What are the economics of Buy To Let and renting in the UK?

There is much to consider in the economics of the Buy To Let industry in the UK which covers those who buy houses to let them out to tenants. Let us get straight to the numbers released this morning by Your Move and ReedRains.

Rental yields are proving resistant to rising purchase prices. The gross yield on a typical rental property in England and Wales (before taking into account factors such as void periods) is steady at 4.8% in February, the same as in January 2016. On an annual basis, this is fractionally lower than the 5.0% gross yield seen a year ago in February 2015.

As mentioned in the piece there is the risk of void periods where you have not tenants and these are gross yields with no allowance for costs. But let me give you a comparison which is that in a low yield world the UK ten-year Gilt will give you 1.46% as I type this which is pretty much the same as the best deposit savings account. If we look back the rental yield has been remarkably stable over the credit crunch period at around 5% which means that it has become ever more attractive as competing yields have fallen.

Thus we note that the business model of a rentier has been a beneficiary of the interest-rate cuts,Quantitative Easing and Funding for Lending Scheme of the Bank of England. Other yields have been pushed lower making it more attractive as it joins shale oil and the economics of the Glazers at Manchester United as unexpected beneficiaries of central banking largesse.

If we continue with the numbers we note that the UK continues to have rising house prices so that there is a gain from this too.

Taking into account both rental income and capital growth, the average landlord in England and Wales has seen total returns of 12.7% over the twelve months to February. This is up from 11.7% in the twelve months to January

Okay and what does that mean in total?

In absolute terms this means that the average landlord in England and Wales has seen a return of £23,227 over the last twelve months, before any deductions such as property maintenance and mortgage payments. Of this, the average capital gain contributed £14,767 while rental income made up £8,460 over the twelve months to February.

Let me reinforce that these are gross numbers which do not allow for costs but as you can see they look very attractive. Now let me throw in the risk element which is supported by the view that it is low risk because economic policy in the UK will always be set for house prices along the lines of Yazz.

The only way is up, baby
For you and me now
The only way is up, baby
For you and me

The Bank of England

This has fed this in various ways and let me illustrate from the Bank of England blog.

The period surrounding the recent Great Recession saw a sharp decline in real house prices in the UK: they fell by about 20% over the period from 2007Q3 to 2009Q2.

Well let me introduce you to the Mervyn King put option for house prices which involved this. Firstly interest-rates were cut to 0.5% in March 2009 which is interesting timing when you look at the above. That same month in 2009 QE began in the UK to reduce bond yields ( think mortgage rates) as monetary policy saw the pedal pushed towards the metal just as the house price fall built up.

You see monetary policy may not be set for house prices but if we raise the level of sophistication central bankers do think this.

the estimation provides strong evidence on the causal link between housing shocks and the macroeconomy during the recent crisis……it is essential to better understand the drivers of the striking comovement between house prices and labour markets in the UK.

It is an oversimplification to say that house prices fix unemployment but you get the idea and this leads us to the view that it will always be official policy to prevent large house price falls. You do not have to believe that the rentiers are protecting themselves although of course it is likely that there are elements of that as in the end they believe it is linked to employment and unemployment to which they will respond.

Also the low risk theme is reinforced by this sort of thing. From Mortgage Strategy.

Tony and Cherie Blair’s property empire is worth £27m, according to research by the Guardian.The couple now own at least 10 houses and 27 flats.

Cherie apparently does not like change which affects her.

Last month Mortgage Strategy reported that Cherie Blair was set to challenge the Government’s buy-to-let tax relief changes in court, arguing it breaches human rights.

A human right to large profits?

Mortgage Rates

The costs of a buy to let have fallen in the credit crunch era as monetary policy has driven them lower. The Council of Mortgage Lenders gave us some insight yesterday.

Our estimate is that gross mortgage lending was £17.6 billion in January, nearly a third higher than a year ago……………The inescapable fact is that part of this recovery in activity and transactions has been down to the strong pick-up in the buy-to-let sector,

From Mortgage Strategy.

Barclays is cutting rates on its residential and buy-to-let product ranges by up to 30 basis points…….Paragon Mortgages now accepts applications for consumer buy-to-let via its sister brand Mortgage Trust.

So yields up and costs are down. Can you think of another business like that in the credit crunch era?

What about those that rent?

The other side of the balance sheet is much less fun and for some must be grim indeed. If we return to the Your Move report we see this.

Rents across England & Wales now stand at £791 per month as of February, 3.3% higher compared to this point last year – or an extra £25 per month for the average tenant.

In real terms this represents quite a rise.

The Consumer Prices Index (CPI) rose by 0.3% in the year to January 2016

But wait Paul Johnson of the Institute of Fiscal Studies and the National Statistician John Pullinger have a solution.

