The private rented sector has been tough for many in 2023. Rents have grown by nearly 7% in the first nine months of the year, taking total growth since the pandemic to 27%. The long awaited Renters Reform Bill is progressing slowly through parliament, while the rising cost of debt has impacted the profitability of many mortgaged landlords.
 

Word of the year: Imbalance

Homes to rent have been in very short supply. The end of a series of national lockdowns sparked an increase in rental demand in the UK in mid-2021 and demand has consistently exceeded supply ever since. An increasing number of landlords are now selling their properties, given that interest rates have risen sharply, eroding the profit which mortgaged landlords can expect to make. There are currently -28% fewer homes listed to rent than the pre-pandemic average, according to Rightmove. Tenants have had to bid rents upwards in order to secure a tenancy under these competitive conditions. Rental growth has also been partly supported by strong growth in incomes, both through earnings growth and increases in benefits.

The RICS survey shows that the gap between demand and supply in the rental market is still significant, while the number of listings available remains at the low levels seen since the beginning of 2022. This suggests rental growth will remain strong for the rest of 2023, so we are forecasting 9.5% growth in the calendar year, lower than the 11.2% seen in 2022, but higher than any other calendar year on record, according to the Zoopla rental index – powered by Hometrack.

Beyond this, it is very difficult to see where an increase in rental supply will come from in the next couple of years. High interest rates will mean landlords continue to struggle in making the numbers add up, suggesting more will leave the sector and fewer will join in their place. A survey by the National Residential Landlords Association in June of this year suggested that far more landlords intend on selling property in the next 12 months than buying. Some will be able to buy with cash and will therefore avoid the high cost of debt, but with the prospect of further house price falls in 2024, it is unlikely that enough will do so to move the dial on supply. Higher interest rates will also make it difficult for renters to get out of the sector by buying a home, keeping rental demand high. This points to an all-too-familiar imbalance of demand over supply continuing to fuel strong rental growth in 2024, which we anticipate will be in the order of 6%.

Dancing on the (affordability) ceiling

Strong growth in rents has already stretched the finances of those in the private rental sector (PRS). We estimate that the average PRS household is spending 35.3% of their income on rent, up from 33% in 2021/22. Next year we expect affordability to be stretched further but thereafter rental growth will not exceed income growth as we reach a rental affordability ceiling. Unfortunately, renters will still be left spending a higher proportion of their income on rent than at any point in the last 18 years.

We are already seeing the impact of a rental affordability ceiling in London, where rents take up a much higher proportion of incomes than the UK average. Rents in the capital have grown by 31% in the last two years according to the Zoopla index, over which time the gap between demand and supply has shrunk, according to the RICS, as renters have exhausted their capacity to bid rents up. Month on month rental growth has fallen from an average of 1.2% in 2022 to 0.6% so far in 2023. Rents in London are likely to underperform over the next 18 months, as renters elsewhere use up financial capacity which does not exist to the same extent in London. 

When will landlords return when mortgage costs fall?

Oxford Economics expect the base rate to fall slowly from the middle of 2024 onwards, which will gradually give lenders greater confidence in decreasing their mortgage rates. This will gradually bring landlords back into the rental sector. Those who can buy with cash or use a lower amount of debt will be the first to return to the market, with rental growth in excess of house price growth making yields look more attractive. But it is likely that any significant increase in stock in the sector will be delayed until 2026 and beyond, when interest rates have fallen more substantially.

If interest rates fall more quickly than expected, for example if there is a risk of a recession in the UK, then mortgage affordability will improve more quickly for landlords. Under these circumstances we may see a greater influx of stock into the sector, meaning rental growth can fall below earnings growth and rental affordability can improve.

We expect an increase of supply in London to be slightly more delayed. Rental yields are lower in the capital, meaning it will take longer for a significant premium over the risk free rate to emerge. This supply challenge, in addition to a slightly stronger economic outlook for London over the rest of the UK means we expect London rental growth to outperform by the end of our forecast period.

Leave it to the professionals?

Struggles for individual private landlords suggest that institutional landlords and the Build to Rent sector will play an increasingly important role in providing high-quality rented accommodation looking forward. The PRS appeals to these operators because it offers a secure long term income stream which is likely to rise with inflation and also ticks the social value box by providing a much-needed source of new housing.

With the pool of renters expected to grow more diverse in terms of age and household composition, there are opportunities for investors to provide both urban flats and suburban family housing to rent in the multifamily and single family markets respectively.

Rental growth in these markets is likely to outperform. Tenants tend to be higher earners, who are less likely to push against an affordability ceiling and have capacity to allocate more of their income to rent. Professionals have also seen above-average increases in earnings since the pandemic, allowing them to bid rents higher. The degree to which the Build to Rent sector can grow in influence will depend on how easily schemes can get funding in a challenging debt market and get planning consent in an arguably even more challenging planning environment.