Gross yields hit a recent peak of 4.17% in September 2008 – but have suffered from falling rents and, more recently, rising property values.
Residential rents in central London fell 1.9% in the three months to June 2009, but prices actually rose by 3.7% – putting downward pressure on yields.
A reduction in the volume of new lets suggests a further significant decline in rental values is unlikely.
Investors looking to add to their London residential rental portfolios in the current market need to pick their stock far more carefully and plan further ahead.
Liam Bailey, head of Knight Frank residential research, said: "Weak rental performance and stronger sales market activity and pricing have combined to put downward pressure on prime market residential yields.
"During the first half of 2008 yields improved as the rental market held its ground while the sales market was hit hard by falling prices. As we moved into 2009 the reverse situation has occurred – with rents under pressure from rapid supply growth and only modest growth in tenant demand.
"In the three-month period to the end of June 2009, rents fell 1.9% in central London and sales prices rose 3.7%. On an annual basis rents are now 19.3% lower than they were in June 2008 and sales prices are 17.2% lower over the same period.
"Falling rents have resulted from a dramatic growth in the volume of available stock – as homeowners decided to keep surplus property rather than sell into a difficult market over the past 12 months. While the volume of tenancies agreed has risen by anything between 15% and 30% across central London – stock levels in some cases have risen by 100% to 200%.
"Once again it has been the more expensive properties which have borne the brunt of the rental falls – with rents on properties costing up to £500 per week falling only 11.3% over the past year, and those costing over £1500 per week falling by 27.3% over the same period.
"Most central London sub-markets have been hit by rental falls – with Chelsea and Kensington being particularly affected with rental falls of over 26% in each area. Only the City – with a rental decline of 9.7% over the past year – has been partially protected from the downturn. The City benefits from a high proportion of lower-priced properties, which as mentioned above, have been better performers during the downturn.
"Indications at the current time are that the sharp growth of stock volumes is reducing. Properties have been letting faster than they have been replaced since early May – and this is helping to reduce void periods. The summer is likely to be characterised by continuing tough negotiations for landlords – but significant rental reductions from here are unlikely. The traditional busy September market could see the beginning of rental increases in some areas – as demand from new employees and their families comes into the market.
"The lesson to be drawn by investors is that investment in London has not turned into a straightforward one-way-bet just because capital values have fallen from the peak. Investors are having to work very carefully at stock-picking, they are having to commit much more equity to purchases than they were doing 18 months ago and they are planning for longer-term more sustainable returns."
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