Communities and Local Government CommitteeWritten submission from Paragon Group
Executive Summary
Tenant demand is already outweighing existing stock in the private rented sector (PRS).
Private rental is the only growing tenure type in the UK. The PRS is already the dominant housing choice with transient sectors of the population including students, economic migrants and those who relocate for employment purposes. Long-term demand in the PRS is forecast to rise, fuelled by major socio-economic factors and a contraction in the owner-occupier and social housing tenures.
Private landlords are the backbone of the PRS, accounting for 89% of landlords and 71% of properties. Buy-to-let financing has enabled growth in the PRS and incentivised landlords to improve their properties, driving up standards in the sector.
Experienced private landlords do not typically purchase new build properties but tend to invest in existing properties because rental demand is focussed overwhelmingly on established communities with good local facilities and transport links. Landlords know the market conditions of the area in which they are investing and choose properties that correspond to local demand.
Institutional investment has only ever played a limited role in the provision of housing and is, by its nature, unsuited to the fragmented, dispersed nature of the rental market because it can only deliver value from economies of scale. There is a distinct lack of tenant demand for the type of properties in which institutions tend to invest except in very specialist sectors.
The most effective way to tackle the issue of supply in the PRS is to foster a regulatory and economic environment that encourages a committed base of landlord investors and lenders.
About the Paragon Group
Paragon is the leading independent provider of mortgages to residential property investors in the private rented sector through our specialist brands, Paragon Mortgages and Mortgage Trust.
We launched our first buy-to-let mortgages in 1995 and have increasingly focused our business on professional landlords who have proven experience in purchasing and letting residential rental property. This focus is reflected in the excellent performance of the Group’s buy-to-let mortgage assets and our reputation as a leading voice in the sector. We currently have approximately 40,000 landlord customers and manage over £9.5 billion of loan assets.
In addition, we operate a specialist loan servicing business for third parties through our Moorgate Loan Servicing brand. The division offers a professional, flexible, efficient and cost effective proposition to lender clients to help them manage their loan assets effectively. Clients include building societies, investment banks, specialist lenders, commercial banks and other financial services companies.
The Role of the Private Rented Sector in Meeting Housing Need
3.4 million households in England, nearly one-in-six, now class the private rented sector (PRS) as home, an increase of 1.4 million since 2001. Private renting is the only growing tenure type although it is still small compared to other European countries and the historic highs reached in the UK during the 1960s.
The PRS is already a popular choice with transient sectors of the population including students, economic migrants and those who relocate for employment purposes. Long-term demand in the PRS is forecast to rise, fuelled by major socio-economic factors such as the growing number of single person households and people starting families later in life. There is a changing perception of renting, with it increasingly seen as a tenure of choice rather than the poorer choice of either social housing or ownership.
First-time buying is declining but it would be inaccurate to portray this as being caused by buy-to-let investors. Mortgage finance has become harder to access as lenders have responded to the credit crunch by requiring larger deposits (the average loan-to-value fell from 95% in 1994 to 77% in 2010) but rising levels of graduate debt, affordability constraints and lifestyle choices have also contributed to the decline of first-time buying.
The contraction of the social housing sector has meant a greater role for the PRS in housing people on lower incomes and the Government’s decision to move social housing rents more in line with market rates in order to finance new housing supply will make private rental an option for many who would not have previously considered it. The Localism Bill is also likely to push more tenants who would previously have not considered renting privately towards the PRS.
Housing supply is failing to meet demand. The UK population is expected to grow to 71.6 million by 2033 with an estimated 290,000 new homes required each year to satisfy that demand. Only 102,500 homes were built in England last year. In the PRS tenant demand is already outweighing existing stock, with the Association of Residential Lettings Agents claiming the sector is operating at capacity.
The current economic environment is exacerbating the underlying pressures on housing. The lack of consumer confidence and the drying up of mortgage finance has resulted in a dysfunctional market that places severe pressure on the PRS, which in turn filters through to rental inflation.
Housing Supply in the PRS
Private landlords
Private landlords are the backbone of the PRS with 71% of properties in the PRS owned by individual landlords. While there is no such thing as a typical landlord, the average landlord is just over 50 years old, is financially astute, has been letting property for 11 years and holds an average of eight properties. The idea that the PRS is dominated by novice landlords is a myth; most individual landlords consider themselves to be professional investors and nine out of 10 have more than six years’ experience in renting out property.
