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What rental boom?

Sadly, this picture is deceptive. Rents may be rising, but so too are consumer prices. In fact, rental inflation has been consistently lower than consumer-price inflation - 2.3 per cent compared to 2.8 per cent in May. The result is that real rents have fallen by nearly 10 per cent since their peak in the summer of 2008.

This is part of a wider problem: average returns from housing look too low to warrant serious investment. The two contributors to landlord returns are net rental yields and house prices. House prices have been roughly flat over the past year, and it is hard to be bullish about their immediate prospects given the weakness of consumer confidence. Yields - rents divided by house prices - have been rising with nominal rents, but remain paltry by historic standards.

In the 1990s, before the long boom, gross rental yields from housing tended to be about 8 per cent. A decade of house-price inflation and a partial correction later, they’re somewhere between 5 and 6 per cent, depending on whose estimate you believe. Depreciation, voids and management costs typically eat up about a third of rental income, so net yields average 3-4 per cent. Without further house-price inflation, that's a very modest return for the hassle of owning a property.

So why - and how - is the private rented sector expanding? We know it is from the English Housing Survey: private landlords now lodge 17 per cent of English households, up from 14 per cent in 2008 (and 9 per cent in the early 1990s). Buy-to-let lending has been growing, but from a very distressed base; 32,300 loans were written in the first quarter, compared to over 93,000 at the 2007 peak. Cash purchases have meanwhile remained at a fairly constant level throughout the downturn. Presumably these landlords think they can achieve higher-than-average yields - or are taking what the investment industry euphemistically calls a 'long-term view' on house prices.

But Michael Ball, a property economist at Reading University who writes the RICS European Housing Review, among other things, reckons that much of the private rented sector's recent expansion can be explained by "reluctant landlords". Some of these are home-owners who can no longer afford their homes but are unable or unwilling to sell. They can downsize temporarily by renting a smaller house and then letting out their own home, boosting both the supply of and demand for rented property. Others have bought a new home but are waiting for a hotter property market before selling their old one.

This theory implies that Britain is not set to become a nation of renters like Germany or Switzerland. When the housing market improves, the reluctant landlords will sell up, reducing the stock of rental properties. The needle will then swing away from the private rented sector. Indeed, Prof Ball thinks owner occupation will remain the tenure of choice in Britain as long as the government continues to tax the rental income of landlords, but not the equivalent rental benefit owner occupiers derive from the equity in their homes - an anomaly that stacks the system financially against landlords and renters.

He also points out that first-time buyers' current need for big deposits is easily exaggerated. For all the hype around 125 per cent mortgages, the average loan-to-value ratio for first time buyers was 85 per cent before the crash. Now it is 80 per cent, but real house prices are a third lower, so average deposits are only fractionally larger than they used to be. Households have not been trapped in the private rented sector; they have been choosing to rent - perhaps because they expect houses to get cheaper.

What does all this mean for investors? First, it suggests it is not worth buying into housing unless you have a clear strategy to achieve better-than-average returns. This may involve focusing on higher-yielding areas of the market, such as student lets or council tenants. But in that case, be prepared to accept a higher risk that tenants don't pay the rent and more hassle with management.

Alternatively, it's possible to minimise the difference between gross and net rental income by doing much of the administration work yourself. This is the approach taken by professional landlords, and it also makes a lot of sense for retired investors with local properties. There may also be local market inefficiencies, or certain tenant segments that are underserved by the market. Prof Ball points to an apparent shortage of rental accommodation for young couples with children, for example.

There is one small comfort for landlords: the alternatives look fraught with risk. It may not be that property is so unappealing - but that we live in an era of low returns.