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A growing number of people are investing in rental properties.
Is it a good investment? How does it compare with putting the money on the stock market?
Buy-to-let landlords have done well over the last fifteen years or so. Will this continue? What are the risks?
This article teases out these and other questions and explores how best to appraise the benefits and risks of an investment in residential lettings.
It explains the technicalities of financial modelling in plain English.
Private rented sector (PRS)
Following the Second World War the number of properties rented by private landlords declined from 8 million in 1944 to a low point of 1.9 million in 1988 when rent controls ceased to apply to new lettings.
The sector has expanded steadily since then, particularly following the introduction of buy-to-let mortgages in the late 1990’s, and has now overtaken social housing as the second largest tenure after home- ownership:
There are now almost 1.5 million landlords in the UK. Most have just one rental property. They are sometimes described as ‘amateur’ landlords to distinguish them from those that make their main living from investment in property.
The government’s Private Landlord Survey in 2010 showed that almost three- quarters of them see rental investment as the safest way to make money to build up a pension, rather than as a source of income in the shorter term.
There may be a few rogue landlords, mostly at the bottom end of the market, and some tenants can also be troublesome. But most private landlords provide a good service.
According to the 2008 Rugg Report on the The Private Rented Sector three-quarters of tenants are either fairly or very satisfied with their landlords.
With so many landlords the market for rented housing is very competitive. It appears to be functioning in the way a market should: responding to rising demand with an increasing supply of rented properties, rather than higher rents.
This is in stark contrast to the home-ownership market, where rising prices have failed to result in increased construction.
Some commentators have blamed buy-to-let for putting additional pressure on an already overheated housing market, competing with first time buyers. They want an end to tax relief on mortgage interest since home owners no longer receive it. They are wrong.
Once operating costs are taken into account the return on investment from rents is negligible.
In many cases it is less than the interest on a savings account.
The profit comes from the growth in house prices on which landlords pay Capital Gains Tax, whereas home-owners do not.
It would be surprising if buy-to-let had no impact on house prices, but a thorough study of this in 2008 by the National Housing and Planning Advice Unit concluded it was marginal:
As Fig 1 shows, a large part of the rise in the private rental sector is matched by a fall in social housing from councils and housing associations through right-to-buy sales. A large proportion of these end up being let by private landlords at market rents, supported by Housing Benefit.
Recent studies such as the government commissioned Montague Report and the Resolution Foundation’s Challenges of Build to Rent have sought ways to encourage institutional investment into a more professionally managed private rental sector and to promote the supply of purpose-built rented housing, posing less competition to first-time buyers.
The main barrier has been the poor return on investment from rental income. This is exacerbated by rising house prices, which have not been matched in recent years by rising rents.
The real problem behind house prices lies in the way planning regulation restricts the supply of new housing. This is made worse by developers holding onto potential sites and watching their value increase, which can sometimes be more profitable than selling them to house builders.
The growth in house prices is fully explored in Economics of Home Ownership.
This report examines the economics of letting: how good an investment is it, and how can this be measured?
Read the Full PDF version of this Article here.
Letcheck Appraisal Tool Download
Letcheck is a simpler version of the financial appraisals tool used by social housing providers, designed to suit the needs of a buy-to-let landlord. It can be downloaded free and used to appraise your own investments, and to explore the examples used in this paper in more depth.
Click here to download the Letcheck Buy to Let appraisal tool.
About the Author
Dave Treanor recently retired as managing director of M3 Housing and secretary of the National Housing Maintenance Forum.
He wrote Housing Investment Appraisal for the National Housing Federation, and developed financial appraisal systems widely used by housing associations.
Prior to that he spent many years working with housing cooperatives.