As the caveat on any investment product will tell you, past performance is no guide to future returns and it’s important to point out that we don’t anticipate anything like the same level of house price growth over the next 25 years as we’ve seen in the past 25. However, there are still plenty of lessons we can learn from the experience of growing a portfolio which can help form a strategy for the future.
The stark diff erence in returns across the country is a product of the house price cycle and the point at which the landlord bought – the results would look diff erent for someone who invested a year earlier or later. An investor who timed the cycle perfectly over the last 25 years, always investing in the fastest growing regions, would see double the average return compared to someone who invested in the slowest areas. In 2016, the values of portfolios in London and the North East were about the same, but, over the last five years faster price growth and higher yields pushed up returns further North.
The scale of returns seen here wouldn’t be possible without significant price growth combined with leverage in the form of a mortgage. When prices rise 10%, an investor with a £50,000 deposit and 75% loan-to-value mortgage will see a return of 40% on their initial investment, before the costs of servicing a mortgage.
Nationally, price growth has generated around two thirds (65%) of the increase in value. The average portfolio today, built over 25 years, is 16.6x larger than one built in a market with no price growth at all – it would be valued at just £249,000 compared to £4,146,000. Lower price growth in the future would significantly reduce the rate at which a portfolio could grow.
This 25-year price growth has been magnified by mortgage leverage, meaning the average investor was able to reap the benefits of growth on a value which is around four times the size of their initial cash investment. Without borrowing to boost the value of property they hold, growing a portfolio in cash is much slower. After 25 years, the average cash portfolio would be worth £272,000, compared to £4,146,000 of equity for a landlord who used leverage.
Over the last 25 years, the North East has emerged as the fastest place to grow the most valuable portfolio, despite the region seeing less house price growth than Southern England. This is down to the power of higher rental yields, which accounted for 61% of returns in the North East and 50% across Northern England.
Reinvesting rents back into the portfolio also plays a key role. Nationally, the average portfolio would be 55% smaller after 25 years if rental income was withdrawn each month rather than reinvested.
The decision about where to grow a portfolio will at least partly depend on your future long- term view of what will happen to house prices. We believe Northern areas will see higher price growth up until 2024 when the house price cycle restarts. This means higher yielding areas will also see more house price growth for the next few years. Then from 2024 we’re expecting price growth across the South of England to once again begin outpacing the North.
However, just as important are the principles behind why you’re building the portfolio. Someone looking to gradually replace PAYE income from a full-time job will likely choose to buy a diff erent (i.e. higher yielding) selection of homes compared to the investor seeking to grow a nest egg for their retirement. In the case of the latter, monthly rental income tends to be less important than ensuring the investment beats inflation so the investor can release a cash sum upon retirement.
