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mistermark

Rents And Implications For Property Prices

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Back in the mid-1990s I owned a number of BTL apartments, studios and 1-beds, close to the City which I rented to recent graduates who'd just got their first jobs in banking or law but weren't ready to buy. With blue-chip employers and middle-class parents willing to gift a deposit and underwrite the lease, it was good business - especially because the yields were 10-15%, when the mortgage rate was maybe 8%.

Around 1999-2000 I sold them all because they'd risen in price so much that the yield was now around 5%, which was less than the mortgages would have been if I'd been on 100% loans, so they looked fundamentally overvalued to me. I was wrong :( . As we all know, both rents and house prices continued to rise, albeit that the latter rose faster than the former, to the point that if I'd been insane enough to still hold them in 2007 the yields might have been down to around 3.5%.

But you can see where I'm coming from: fundamental value means buying properties where the rental yield exceeds the cost of capital. Right now, I can get BTL loans at around 5%, by the time the arrangement fees are factored in. But I don't want to buy on the basis that they'll stay at that level for long. The long-run average cost of capital is probably about 7%, so I'm trying to hold off going back into the market until I can buy units that generate at least a 7% net yield (by 'net' I mean after void period, letting agent's fees and ground rent/service charge if applicable).

Many of the so-called BMV intermediaries send me details of properties they claim offer anything from 8 to 13% yields, but when I look in more detail these are based on a very rosy view of the gross rent they might have achieved at the peak of the market. As we all know, rents have dropped due to oversupply.

So what I'm thinking is this: do I buy units now that have a 5% net yield, and bank on the rents rising as the economy hopefully recovers, so that they eventually return at least 7% of the purchase price per year, or do I keen holding off in expectation either of house prices falling further or of rents rising without prices going up in tandem, so that my 7% target can be achieved?

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Back in the mid-1990s I owned a number of BTL apartments, studios and 1-beds, close to the City which I rented to recent graduates who'd just got their first jobs in banking or law but weren't ready to buy. With blue-chip employers and middle-class parents willing to gift a deposit and underwrite the lease, it was good business - especially because the yields were 10-15%, when the mortgage rate was maybe 8%.

Around 1999-2000 I sold them all because they'd risen in price so much that the yield was now around 5%, which was less than the mortgages would have been if I'd been on 100% loans, so they looked fundamentally overvalued to me. I was wrong :( . As we all know, both rents and house prices continued to rise, albeit that the latter rose faster than the former, to the point that if I'd been insane enough to still hold them in 2007 the yields might have been down to around 3.5%.

OK, let's analyze what your mistake was. You based your decision to buy or sell on absolute yield calculated on present return divided by present value. If you had held the properties until 2007, your yield would have been very good based on your original investment, but you are looking at the yield in terms of the value of the asset at evaluation time and ignoring the value of the capital gain. When it comes to parting with the asset, you need to be asking whether you can get a higher yield from putting the value elsewhere - ie a relative comparison [eg letting gets me 3.6%, cocoa futures gets me 3.4%], not an absolute criterion [eg letting gets me only 5.4%, so I will get out of that because 5.4% is bad, even though I have no idea where I will get more]. And you need to take into account potential for capital gain.

But you can see where I'm coming from: fundamental value means buying properties where the rental yield exceeds the cost of capital. Right now, I can get BTL loans at around 5%, by the time the arrangement fees are factored in. But I don't want to buy on the basis that they'll stay at that level for long. The long-run average cost of capital is probably about 7%, so I'm trying to hold off going back into the market until I can buy units that generate at least a 7% net yield (by 'net' I mean after void period, letting agent's fees and ground rent/service charge if applicable).

Many of the so-called BMV intermediaries send me details of properties they claim offer anything from 8 to 13% yields, but when I look in more detail these are based on a very rosy view of the gross rent they might have achieved at the peak of the market. As we all know, rents have dropped due to oversupply.

So what I'm thinking is this: do I buy units now that have a 5% net yield, and bank on the rents rising as the economy hopefully recovers, so that they eventually return at least 7% of the purchase price per year, or do I keen holding off in expectation either of house prices falling further or of rents rising without prices going up in tandem, so that my 7% target can be achieved?

The whole bubble was based on oversupply and it being [perceived as] a viable business model to buy flats and hold them empty because the capital gains paid the cost of finance. So now there is a total oversupply of sh1tty flats, which will have to go to social tenants and bring the sector into disrepute. Whatever happens to the economy, it is not going to be so good for this sector of the market. I would say that your 7% target will be met in the near medium term, but not by values stabilising and rents rising, more likely by values falling and rents stabilising. This will help the future investor, but not the present investor. Yield is not the be all and end all and you need to keep an eye on capital values.

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