UK rental property market booms as investors seek income alternatives

In this week’s bulletin:

  • Since the mid-June trough, markets have made steady progress during the summer, albeit in very thin trading.
  • Second quarter GDP figures indicate the anticipated global slowdown, although stronger retail sales and employment figures in the UK confuse the recessionary picture.
  • Latest inflation rise puts further pressure on deposit returns and the outlook for savers continues to look tough.
  • UK rental property market booms as investors seek income alternatives.

 

Markets enjoy the summer break

  • ‘Risk-on’ rally provides some relief for investors
  • European market hits 13-month high

The Olympics’ aftermath has provided evidence not only of how dull the television schedule was before the Games but also that markets have continued to make relatively gentle progress. The holiday feeling has certainly prevailed. In what is traditionally a quiet month for markets, Monday’s trading volumes in the UK were the lowest in a decade, whilst activity in the S&P 500 is some 30% below its average for the past five Augusts; a factor which amplifies the effects of otherwise small movements into and out of stocks.

As further evidence of a slightly more relaxed frame of mind, Wall Street’s ‘fear gauge’ – the VIX – which measures US equity volatility, registered its lowest reading in five years, down 60% in the last 12 months. “Volatility has fallen because risk had been priced irrationally high for some time, and rationality is only now being priced into the market,” was the view of Douglas Coté at ING Investment Management.

Investors may be beginning to think that things may not be quite as bad as everyone thought. Certainly as far as the eurozone is concerned, there seems increased faith that the single currency can hold together, although it seems inevitable that any solutions will be painful and slow to implement. German Chancellor Angela Merkel made welcome comments that the pledge by the European Central Bank to do whatever it takes to support the euro project was “completely in line” with the approach taken by European leaders, easing fears that Germany was not on board with the ECB’s strategy of intervening to reduce the borrowing costs of heavily indebted nations such as Spain and Italy. Investors responded by buying Spanish debt, sending 10-year bond yields tumbling to the lowest level for almost six weeks.

“You can see the building blocks falling into place for Draghi’s bond-buying programme to go ahead. You can also see numerous obstacles and it is not going to be quick but markets are beginning to sense that there could be a ‘game changer’ here.”

Andrew Milligan, Standard Life Investments

The mood has helped sustain the rally in European stock markets – the FTSEurofirst 300 closed the week at a 13-month high, up 17% since the trough in early June. US stocks are up some 10% over the same period – the S&P 500 nudging towards its 52-week high; and the FTSE 100 has rallied by 11%, closing the week at its highest level since the start of April. The Spanish and Italian bourses have been two of the best performers in the world since Mario Draghi made his commitment in late July, rising 26% and 22% respectively.

What will happen when traders clamber off their sun-loungers and get back to work? Dithering by European politicians and concerns over America’s ‘fiscal cliff’ continue to have the potential to spook the markets. The pattern of big waves in ‘risk-off’ and ‘risk-on’ sentiment has typified much of the last two years. What remains the problem for investors is spotting the turning points. Given the difficulty of market timing, the old adages of maintaining a well-diversified portfolio and drip-feeding money into the market, to help counter volatility, remain as true as ever.

 

Growth figures provide food for thought

  • Second-quarter GDP numbers confirm global slowdown

Last week brought news that eurozone GDP had contracted by 0.2% in the second quarter, following a flat first quarter and a contraction of 0.3% in the final quarter of 2011. Better-than-expected numbers from Germany, France and the Netherlands were offset by negative surprises from Portugal and Finland. Very low unemployment and falling inflation in Germany are helping boost household purchasing power and consumption. Meanwhile, austerity in Italy, Spain and Portugal continues to hit business investment and consumption. Overall, the story of a resilient core and a floundering periphery continues.

A similar picture of slowing growth was confirmed in the US and Japan which, together with the eurozone, account for 40% of world GDP. Doubts remain over whether the slowdown in the US is steep enough to guarantee that the Federal Reserve will announce further stimulus this year, in the shape of QE3. Second-quarter growth in China was little-changed, but with room for further stimulus the country seems to be on track for a GDP rise of around 8% for the year. The figures contributed to expectations that global GDP slipped below 3% on an annualised basis in the second quarter of this year, its lowest level since 2009.

Here in the UK, retail sales posted a reasonable and unexpected rise of 0.3% in July, aided largely by petrol and food sales. Added to this, the sales figures for June were also revised up sharply from 0.1% to 0.8%, revealing a bigger Jubilee boost and leading to expectations that this week will see the    follow-up estimate of second-quarter GDP confirm that Britain’s economy dipped less than was originally feared. Providing another puzzle for the economists analysing a country mired in double-dip recession was news that over 200,000 jobs were created between April and June, possibly reflecting a number of contributory factors: growth in service-sector output, a more efficient jobs market, and falling real wages keeping employers’ bills down and enabling them to recruit.

