How the property market has changed, and why what worked before won’t work any more
FREE CHAPTER OF THE BOOK
To help answer some of the ‘most asked questions’ of the moment about the property market in these uncertain, fast-changing times and to highlight the official paperback launch date (14th May), here’s another free chapter of the book, which seems to have struck a chord with investors and recently became an Amazon #1 bestseller.
This chapter highlights the most important changes that residential property investors need to know about and puts the impacts of #coronavirus on the property market into context.
Perhaps the ‘most asked question’ I’ve had from investors over the last few months is, ‘what does Coronavirus mean for you?’, often with a follow up, ‘is the housing market about to crash?’
My answer, as always, is that broad brush #statistics and forecasts are not particularly helpful for investors; we don’t have one housing market.
Some parts of the market (e.g. non-prime regional rental housing) continue to perform well. Others (e.g. prime, internationally-targeted newbuild developments) — not so much.
It’s all about supply and demand. Find out more about what’s really driving the property market via the chapter, and visit bit.ly/strategicpropertyinvesting if you’d like to get a copy. All profits go to bit.ly/letsbeatcovid
In this chapter, I will highlight what has changed in the UK residential property market over the last few years and how this new market context means that what once worked may no longer be viable for many investors.
It’s not all doom and gloom, however. The fundamental forces of supply and demand have not changed. We all still need to live somewhere and supply is inevitably restricted. We have limited land, building constraints and a restrictive planning system. What investors want and need has not changed either. Investors still love the idea of stability, ongoing profits, and a way to grow wealth safely without too much effort.
However, market shifts have undeniably affected what works and how. These changes are beyond the control of any one investor. They affect the returns, risks, effort and performance relative to the alternatives that I outlined in the previous chapter. This is especially significant for private small and medium-sized (SME) investors.
As mentioned previously, most residential investors are small land- lords with four or fewer properties (93% in 2016, though this percentage has fallen since).
Many are unaware of some or all of the changes that are affecting them. Significantly, there is an overriding policy shift meaning that investors who want to continue investing profitably must scale up and professionalise or focus on indirect investments.
At the risk of dating this book, this chapter summarises what’s changed in recent years across five key areas: political, economic, social, technological and legal/regulatory circumstances.
It’s important to understand these changes before you invest as they will affect your outcomes and decisions.
1. POLITICAL CHANGES: EXAGGERATING, BUT NOT CAUSING A SLOWDOWN
When I began writing this book, the impact of Brexit was the first question investors asked me about. There was huge uncertainty that stretched out for years. What would happen, how, and when? Question marks around Brexit created a less confident environment, delayed decisions, reduced supply of new housing stock, lower valuations and slower sales cycles.
Newspaper headlines suggested that political uncertainty was the cause of housing market doom. Contrary to popular opinion, the evidence suggested otherwise. Uncertainty had the effect of compounding existing property market issues, rather than causing them.
Since then, confidence has improved in line with greater political certainty. So why keep commentary on this particular political shift in the book? The truth is, regardless of the realities of implementing Brexit, this will not be the last cause of political change and uncertainty our property market experiences, and it’s not over yet. In fact, between drafting and publishing this book, the world began to feel the economic, social, health and political consequences of Covid-19, again highlighting how such crises and uncertainty can affect short- to medium-term confidence.
Long-term investors must remember one key point. Markets and opportunists can be forgetful. This point is relevant whether the question of the day is around Brexit uncertainties, pandemics, or uncertainties created by any other issue. The long-term performance of residential property investment is driven by long-term demand for, and supply of, housing. The structural causes of demand and supply for housing are not really affected by any short-term uncertainty. In the absence of structural change, the growing demand for affordable, quality housing and a shortage of supply continues.
Demand for housing is essential in nature. This is evidenced by how Brexit uncertainties had a negligible impact on residential property rental demand, though they have affected valuations and the demand for housing.
Meanwhile, housing supply is relatively fixed and slow to respond. This is what economists describe as ‘inelastic’. Research suggests we need 340,000 new homes built annually up to 2031. We remain woefully below that level of new supply, as an average of only 122,704 new homes were completed each year between 2010 and 2017. Affordability constraints mean there is continued and growing demand for rental properties from tenants. New regulations, tax frameworks affecting second-time buyers and tighter lending criteria introduced by banks are restricting new supply from investors.
