Rental returns continue their upward path

Average total returns generated by landlords have reached their highest level in five months, as both rents and property values continue to rise. Over the past quarter, rents are up 8.2% and house prices paid by landlords up 5.5%, according to the latest Paragon Buy-to-Let Index.

As a result, total ungeared returns generated by landlords in March stood at 12.9%, compared with 8.0% in January and 10.0% in February.

Nigel Terrington, chief executive of Paragon, says: “Net inward migration is increasing Britain’s population by 500 people per day, according to recent reports based on National Statistics’ data. There is a clear link between this influx of people and the growth in demand for rented homes, with the vast majority of new arrivals in the UK choosing the private rented sector for their accommodation needs. This has an impact on rents which are 8% higher now than they were three months ago.”

Paragon’s findings are corroborated by the latest quarterly landlord survey from ARLA, the Association of Residential Lettings Agents, who recently announced that annual rates of return for a cash purchase of residential rental property currently stand at 11.2%.

Nigel Terrington points out, however, that the vast majority of investors who raise a mortgage to finance their property purchases can achieve a much higher return on the equity they have invested:

“The typical investor gears his residential property portfolio and funds his property acquisitions through a combination of cash and mortgage finance, which has the effect of significantly increasing the effective yield on money invested. Paragon’s data shows that with a loan-to-value of 65% (the Paragon portfolio average), an investor achieved an average rental yield over base rate of 2.5% at the end of 2006, slightly lower than one year earlier (3%), but still strong.

ARLA’s Q1 release shows a similar picture. According to their figures, the average annual return on a geared investment is almost 22%, calculated over a five year period.

“While the favourable trend of rental yields is a positive indicator for landlords, it does not tell the whole story,” explains Nigel Terrington. “The yield figures provide a one-off snapshot of the return to the investor at the point when he acquires a new property. However rents will grow over time, improving the landlords’ inception yield.

“Buy-to-let clearly offers superior returns, so it is not surprising that residential property is an important component in many people’s portfolios, particularly for those who are looking for long term investments for retirement provision. Experienced property investors have a high degree of control over the outcome of their buy-to-let activity, which is why many of them favour it over other asset classes.”