In my last article we looked at how, even when taking into account the so called housing “crash” of recent years, average house price inflation has far outstripped average wage increases over the last 10 years. Even when taken across a longer timeline this trend is clear. House prices rose by 273% in real terms between 1959 and 2009 while the growth in real earnings was only 169% over the same period. But why is this so and how can we benefit from understanding this phenomenon? 

This growth in UK house prices, in excess of general inflation, is mainly down to key market driver of supply & demand::

1.    Housing shortage

The lack of good quality housing is an issue that has dominated the UK market for at least half a century. New homes in the UK are built at a much lower rate per household than is common for other parts of the developed world.

In total, Britain has built 13m houses over the past 50 years, according to Halifax, but the housing supply in the UK has slowed to its lowest level since the Second World War, with only 156,816 houses completed in 2009. The Treasury Commission ‘Barker’ report has established that the UK needs 300,000 new homes per annum to satisfy the growing demand, with a minimum 35,000 new homes a year in London alone. The UK’s house builders are yet to hit this target.
Despite a recent resurgence in housing starts, completions of homes are forecast to sink to about 108,000 units in 2011. Demand is set to increase significantly, leading to a shortfall of as many as 95,000 in 2011.

2.    Increasing demand

Between 1999 and 2007 the number of global billionaires grew by 277% - perhaps the most influential new entrants being the Russian and Middle-Eastern oligarch.
As more nationalities became part of this exclusive club, a London play-pad became a must-have for the rich and famous with 45% of £2 million-plus purchases going to non-UK buyers over the past 12 months. This corresponding rise in demand for luxury accommodation has further drastically reduced the available housing stock.

Between 1959 and 2009 Britain's population grew by 9 million to 61.8 million, but the number of households rose from 16.7m to 26.6m indicating that today’s Brit are also far more likely to be living alone. As recently as 1971, fewer than one-in-five households were occupied by a single person, but this rose to one-in-three by last year.
But the gap between what buyers can afford and the price of good quality property is now so wide that where once the Englishman’s home was his castle, Britain is fast becoming a nation of tenants. The average age of a first-time purchaser buying without assistance is now 38!

Many aspiring home-owners cheered on the housing slowdown in the belief that it will help them onto the first rung of the housing ladder when in fact, rather than being boosted by falling house prices, first-time buyers’ ability to purchase a home has been seriously undermined during the course of the slowdown. This is mainly due to the fact that lenders tightened their lending criteria dramatically in the aftershock of the credit crunch.

This has led to a 40% increase in the private rented sector over the last five years while home ownership has slipped back to 68%. In 1961, 33% of homes were privately rented, but this fell over 30 years to 9%. It has since started to rise again, reaching 14% in 2008. However, not all are forced to live in rented properties – many choose and prefer to rent. A 2007 Council of Mortgage Lenders survey found that only 50% of those under 25 have any desire to own their own home within 2 years. Another study concluded that around 12% of all tenants see themselves as “permanent lifestyle tenants.”

So what does the future hold?

Despite the volatility of the last few years, the UK firmly remains a place to generate and hold wealth, and London has retained its crown and credibility as a world financial centre. The new decade however heralds a significant change in the UK property market and the residential investment market has in many ways reached a crossroads.
Restricted mortgage availability means that entry into the housing market remains difficult for those without the cash for a large deposit. This makes it unlikely that the buy-to-let market will make a comeback in the same form during this new decade.

Yet, given restricted access to home ownership, investors who have the necessary equity available are increasingly recognizing the growing demand for privately rented accommodation. People still need to live somewhere so if they don’t have a large deposit or access to favorable mortgage products they will rent. This is likely to be a key driver of rental growth over the next decade, particularly in the lower tiers of the housing market to which the private rented sector is already leaning. Listings data from the online property search engine Globrix indicates that one- and two-bedroom flats account for 51% of the rental supply, but just 21% of sales stock. Three- and four-bedroom houses account for just 25% of the rental market, but as much as 55% of the sales market.

This in itself leave investors with a bit of a conundrum – lower tier properties (don’t read low cost or social housing) such as one and two bed apartment s are likely to produce a higher monthly income but because it is usually these types of properties that first time buyers can afford, capital values will grow slower until mortgage finance for those trying to get on the housing ladder is again readily available.

On the other hand higher tier properties, like larger family homes, will show higher capital growth in the short term as because the equity-rich owner occupier buyers dictate capital values, consequentially suppressing the income return in the higher value markets.

It’s also worth remembering though that income yields have a geographical trend not only in the UK but even in the different areas within Greater London. So it’s more important than ever that investors look closely at what they buy, where they buy and at what price to ensure a balance between income yield in the short term and total return in the medium to long term.

While the last decade will be remembered for the explosion of the buy-to-let phenomenon in the UK, the next will remembered for the innovation of the residential property investor, not just to meet the demand for private rented accommodation - but also to couple yield with realistic capital growth.

Wishing you health, wealth and happiness,

Mike Smuts
Property investor and MD of Smuts & Taylor.