The shortage of well-managed, quality, affordable housing in areas where people want and need to live is a political issue that affects the housing market more significantly than Brexit. Political uncertainty can clearly exaggerate issues by affecting confidence. However, it is not the underlying cause of structural property market changes.
2. ECONOMIC CHANGES: INCREASING DEMAND FROM TENANTS AND INVESTORS
The economy has a big impact on investment. Yet demand for housing has a relatively low correlation to economic demand, as we all need a roof over our heads. This is one of the most attractive things about investing in residential property.
Important trends relating to our economy include long-term low interest rates that continue to stimulate property demand. Capital is easily available and investors have a strong demand for yields that exceed the base rate. This low base rate environment is likely to stay. Reasons for this include how technological improvements inspire greater efficiency and this is keeping inflation levels low. It also means base rates cannot be reduced by much to stimulate investment or consumption.
As a result, the idea that growth in investor appetites will continue to result in blanket capital growth seems unlikely.
Thanks to globalisation, strong rewards and low risks, capital continues to be attracted into the UK property market. At the time of writing, UK property assets are discounted internationally, thanks to the weak value of the pound, itself a factor of confidence and interest rates. Consequently, international demand and, therefore, property values remain relatively stable.
There are plenty of reasons why owner-occupiers, national and international investors continue to be attracted to UK property. It is still a great asset for investors seeking returns and stability. Competition from powerful institutions, international investors, and other income-hungry investors is bidding prices up for income-focused assets, such as student housing. This, in turn, pushes yields down.
3. SOCIAL CHANGES: GROWING DEMAND FOR AFFORDABLE, QUALITY HOUSING AND GROWING DEMAND FOR YIELD- FOCUSED INVESTMENT
Population growth, demographic changes and preferences mean there are more smaller households and a higher demand for housing.
The number of families in the UK increased by 8% in the ten years to 2018. Household sizes are shrinking, compounded by a higher divorce rate and healthcare improvements that mean people are living longer. When this is combined with rising living standards and a preference for smaller households, it results in a higher demand for housing. This has pushed prices and rents up.
Affordability is constraining homeownership and investment, particularly for the younger generation. Average house prices have risen from being around five times higher than people’s income in 2002 to almost eight times by 2018. ‘Generation Rent’ struggle to get on the housing ladder, as a result.
In 2018, the average single first-time buyer needed ten years to save a 15% deposit for a property (and significantly longer in London).
It’s no surprise that in the twenty years to 2018, the proportion of younger people (25–34) owning their own home fell from 48% to 28%. More broadly, millennials are settling down later and increasingly favour flexible access to premium features, such as a concierge or gym, over the less affordable and less flexible responsibility and burden of property ownership. The trend of access over ownership encompasses transport, for example, using Uber rather than owning a car, through to housing. Younger people are less likely to buy, as homeowners or investors, and more likely to rent. Continued and growing demand for rental housing improves the potential returns to well-located, well-priced long-term property investments.
On the investment side, one consequence of the preference for access over ownership is how many retiring landlords are facing succession issues. 60% of the landlord population is aged over 55. Since more than 90% of the UK’s private rental sector housing stock is owned by private landlords, this is a substantial force.
Our ageing population also creates more competition for yield-focused investments. Pension funds are becoming the most powerful investors globally in absolute and relative terms, and have a growing appetite for stable, income-producing assets. The requirement for yield from these powerful, sophisticated investors has been exaggerated thanks to compulsory pension contributions.
4. TECHNOLOGICAL CHANGES: MAKING INVESTING MORE ACCESSIBLE
Technology is opening up access in the property market, as well as increasing efficiency and quality for cost. Proptech has grown exponentially in its impact, often at little or no cost to the user. Online listing portals, such as Zoopla and Rightmove, have opened up access to opportunities and data. More digitised processes, such as Customer Relationship Management software, are making manage- ment easier, cheaper and faster. Digital and online booking capabil- ities, like Airbnb, enable homeowners to flexibly rent out space and mean that people can move around more easily. The growing impact of online and hybrid estate agencies and lettings services, data plat- forms and the tokenisation of real estate through alternative finance are improving accessibility to specific opportunities and information.
We are moving into an age where data-driven decisions can be made with limited human interference. Investors can find, research and manage opportunities and implement decisions from anywhere in the world. Investing can be as easy as shopping on eBay, via crowd- funding or peer-to peer-loan platforms.
