Prime rental growth starts to cool as demand eases back and stock slowly increases. But financial pressures, possible regulation and the alignment between tenants' and landlords' expectations will be key over the coming months
Jessica Tomlinson, Associate, Savills Residential Research
After a red-hot rental market over the last few years, the third quarter of 2023 marked a noticeable cooldown in the pace of growth.
Prime regional rents increased by a relatively modest 0.6% in the quarter – a significant reduction on the 2.6% recorded in Q2 – and leaves rents 4.7% higher than a year ago. While on an annual basis this is still above historic levels, it is a shift from the increase of 8.3% in the year to September 2022.
In comparison, in prime London, rents grew by 1.7% in the quarter, broadly on par with Q2. Nevertheless, growth slowed compared to Q3 2022 (3.0%), emphasising a recent adjustment in the market. Annual growth now stands at 5.4% across London, down from the highs of 13.6% a year previous.
Generally smaller, lower-value properties continue to fuel rental growth. In these markets competition remains, particularly from needs-based tenants who continue to search across a limited supply of available stock. Demand has been further supplemented by those whose prospects of getting on the housing ladder may have shifted back towards renting in the face of higher mortgage costs.
Across the regional markets, rental values of flats increased by 2.6% in Q3, while on average, houses remained flat. In these more discretionary markets, which are often more lifestyle-driven, demand has moderated as prospective tenants become more conscious on price. Similarly in prime London, rents for properties with one or two bedrooms increased by 2.1% in the quarter. Whereas those with five or more bedrooms only increased by 1.1%.
Yields on prime London rental stock have increased across all submarkets over the last three years. And the increases have been strongest for flats, where rental growth has been the greatest and capital values have come under most pressure. Notably, in Q3, the average prime gross yield for flats in North & East London reached over 5% for the first time since at least March 2014, when we first started reporting on them.
Rental growth across Scotland’s prime lettings market has also continued to be strong over the third quarter. Prime rents in Edinburgh increased by 2.6% in the three months to September 2023. The average prime rent in Scotland’s capital is now 7.3% higher than a year ago and 26.6% more than the level before the beginning of the pandemic.
The significant growth in rents has come against a backdrop of higher buy-to-let lending rates and increased government regulation which include a cap on in-tenancy rent increases and a temporary moratorium on eviction. These regulations are in place at least until the end of March 2024.
With an Additional Dwelling Supplement of 6%, unsurprisingly, many landlords have decided to exit the market and, as a result, the number of listings in the capital during Q2 2023 was -13% behind the five-year average according to Savills Research using Rightmove.
There is more disruption ahead with the introduction of a licensing regime for short-term lets in Scotland. While this could lead to an increase in supply, there is still a shortfall in the face of demand from a wide range of tenants, including professionals, relocators and students, and this is likely to apply upward pressure on values going forward.
The imbalance between supply and demand has been a constant trend over the past few years. Although that imbalance remains, there are signs it is beginning to shift.
Overall stock levels have started to increase as some properties move into the rental market from a more subdued sales market. And demand has eased back from last year’s levels across the board. As a result, the number of new applicants per property in August is now below the highs seen in the same month in 2021 and 2022, though it still remains significantly above August 2019. That said, in London, the upticks have been unevenly spread across certain locations and particular property types.
Meanwhile, the gap between tenant and landlord rental expectations has widened over the third quarter. As the market continues to evolve, those landlords who respond to changing conditions will likely attract the most secure tenants for the future.
The supply and demand imbalance is likely to continue to determine the pace of growth over the short term, but longer term, there may be more factors at play.
Undoubtedly, landlords with some form of mortgage debt will be feeling the pinch in the current interest rate environment. As a result, there has been a decrease in new investment activity and an increase in Landlords selling property, both of which will limit levels of supply.
Alongside this, the practical implications of draft legislation surrounding the Renters (Reform) Bill will be on the minds of landlords.
However, the recent decision to withdraw plans to tighten minimum energy efficiency standards may provide some respite.
This said, overall we expect supply to remain tight, pushing rents to the top end of the range of tenants' budgets. And so, ultimately, cash landlords and those who are willing to take a long-term view on their investment will benefit from the returns of rental growth and higher gross yields.
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