In 2020, we expect the cost of mortgage debt to have risen, we have assumed a 4.5% mortgage interest rate, and income yields to have fallen because we expect price growth to exceed rental value growth in the next five years. Both of these factors would suppress the rental cash surplus deliverable from the same properties,’ Cook explained.
‘The pressure on returns is compounded by the additional stamp duty on the acquisition of the property effective from 01 April which slightly increases the reliance on mortgage debt and, more significantly so, by the reduced tax relief on interest payments,’ he said.
The combined effect of all of these factors is that only the one bedroom flat in the east of City delivers a cash surplus where 40% of the costs of purchase are funded by a mortgage making landlords reliant on capital growth for their returns. Across the other two examples the loss varies from 4% of gross rental income in the case of the south west London property to 18% of gross rent of the much larger central London property.
‘Our analysis indicates that to operate on a break even basis in 2020 it would be necessary to use cash to fund 72% of the total acquisition costs of the central London property, a figure that falls to 57% in respect of the east of City property. However, if just 20% debt is used to fund the total acquisition costs, the figures are more positive,’ Cook pointed out.
For those holding the investment property from 2015 to 2020, Savills is forecasting an increase in house prices of 21.5% in prime central London and 18.2% in other prime London locations, which means the value of the properties will increase by £109,000 for the one bed, £218,000 for the three bed and £1.097,000 for the four bed.