Contrary to public perceptions, landlords do not usually buy up new build properties but tend to invest in existing properties because rental demand is focussed overwhelmingly on established communities with good local facilities and transport links. The PRS grows through landlords purchasing and improving existing properties which avoids the new property premium, offers scope for refurbishment (and therefore higher yields) and is aligned better with tenant demand. DCLG figures show 77% of property owned by private landlords was constructed pre-1980.
Furthermore, private landlords typically know the market conditions of the area in which they are investing and so choose properties that correspond to local demand, often holding a mix of different property types to match the needs of different tenant types.
The flexibility afforded by private landlords’ investment in diverse property portfolios to respond to this variation in tenant demand is one of the reasons why private landlords are the dominant suppliers to the PRS. Another important factor is that the private landlord model is much more economically efficient than any other. Private landlords will often discount their own efforts in managing and improving their properties, lowering the cost of a portfolio and leaving tenants as beneficiaries of lower rents as a result.
Buy-to-let support of the PRS
Buy-to-let has increased choice for tenants and is an important (but not exclusive) source of finance for the PRS. The rapid growth in the PRS and the number, and value, of buy-to-let mortgages since the late 1990s coincided with a period of strong economic growth and an increase in demand for flexible, high quality rented accommodation amongst several demographic groups. The growth in the market has also prompted an improvement in housing stock as landlords have been incentivised to improve their properties.
Buy-to-let was significantly affected by the credit crunch with an 81% decrease in the value of new loans, and the number of buy-to-let products declining by 90% from July 2007. Although buy-to-let lending has entered a period of recovery, it remains difficult for private landlords to access finance for property purchases, thus contributing to the current market dysfunction.
Institutional investment
There has been a great deal of comment on the role of institutional investment in the current debate on the housing supply crisis. For many, it appears to be a panacea to the structural problems affecting the housing market. However, institutional investment has only ever played a limited role in the provision of housing, even when it has been encouraged by successive governments. Its current role extends only to students, the elderly and large housing developments.
There are several reasons why institutional investment has not had the impact expected by some policy-makers. This type of investment is, by its nature, unsuited to the fragmented, dispersed nature of the rental market because it only delivers value from economies of scale. The kind of properties that institutional investors are likely to invest in through “build-to-let” schemes, such as two-bedroom flats, in large purpose-built developments are unattractive to tenants and there is already an over-supply of this type of property caused by pre-credit crunch property developer and investment club activity.
Institutional investment also works against the development of generally mixed communities because of the preference for larger developments. The Government’s Rugg Review noted that encouraging institutional investment via build-to-let might create rental “silos” and make the market more inflexible.
Furthermore, while private landlords do not charge for their time, investing instead their “sweat equity”, the kind of management companies that the institutional investment model requires can significantly affect the cost of managing properties, reducing investment returns, creating inflationary pressures on rents and raising questions about economic viability.
Paragon does not oppose attempts to encourage institutional investment, notwithstanding the above concerns, but it is important that institutional and individual investment should be seen as complementary and treated equally in terms of regulation, tax breaks and other fiscal incentives. Any skewing of incentives towards institutional investors could actually result in a contraction of supply over the medium term if individual investors feel they are not competing on a level playing field.
Alleviating Pressure in the PRS
Paragon believes that there is stock available within the UK for landlords to invest in, and there is a will among individual investors to purchase that stock. However, the muted wholesale credit markets and the lack of consumer confidence in the owner-occupier sector have stalled the usual operation of the housing market. European Commission proposals that seek to bring buy-to-let into the scope of consumer regulation would further restrict finance and hamper the delivery of new PRS supply.
As stated above, private landlords—the backbone of the PRS—do not typically invest in new build property, and will only do so where there are proven and sustainable levels of tenant demand. But government initiatives on public land and empty homes are welcome for the effect they may have on reducing the pressure on different tenures. The most effective way to tackle the issue of supply in the PRS is to foster a regulatory and economic environment that encourages a committed base of landlord investors and lenders. It is also important that governments work together to achieve solutions to the global economic problems that have constricted the supply of finance.
The Coalition Government has so far shown a good understanding of the PRS and has stopped further layers of landlord regulation. It is another myth that the sector is not regulated—there are over 50 Acts of Parliament and 70 sets of regulations that govern the sector. Increasing this regulatory burden risks causing landlords to leave the sector and so put further stress on supply.
There are tools that can be used to further encourage landlord investors and create a business environment more akin to that of countries with comparable private rented sectors where landlords benefit from more competitive taxation regimes and are able, in some cases, to offset capital losses. Paragon would welcome any initiatives that are intended to encourage private landlord investment.
October 2011