• Complex market depending on location of property
• Balance between quality of tenant and quantity of rent
• Better rather than bigger – net yields depend on avoiding voids
• Supply of new property more restricted in central London
• Market remains strong when demand exceeds supply - and will probably continue to do so
• In a low-interest environment, investors need to expect lower yields
• Lower yields need to be seen in context of gilt yields; half what they were in the recent past

The trouble with any investment is that nothing is simple. The Victorians had it much easier with their 3% Consols; you had your capital, you bought your Consols and you enjoyed the income. Income tax? What was that? Inflation? Heard about it in some backward foreign country. Capital gains tax? A twinkle in the eye of some socialist with a beard who had spent too long in the British Museum Library.

When it comes to property investment, things don't get easier. It is not helped by the smokescreen put up by many rental agents who are keen to talk up their book. The question most investors want answering is, 'What is the return I can expect to make from a residential property investment?' The first counter-question is where and how much? If you have a portfolio of terraced houses let to students in Tyne & Wear, your gross rental yield; that is before reductions for expenses; could well be 18%. However, you may need skills normally found in Wormwood Scrubs to collect your rent and your potential for capital gain may be limited to say the least. Because the unit costs are so low, the relative costs of major repairs can blow a huge hole in the net yield.

A residential investment in Central London has a very different profile, not least in the price you pay for a unit; what might cost £40,000 in Tyne & Wear could cost £400,000 in Central London. The gross yield for prime London property over the last few years has been around 8%, as both rents and capital prices have risen in virtual tandem. There was something of a de-coupling last year, however, as the sharp rise in capital prices outstripped the rise in rents, reducing prime gross yields to around 7.5%.

The tenant profile is also rather different with the biggest market being City employees or the big international banks themselves; not quite the rental proposition of the hypothetical student in Tyne & Wear. On the plus side, your tenant is more likely to pay his rent; if Morgan Stanley goes bust then we might all just as well learn how to grow vegetables. On the minus side, these tenants are very fussy; the ten-year-old bathroom that may be just fine in the Old Rectory at Great Snoring won't be acceptable to an aspiring Master of the Universe weaned in a power shower. If you want to attract this type of tenant; and most landlords do because they are as blue chip as you can get ; the implications are that a high proportion of gross rent gets taken up in maintenance.

Gross yield is all very well, but if you build your investment castle on gross yield foundations, it won't stand up for very long. Unlike commercial leases, which are normally on a full repairing basis, domestic leases drop almost everything (except the council tax bill) into the landlord's lap. This would include the service charges for a block of flats, which is one of the reasons that mansion blocks tend to be less popular with investors; the landlord is paying for expensive lifts and porters but this is often not reflected in the rent that the tenant is paying. After rental and management fees are taken into account (in the UK these fees are paid for the duration of the tenancy, not just the first year), the net yield will typically be about 2% below the gross yield, that is about 5.5%. All this presumes that the tenants cross each other on the stairs; a weekly rent extrapolated over fifty-two weeks may look good but, if you have a void of six weeks between tenancies, then your 5.5% can rapidly become 5%. In general, the bigger properties, whether houses or flats, tend to take more time to let but rent for longer because the tenant is normally a family, and they are usually less itinerant than the single or coupled occupant of the typical two-bedroom flat. An additional benefit is that families normally have their own furniture, so that the let can be unfurnished.

Quality is vital, whatever the size. It is important to remember that every good tenant is probably seeing between ten and fifteen properties in a short space of time before making a decision. With a rental property you get what you see; no room here for the decorator manqué ; and that means that presentation is everything.

While a good rent is vital to the cash flow of any investment, it is probably fair to say that most landlords are looking at their investment primarily with capital gain in mind; they buy because they expect the price of the asset to; higher in five years' time. That return also tends to be magnified because of the effects of borrowing. This is so much a part of any property investment that its effect on the rate of return; both positively when things go well, and negatively when interest rates are high; really needs to be built into the investment appraisal. The result of this borrowing on an investor's internal rate of return; his annual return on equity capital taking into account both rental income and capital gain; is shown below. This example makes certain assumptions on interest rates, inflation and market appreciation and assumes a net yield of 5%.

