Alpa Bhakta, CEO at Butterfield Mortgages, looks at how property investors can succeed in the fast-growing rental sector in the UK, with a focus on the prime central London market.

The macroeconomic and market trends that have dominated the Property investment landscape in the last 19 months are well known by now: high inflation has ravaged buyers’ spending power; the Bank of England’s interest rate hiking cycle has massively increased the cost of borrowing; and the mainstream mortgage markets have been in a constant state of flux.

Some prospective buyers have put their plans on hold as a result, activity levels have dipped, and we have seen house prices begin to soften around the country. According to Nationwide’s recent House Price Index (HPI), for example, the value of an average home fell 5.3% year-on-year in September.

And, although the Office for National Statistics (ONS) most recent HPI showed that values in the capital have experienced a comparatively small decline of 0.8% year-on-year, the prime central London (PCL) property market has not been exempt from the impact of these economic headwinds.

As such, many landlords and Property Investors in the PCL sector will be considering ways in which they can maintain their profits as the economic climate continues to produce turbulence and uncertainty.

Opportunities for property investors lie in the rental market

Positively, the Rental sector has experienced significant growth. Thus, investing in a rental property could provide an attractive option to investors who are seeking a steady stream of income.

Indeed, according to the ONS’s most recent Index of Private Housing Rental Prices, rents in the capital grew by 5.9% in the 12 months to August 2023. This figure sits above the nationwide average of 5.4% and makes the London rental market the best-performing region in England in this period.

Moreover, the forecasts for London’s rental market in the months and years to come look bright as well. According to Hamptons, for example, rents in the capital are predicted to remain the highest in the country over the next four years with a total increase of 25% by 2026.

Meanwhile, with data from AirDNA showing that Airbnb rentals have an occupancy rate of around 75% and an average daily rate of £227, the short-term rental and holiday-let market in London could be another potential opportunity for those landlords who want to continue to use their property during certain periods of the year.

In contrast to the decline of property values, therefore, the yields that a rental property can provide could offset the impact of a dampened sales market on an investor’s portfolio and provide a useful buffer against any further price drops. In any case, adding rental properties to a pre-existing portfolio will only help to create a more balanced and resilient portfolio.

Things to be aware of when shifting focus to the PCL rental sector

However, for many property investors, shifting focus to the rental market may not be something that they have considered or done before.

Indeed, due to the high level of demand for prime properties and the historical performance of the PCL sector, the traditional focus has typically been on buying properties for capital appreciation rather than use as rental properties. As such, there are a few things that investors should be aware of when considering a foray into the rental space.

For example, unless they obtain planning permission, investors are restricted to letting their property out on a short-term basis for a maximum of 90 nights in a calendar year. They must also pay Council Tax on the property, even though they are not inhabiting it full-time. Therefore, unless investors can fill their properties for the allocated period, their profitability may be harmed by a lack of year-round rental income and additional tax obligations.

Elsewhere, all rental properties in the UK must meet the minimum energy efficiency standards, so property investors who are converting an investment property into a rental unit need to secure an Energy Performance Certificate (EPC). This means that, if the property isn’t eligible for an EPC rating of A-E, potentially costly renovations and improvements would need to be made – particularly if the property is an old or historical building, as many PCL properties are.

Moreover, short-term rental properties obviously have a higher turnover of tenants (or guests), so property investors must also account for potentially higher maintenance costs, as well as additional wear and tear that could impact the value of the property in the long run.

Financing a foray into the rental space

Finally, it’s vital that property investors have the right finance in place for any foray into the rental space. Indeed, some lenders may require them to secure a different kind of mortgage if they wish to change the use of a property. As such, by working with a broker, they’ll likely need to take on the services of a lender who can provide bespoke financial products – such as buy-to-let (BTL) mortgages – that cater to their specific needs.

The PCL market typically has a higher density of high-net-worth (HNW) or overseas investors than the rest of the UK market, so flexibility is a particularly important quality for lenders to have due to the complex nature of the borrowers’ financial backgrounds. Therefore, for PCL property investors who are keen to rent out their properties, finding a lender that can take into account their overall financial profile and portfolio of assets when crafting mortgage packages is an all-important consideration.

To briefly conclude, the PCL rental sector is clearly providing property investors with intriguing and potentially profitable alternatives to the standard practice of capital appreciation. However, uncertainty and turbulence continue to dominate the property investment landscape, so property investors must consider the complexities of the rental sector before investing.

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Alpa Bhakta is the CEO of Butterfield Mortgages, a London-based prime property mortgage provider with a focus on the needs of UK and international HNWIs.  

Butterfield Mortgages Limited is authorised and regulated by the Financial Conduct Authority (Financial Services Register Number: 119274).