In January 2016, the 12-month rate (the rate at which prices increased between January 2015 and January 2016) for CPIH stood at 0.6%.

Renters will be disappointed with that so shall we move on with those two gentlemen wearing dunces caps as they try on the new suits they have bought in advance of the expected Knighthood ceremony.

Rents are growing faster than wages too.

Average weekly earnings for employees in Great Britain increased by 2.1% including bonuses.

We can look back for some perspective as you see the average rent was £648 per month back in 2009 and is now £791 for an increase of 22%. This made me wonder what wages have done so according to the ONS the average weekly wage was £451 at the end of 2009 and In January was £497 for an increase of 10%. That is quite a gap as Yazz limbers up for another verse.

sure ain’t no fun
but if we should be evicted from our homes
we’ll just move somewhere else
and still carry on
Hold on, Hold on, Hold on

Comment

As you can see from the numbers above it has been much more profitable in the credit crunch era to be a rentier than a renter. Please do not misunderstand me on an individual basis buying and letting out a place has been a successful strategy and well done to those who have done it. But as we move to the collective level we see that it distorts the UK economy as good returns can be made for what is perceived to be very low risk. This is reinforced by Bank of England policy such as the Funding for Lending Scheme and by the way that “vigilant” the new buzz word actually means being vigilant for the cakes on its afternoon tea trolley. Meanwhile first-time buyers need ever more “Help” to afford a property as prices go ever higher.

I welcome the tax changes as we will soon see a 3% Stamp Duty surcharge and there are moves afoot to reduce the tax deductability on interest. But on the returns highlighted above is a 3% charge a big deal? Accordingly the situation continues to mimic the message from the Borg in my view.

We are the Borg. Lower your shields and surrender your ships. We will add your biological and technological distinctiveness to our own. Your culture will adapt to service us. Resistance is futile

Advertisements

28 thoughts on “What are the economics of Buy To Let and renting in the UK?

  1. ‘But wait Paul Johnson of the Institute of Fiscal Studies and the National Statistician John Pullinger have a solution.

    In January 2016, the 12-month rate (the rate at which prices increased between January 2015 and January 2016) for CPIH stood at 0.6%.’
    ‘Rents are growing faster than wages too.

    Average weekly earnings for employees in Great Britain increased by 2.1% including bonuses.’

    Thought provoking piece Shaun.It’s hard to know where to start.

    1) The reason they can’t let the housing market fall is that it would crimp the credit expansion upon which our economic expansion is based.No credit creation in the private banking sector.No growth.Which-as was discussed yesterday-will work until it doesn’t then it’ll be ‘watch out below’.

    2) the problem with BTL is that it’s continued success has made us a hostage to fortune in that without it’s continued growth,demand in the residential market will fall to a level commensurate with falling prices.So we have a situation where we rely on BTL demand to sustain bank balance sheets.
    However,there’s a political price to pay for this and that is that homeowners historically have been much more likely to vote Tory (having said that,they’re really voting Labour either),thus we’ve had the recent changes eg stamp duty,clause 24.
    I suppose the hope is that prices will stand still and wages will pick up to a level where first time buyers in Nottingham can buy a three bed semi for £150,00.
    Only problem is-as you highlight-that’s just not going to happen,particularly when rents are rising and people can’t save a deposit at the old prices.
    The CB’s and banks are between a rock and a hard place.

    3) Economic growth is suffering because investment and entrepreneurial flair are being diverted to what effectively amounts to be the Ponzi part of the economy.The UK isn’t alone here.

    4) As a business plan BTL on gross yields of 4.8% is predicated mainly upon capital gains.Allowing a void,a management fee and maintenance costs wipe out what cashflow profit there is.
    It says a lot that a lot of 75% LTV BTLers couldn’t even withstand a drop in housing benefit,let alone a sustained market rout or a reining in of the fiscal deficit.
    That was before clause 24

    5) A lot of banks lent BTL at 75% LTV with rental cover of 125%……..which means they’ll get hosed if people start handing the keys back.

    Sorry to rant on.Like I said,rock and a hard place.

    • On points 4 and 5 – absolutely spot on too many people think it’s easy money yet my first house I bought in 87 has been put up for sale and when I applied RPI to the asking price it transpired it has merely paced RPI for all the hype about capital appreciation of houses outpacing inflation. I should point out this is in the North West.

      I thonk Landlords fall into 2 types in finance terms:

      1. Those loade with cash who onmly do cash purchases and make good returns as tehy have no loans to service.

      2. Those with little or no capital whom are highly leveraged and are hanging on by their finger nails quite confident that they’ll make “loadsamoney” 5 – 10 years along because”houses go up because that’s what they do” – If I had a quid for every time I’ve been told that I could afford a new Mercedes C Class!