 

Savers continue to suffer

  • Latest inflation figures provide a further blow to real-return prospects

News that UK inflation unexpectedly rose in July, for the first time in four months, was a disappointment but generally viewed as a temporary blip. The Consumer Prices Index increased from 2.4% to 2.6%, largely, it seems, as a consequence of the poor weather this summer. Airfares inflation, a notoriously volatile factor, rose as travellers escaped to warmer climes in Europe and clothing prices rebounded after retailers had been forced into early and unusually sharp discounting of their summer ranges.

The expectation remains that inflation will drop below the Bank of England’s (BoE) 2% target within the next two or three months, helped substantially by the approaching anniversary of last year’s utility price hikes. Notwithstanding this better news on the horizon, the figures again put the focus on the sagging fortunes of savers who are relying on deposits to supplement their income. Basic-rate taxpayers need to find a savings account paying at least 3.25% to counter the effects of tax and inflation. Data from Moneyfacts (source: Financial Times) confirms that savers have a choice of 227 accounts – out of a total of 1,092 – that achieve this goal. However, 128 of these are cash ISAs, in which the amount that can be deposited is limited to just £5,640. There are no easy-access accounts that beat inflation. Using the alternative Retail Prices Index measure, which rose to 3.2%, the figures are even gloomier; only 58 accounts provide a real return. Whilst the average savings account rate of 1.04% is dire enough, the estimate that £115 billion is languishing in savings accounts paying 0% (source: Daily Telegraph) is a salutary reminder of the need for savers to review their own arrangements and ensure every penny is working as hard as possible in this environment.

Is there light at the end of the tunnel? Last week’s money markets implied that the base rate would be cut from 0.50% to 0.25% in February next year, rising back to 0.50% in August 2015 and up to 0.75% in 2017 – that said, this is a shift from just two weeks ago, when markets were pricing in a rate cut before the end of the year; all of which underlines the existing uncertainty. Speculation also continues over the possible impact on savers of the BoE’s Funding for Lending Scheme that came into being at the start of the month and is expected to cut substantially banks’ funding costs, which in turn, it is hoped, will encourage cheaper lending to businesses and households. Fears remain that, in being offered cheap new money, banks will have less need to attract savers and rates might fall.

Whether or not the Daily Telegraph comes to the rescue of savers remains to be seen, but its suggestions that the government abolish or reduce the tax on savings, doubles the cash ISA allowance or fundamentally overhauls the savings tax system will be seized upon by those hoping, perhaps forlornly, that cash will come to the rescue. What does remain clear is that neither the economy nor individuals can afford for people to stop saving or planning for their future.

 

The lure of the landlord

  • Rental costs hit record high as homebuyers remain priced out of the market

The search for income is attracting an increasing number of savers into the buy-to-let market, enticed by rent levels that have just hit a record high. The average rent paid by private tenants in England and Wales reached £725 a month in July, nearly 3% higher than a year ago. The rise in rents and the demand for rented accommodation are consequences of the frustrations felt by first-time buyers. The dearth of new housing – the level of new home starts by builders has hit a three-year low – the continued rationing of mortgage funds and the inability of borrowers to put down a 20–25% deposit means that home buyers are effectively locked out of the market. As a result, many are still being forced to rent a flat or house when, ideally, they would have bought one in the past few years. Owner occupation of households in England has fallen to 66%, back to the level of 1989, having reached a peak of 70.9% in 2003.

This is not good news for those families struggling with the impact of every rent rise, but the booming rental market is clearly benefiting others. The number of people earning income from rent has increased by almost a third in two years, according to accountants UHY Hacker Young. The average total yield on buy-to-let properties is currently 4.5%, but investors are being cautioned to look beyond the obvious attractions of such income levels and consider the potential pitfalls. The principle of diversification applies equally to rental property, highlighted by figures showing that 100,000 tenants have fallen into severe rental arrears – a figure that is up almost a quarter over the past year. But it is not just rents that have hit a high; buy-to-let repossessions have also reached record levels, suggesting that it is not just tenants who are struggling to pay the bills.

With real house prices having fallen by over a fifth since their peak and likely to remain flat at best over the next few years, landlords should forget the notion that buy-to-let property is a licence to print money and instead recognise it as a long-term business activity. As with any other asset class, buy-to-let property should not be seen as a panacea but as something that may have a place in a diversified portfolio.

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