18 months of rising house prices have changed the Buy to Let market across the UK. As house prices increase, many new landlords face lower rental yields. This is because the higher cost of buying reduces the percentage profit landlords can make on their investment.
Good Yields are Essential for Letting Success
Buy to Let investments are successful when landlords can buy a property cheaply and then rent it out at a market rate that equals at least 125% of their mortgage payments.
The annual rental yield a property offers can be calculated as a percentage of the price paid for the property. For example, if a property cost £450,000, with a monthly rent of £3000, then the annual yield would be 8% (12×3000/450,000).
When the cost of a buying property rises, the yield available to the landlord falls. If, in addition, unexpected maintenance is necessary, market rents decrease, or mortgage rates rise, landlords can find themselves in financial difficulties.
One of the best ways to avoid this problem is to pick a property in a location where rental properties are in high demand, but where homes can be bought for reasonable prices.
In HSBC’s recent ‘UK Buy to Let Hotspots’ research (May 2015), we can see that the bottom 10 locations in the UK all offer landlords less than 4% yield annually, with the worst location of all offering less than 3% on average. Such low yields leave landlords vulnerable should market conditions change.
London Tops the ‘Worst’ List
In HSBC’s report, 6 out of 10 of the worst UK locations for Buy to Let are in London, where prices have risen most strongly since 2014.
While some London boroughs still offer landlords a healthy yield (Newham, 5.2%), even the best-performing areas of the city are unlikely to see rent rises that can keep pace with growing house prices.
In more affordable parts of the capital yields have tumbled, with a 13.4% average decrease in yields in Newham, an 11.1% decrease in Brent and a 12.7% decrease in Lewisham.
At the same time, average house prices of almost £500,000 in London mean that would-be landlords need large cash deposits in order to invest. This means that only those with large sums of capital can consider the capital at all.
Prime Property Offers Small Yields
From a Buy to Let perspective, Prime London locations top the list of worst places to be a landlord because it offers the UK’s most expensive asking prices.
While prices boomed in 2014, there has been a significant market fall in recent months, reflecting both value for money concerns and a drop in interest from foreign investors.
Despite a short-lived rise in prices following the general election result, prices continue to follow a downward trend. Prices in Kensington and Chelsea and Westminster have fallen sharply, and current yields of 2.87% and 3.15% offer landlords a very small safety net if the financial climate continues to be challenging.
Rising Prices Reduce Yields
Rising prices have also affected inner London areas popular with families, such as Hammersmith and Fulham, Camden and Harrow. These boroughs have seen rental yields hit particularly hard, with annual yields declining by 7.9%, 13.4% and 12.3% respectively in the last twelve months.
While landlords with capital to invest could still benefit from increases in the value of their property, those who seek a steady annual income should avoid these areas.
Transport is Key
One of the major market trends of the past year has been the movement of many inner London residents to outer London or commuter towns in the South East in search of better value for money.
A combination of the rising market and improved transport links, such as the forthcoming Crossrail, are driving this movement. This trend has increased rental demand and house prices in areas which benefit from access to these transport links (e.g. Oxford), while leaving those with poor transport links behind.
Good transport links are the reason why locations such as Brighton and Hove and Southend-on Sea are in the top 20 locations for Buy to Let (journey times to central London by rail are under an hour), while more affordable Hastings and Eastbourne are listed in the bottom 20 (both of which of have journey times of approximately 90 minutes to London).
Beware a Sluggish Market
There are only two areas outside London and the South East of England in the top 20 worst areas for Buy to Let: Lincoln and Ipswich. Located in the Midlands and East Anglia respectively, both suffer from a sluggish housing market and declining rental yields.
In Lincoln, the average cost of a property is £130,163, with yields declining by 4.1%. This would suggest the rental market is sluggish and therefore, while it is affordable, it is not a good area for investment.
Ipswich also benefits from affordable average property prices of £171,322. According to home.co.uk, the average price of a property in Ipswich has fallen 3% in the last 12 months. However, yields are also declining here, reflecting an overall fall in demand for homes.
Know Your Market
These figures suggest just how important it is for investors to know the specifics of their local market before investing in property. While areas of high employment and increasing rental demand (such as London) may be attractive, high property prices may mean they offer a poor yield.
At the same time, areas where property prices are lower may not offer value for money either. If lower prices reflect lower demand for homes landlords may find they experience higher numbers of void periods, as well as falling capital gains.
Wherever you choose to invest, remember that careful research pays dividends.
Top 10 Worst Buy to Let Locations (HSBC, May 2015)
Location Yield Annual Increase Average House Price
1. Kensington and Chelsea 2.87% -0.4% £1,310,083
2. Westminster 3.15% -9.4% £990,898
3. Hammersmith and Fulham 3.23% -7.9% £797,170
4. Haringey 3.4% 0.5% £489,291
5. Camden 3.46% -13.4% £826,156
6. Hastings 3.54% 7.9% £197,560
7. Richmond upon Thames 3.71% -1.8% £631,440
8. Harrow 3.94% -12.3% £380,196
9. Eastbourne 3.95% -16.0% £197,560
10. Redbridge 3.98% -7.9% £361,822