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Will the squeeze on buy-to-let returns continue?

The rate of rental growth has improved but investors that sought to take advantage of potential stamp duty savings face the threat of diminished returns in the near-term
Will the squeeze on buy-to-let returns continue?
  • Rents rose by an average 2.3 per cent across the UK, excluding London, during the fourth quarter
  • However, that was outpaced by house price inflation, squeezing short-term returns for landlords that bought amid the housing market boom

Rents grew at a higher rate during the fourth quarter but continued to substantially lag house price inflation, squeezing near-term returns for buy-to-let investors that rushed to take advantage of the stamp duty break.

The annual rate of rental growth improved to 2.3 per cent - excluding London - during the fourth quarter, according to Zoopla, up from the 1.6 per cent reported for the prior three months. Including London, rents across the country fell 1.2 per cent compared with the same period in 2019. 

However, the rate of rental growth was still substantially behind house price inflation reported during the period, which in some cases, has meant stamp duty savings have been easily wiped out. According to the Office for National Statistics, the average house price in England increased by an annual 7.6 per cent - or just over £20,000 - to £267,000 in November, far exceeding the equivalent stamp duty saving of £3,350. 

Buy-to-let investors - who still have to pay the additional 3 per cent rate on purchases up to £500,000 ahead of 31 March - were caught up in the rush to take advantage of the tax break. Over the fourth quarter, investors buying property to let accounted for 13 per cent of sales agreed in the UK, according to data from Hamptons International. That translated into just over 51,000 completions, the estate agency estimated, the highest figure for that quarter since 2015. 

Rents could remain subdued this year as government support schemes unwind and the rate of unemployment rises, heightening affordability constraints that will prevent rents from rising too much. 

The impact will be highly localised, argued said Gráinne Gilmore, head of research at Zoopla. “We will have areas that are seeing higher levels of unemployment than other areas,” she said. There is greater “headroom” for growth in the north of England and the midlands, where rents are typically more affordable, she added. 

However, a lower level of supply in the market should also keep a floor under rent levels and mean the market avoids the substantial falls experienced following the 2008 financial crisis, said Gilmore. “We were just coming off a lot of investment into the buy-to-let sector so supply was flowing freely and we’re not at that stage now,” she said. Equally, the barriers facing first-time buyers, including restricted availability of higher loan-to-value mortgages, will also buoy demand for rental properties, she said. 

Nevertheless, those landlords that bought following the stamp duty break could see rental yields come under pressure, argued David Lawrenson, owner of property consultancy LettingFocus.com and a buy-to-let investor with a portfolio of properties. 

“I think they’ve made a mistake,” said Lawrenson. “I can’t see these levels of house prices being sustained for the next 12-18 months.” Landlords would be wiser to wait and see if sales prices come down later this year, he argued, particularly as household incomes come under strain. 

There are early signs of a weakening in house values ahead of the tapering of the stamp duty holiday: January house prices declined 0.3 per cent on the prior month, according to mortgage lender Halifax, the first fall in six months.  

Rents in some of the UK’s major cities, including Manchester, Birmingham and Edinburgh, have been particularly weak. There were declines across those cities during the final three months of the year, according to Zoopla, in contrast to rises enjoyed in their respective neighbouring boroughs. 

The ‘halo’ effect was driven by people searching for more space, including outdoor areas, and no longer necessarily needing to commute to the office, said Gilmore. Those people are perhaps “casting their net wider”, she said. 

“We can see that across the market family homes are renting out much more quickly than flats,” said Gilmore. A year ago, the opposite trend would have been apparent in most areas, she said.  

Lawrenson said rents on properties he owned in central locations such as Bermondsey had fallen by around 5 per cent post-pandemic, while those further out had risen by an average 3 to 5 per cent. 

Borrowing costs attached to buy-to-let mortgage rates are still historically low, which will aid returns for landlords. However, there is every chance that growth in rents will remain subdued as household budgets are squeezed. Investors that bought amid the housing market boom may be among those to feel the pinch to returns most keenly.