5. LEGAL AND REGULATORY CHANGE: SHIFTING THE BALANCE OF POWER FROM SMALLER INVESTORS
Legal and regulatory factors are perhaps the most important cause of change in the UK property market. There is cross-party political will to solve the housing crisis and professionalise property investment. The increased cost and administrative burden of staying on top of more regulations discourage small investors with a few buy- to-lets. Armchair investment is becoming less profitable, more challenging and more time-consuming.
Regulatory and legal considerations for property investors include:
- Changes to Mortgage Interest Relief via Section 24, which have increased the tax burden for individuals owning buy-to-let property. Holding a property with a mortgage for a higher or nearly higher rate taxpayer has shifted from being a profitable sideline business to a real loss.
- If mortgage interest was 75%+ of rental income on a property before this change, the new regime means the investor owning this property in their personal name will now begin to make a loss.
- The Stamp Duty Land Tax (SDLT) surcharge, an additional 3% on top of the existing transaction tax, makes buying more residential properties less attractive. With the surcharge, SDLT would be £9,000 rather than £2,100 on a purchase price of £230,000 (about the average for UK properties).
- New lending standards from the Prudential Regulation Authority have caused friction on the financing side. For landlords with four or more properties, borrowing is now harder.
- Additional licensing requirements mean that strong and specialist local and national market knowledge is required by investors. There are more and more stringent local and national regulations. These range from national House in Multiple Occupancy (HMO) licensing to the Selective Licensing of private rental properties in specific geographies.
- The Tenant Fees Act 2019 has shifted costs from the tenant to investors, meaning that traditional buy-to-let investments have lower returns.
- Other taxes, such as the Annual Tax on Enveloped Dwellings, add to the cost base and administrative burden of property investment in company structures.
- Meanwhile, tax reliefs, such as for Build to Rent (scaled development for the purpose of holding long-term to rent out), or Real Estate Investment Trusts (REITs), which are funds focused on holding property, make institutional investment easier and mean it’s harder for smaller investors to compete.
A combination of political will across parties and recent regulations is encouraging professional, institutional investment. By contrast, homeownership is the only form of direct ownership that individuals are encouraged towards, in particular first-time buyers and those who do not own a home. The idea behind professionalisation is that fewer larger and more professional operators are easier to regulate and oversee to ensure professional standards and better housing opportunities for all. The days when slum landlords made easy money without taking care of their tenants are over.
The increased cost and administrative burden of staying on top of more regulations mean that traditional approaches to property are less profitable, more challenging and more time-consuming. Private property investors are being discouraged from direct investments. Instead, they are being encouraged to focus on the increasing range of truly passive property investment options. Individual investors facing shrinking profit margins are offloading thousands of privately-owned rental properties.
These changes are significant for people who intend to invest, as well as for the housing market because smaller investors dominate the market. Across the market, the proportion of landlords with just one property has declined from 78% in 2010 to 45% in 2018. The proportion of landlords with five or more properties has increased from 5% to 17% and is still rising. Many small investors who are aware of these market-wide changes are scaling up, professionalising or getting out.
STRATEGY SOUNDBITE: CHAPTER SUMMARY
The fundamental forces of supply and demand have not changed. We all still need to live somewhere, and housing supply is inevitably restricted in the UK. What investors want and need has not changed either. Investors still love the idea of stability, ongoing profits, and a way to grow wealth safely, without too much effort.
Currently, the vast majority of UK property investors lack knowledge of some or all of the trends described in this chapter. The impacts of these five key areas of change are unavoidable and inevitable. Regulatory changes, in particular, have affected the viability of traditionally profitable approaches to UK residential property and increased the costs and risks of getting it wrong. Traditional approaches to UK residential property, such as side- line buy-to-let investment, are more costly and complicated for the type of investor who has come to dominate the private rental sector.
To invest successfully in this new environment you must understand this fast-changing market, and then ensure your approach is strategic, value-focused, and professional. For many would-be armchair investors, this means taking a step back, focusing on the fundamentals of demand and supply, and targeting truly passive options led by professional operators rather than taking a hands-on role. Far from being bad news, greater complexity and uncertainty creates opportunity, and the opportunities for many investors today are a better fit for what they really want and need: passive, relatively low-risk investments.
For further updates on the impacts of new regulatory and wider market changes, I regularly share updates and insights which you can access for free. Connect on LinkedIn (https://www.linkedin.com/in/annaclareharper/), join my mailing list (https://annaclareharper.com/contact/) and download or listen to The Return: Property & Investment Podcast on iTunes, Spotify or online (bit.ly/returnpodcast).