COSTS Purchase Price; £600,000 (including renovation costs) Rent per annum; £43,200 (£900 per week for 48 weeks per annum) Operating expenses per
annum; £11,000

VARIABLES
Borrowings; £360,000 (60%) Interest Rate; 8.5% Market Appreciation; 4% Inflation (RPI); 3% Internal Rate of Return; 11.85% (Annual over 3 years)

But all this, you will rightly say, is dependent on the engine of price rises. What chance of that with prices in London now approaching those of 1988 in real terms; that is when intervening inflation is taken into account? Add to this the disappearance of Asian buyers, stock markets on both sides of the pond showing symptoms of vertigo, interest rates high, and the word 'stagflation' entering the journalistic lexicon. Our view is that it depends on where you are investing.

Docklands, or the City-fringe areas, don't look that promising, squeezed as they are between falling demand from Far Eastern buyers and a supply that is still coming through. There are approximately six thousand new units in the pipeline, in that area, which should be finished this year; in Kensington and Chelsea there are only five hundred. A large proportion of these may well have been pre-sold but with the financial mayhem at home there must be a question mark over whether those Asian buyers will simply drop their deposits and leave the developers to sue an offshore company. As this supply hits the rental market, it is not likely to have a positive influence on yields.

In Central London, the picture is rather different as the impact of new build on supply is comparatively minimal. There are the big developments like Kensington Green and Earl's Terrace but, by and large, the supply of either big flats or houses is finite; how many new houses backing on to communal gardens have been built recently? If there has been one we haven't been aware of it. The result is high demand hitting static supply; the same as in the country market. While bonuses are off from last year, the rich continue to get richer, as the partners of Goldman Sachs will tell you. Inheritance remains a steady fuel for property purchase; as a wag once said, 'While there is death there is hope.'

To be sure, there is a pronounced slowing down in London since this time last year, with ambitious asking prices meeting a stony response from buyers who, on the whole, don't feel that they need to catch the market in quite the same way. But to extrapolate that into a bear market would not be wise – our experience is that every time we try to buy something there is nearly always at least one other buyer and, in the country, more like three or four. This goes for the whole price spectrum from one-bedroom flats to the best estates. We are seeing few signs of any slowdown in the country, for those special houses our clients want to buy. The common denominator, as always, is quality and that applies as well to the rental market where we have much more demand for good properties than we can satisfy.

So is it a good time to buy in London? As any good politician will tell you, the best way to answer a direct question is equivocally to answer another one. We feel that it is not a good time to sell. Why? Because the crystal ball is cloudy and there seem to be two prognoses for the medium term, both of which have their logic.

On the one hand, there are the chartists. Property has had a good run and is standing at the levels it achieved in 1988, the last peak of the cycle. Interest rates are high and stock markets on both sides of the Atlantic are feeling the effects of Hurricane Boris. Most people, and all journalists, are predicting a downturn.

On the other hand, there is the Euro and the Victorians' 3% Consols. What, you may ask, is the possible connection between these two strange bedfellows? The answer is in long-term interest rates and the return people expect from their investment. As we head towards, at least, convergence with the Euro, interest rates are likely to fall to European long-term levels. In itself this is likely to favour property; the example of Ireland is a good one. The argument continues that, as returns from all asset classes are falling due to demographics and low inflation, high yields will become increasingly attractive leading to higher capital prices. Take your pick.

Our own view is that, while the second scenario will come to pass, the current gloom does not make immediate price rises likely in London, though the chronic imbalance between supply and demand in the country points to prices heading in a northerly direction. A crash? Unlikely, as crashes tend to come out of a clear blue sky and, if this does happen, it will be the most forecast event since England's defeat in the World Cup. We would plump for the bumpy landing with a soggy market in London over the short term.

What does seem certain, however, is that we are unlikely to see the sort of increases in property, or any other asset, that we have been used to over the last two generations. There are likely to be a few disappointed people as a result. A recent survey in the US found that 80% of stock market investors expect a return of over 20% per annum over the next ten years. This would imply, on current valuations, an economy six times its present size in ten years' time, inflation at 1970s' levels or the investment skills of Warren Buffet who has 'only' managed 23% compounded over his career, none of which is particularly likely. One day, we may all be pleased to get our real 3%; just like the Victorians.

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