      I’d add to your point about housing having to be kept pumped up to keep credit expansion going that it’s also because of the British property fetish whereby if Brits see property prices go south they panic, stop spending and start saving which causes a liquidity squeeze outwith the credit markets.

  2. Quite.

    Ironic that Keynes’ ‘Euthenasia of the rentier’ achieves quite the opposite if you choose to hold your capital in the form of land, as rentiers increasingly are, driven by the incentive structure inherent in policy.

    • Hi Adam and welcome to my corner of the world wide web

      As to the quote from the General Theory there is much to think about.

      “Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment…………..yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. ”

      After all we have reduced interest-rates and in many places to levels below what Keynes would have planned and yet the 0.01% thrive. In fact land as he puts it seems to be listening much more to Mark Twain.

      “Buy land, they’re not making it anymore.”

  3. Every B-t-L mortgage subsidised by robbing the disabled.
    I’m spitting angry and would like to put Osborne in a wheelchair.

  4. as we’ve posted many times before

    its the Banks !

    and crony HMG

    still popcorn is here , pull up the sofa and settle in

    Forbin

  5. Hi Shaun
    I only read a it of your piece today before I had to respond.
    You have pointed out another excellent reason why Yellen should not delay in raising rates, it encourages the blood-sucking Glazers to depart OT!

    • Anyway getting back to BtL etc, I was a reluctant BtLer in London after my daughter graduated. My experience was that if you fully accounted for all expenses, the only real return was capital growth. Which was OK as long as you had time for all the hassle. As you say the UK economy and banks are very dependant on this growth continuing. It entered the land of Alice some time ago, but not apparently as deep as Sweden or China as the attached graphic shows.
      http://www.zerohedge.com/news/2016-03-18/stunning-size-chinas-housing-bubble-one-chart

      • Could not agree more, if you take all the costs into account, a BtL will only make a good return with capital growth. If you invest at the wrong time, you could loose a packet.
        You only need a bad tenant ( yes they do exist) not paying rent, refusing to leave and trashing the place, to return a negative yield. What other investment do you need to go to Court to get it back? And don’t expect a fair hearing from British Justice, you are the nasty landlord and they are the poor defenceless tenant being victimised.

  6. BTL also has the risk of a tenant trashing your property.

    2 general outcomes of an inflationary episode come to mind.

    Firstly, repeat of 1992 with high interst rates to control rampant inflation, which causes much repossession. Unlikely because it’s politically unpalatable.

    Secondly, inflation shrinks the debts before the BOE raises rates making rentiers richer and first home purchase ever more difficult.

    If I had to bet, I’d bet on the second ….

    • Hi ExpatInBG

      The mood music agrees with you as the inflationistas are back on the warpath.

      Noah Smith ‏@Noahpinion Mar 17
      Yay, a tiny bit of inflation! Now let’s try 4%! http://marginalrevolution.com/marginalrevolution/2016/03/u-s-core-inflation.html

      There is a core of Bloomberg writers who have been cheerleaders for Abenomics i.e higher inflation. They seem to be rather quiet these days!

      One of the reasons I replied to the McDonnell Review was the danger that otherwise every reply would be for higher inflation without anyone pointing out that it is a trap.

      • What happens when there is a run on sterling? I’m not a betting man but I’d say there’s an even chance of one by the end of the year and it’s odd-on by the end of this government’s 5 year term (if it survives that long!).

        To clarify, I don’t mean a 20% drop over 3 years, more like a 10% fall in the space of a few days.

        Imagine what would happen if the government collapses, the Conservative party splits, there is no clear majority after a General Election and it takes a while to form a very shaky coalition of possibly very unlikely bedfellows. That’s the kind of scenario I envisage triggering a sterling crisis.

        What option would the BOE have except to raise interest rates sharply? The impact on the housing market, banking system and the rest of the economy doesn’t bear thinking about.

        • I’m inclined to agree with you. I think that there will be bitterness whatever the outcome of the referendum and that a split in the Tories is a distinct possibility.

          I also don’t believe that the BOE will raise rates voluntarily; it will be forced on them. When inflation increases they will ignore it like in 2011 but if sterling collapses I think they will have to act and that really will put the cat amongst the pigeons as you say.

          I also agree with the timing.

        • Belgium did very well a few years back without a political party to run it and it was run by technocrats. I’m very happy to give it a try.

      • I regard playing with inflation like playing with fire, you might get burnt.

        You often point out that ZIRP hasn’t worked in Japan – despite trying for 20 years.

        There are plenty of historic examples of painful inflation episodes that co-relate with currency crisises.

      • Buzzin – be careful what you wish for, you might just get it. And remember – in a crisis, the poor suffer more than the rich

        • Wrong.
          Bob Dylan, “Like a Rolling Stone”: When you ain’t got nothin’, You ain’t got nothin’ to lose…

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s