By Nicholas Barnes, head of Research at Chesterton Humberts
We may not like to admit it, but the fruitful economic climate we enjoyed before the global recession is unlikely to return any time soon and wealth preservation has become as important as wealth creation. This changed environment has spawned a plethora of alternative investment proposals as mainstream assets have appeared less secure.
The virtues of, inter alia, precious metals, fine wines and agricultural land are all being heavily promoted as alternatives to the volatile stock market and low yielding gilts, while prevailing low interest rates have relegated cash to the position of poor relative.
The fact of the matter is that the elusive investment panacea remains just that – and probably always will. In order to balance risk and return, it is important to create a diversified portfolio – and property should form at least a part of this.
In addition to being an acknowledged portfolio diversifier, residential also displays low correlation to mainstream asset classes and has outperformed them over medium and long term periods whilst comfortably outpacing inflation.
The most recent data from IPD (Investment Property Databank – the benchmark performance index in the UK for property) tells us that the total nominal ungeared return for residential property in 2011 was 11.3% compared to -3.5% for equities. With a reasonable level of gearing this return could be considerably enhanced.
Sustained strong tenant demand combined with a shortage of available rented accommodation has been driving rental growth over the past couple of years, to the extent that we have observed some examples of “rental gazumping” in the prime London market while in the wider market affordability issues are appearing. Average rents at a national level increased by around 5.5% in 2011 rising to 7.25% in the prime London locations.
Gross yields on single units in the prime central London locations average around 3.4%, however block purchases in less prime but still good locations can achieve 200+ basis points in excess of this.
Of course there are potential pitfalls as is the case with most investments. Investors will need to be aware of their true operating costs and they will need to properly manage and service their properties in order to attract and retain tenants and minimise void periods. Prudent stock and location selection are also givens, which means thorough market research prior to committing funds. Having satisfied these criteria, what sort of opportunities await the savvy residential investor?
The UK residential sector offers a variety of avenues for investors. The classic apartment or house rented to private households is the most common, however there are other attractive options such as student housing and social housing. Student accommodation is a growth sector and can be especially lucrative in the higher end segment, which is dominated by wealthy non-EU HE students from whom it is not uncommon to receive one year’s rent in advance.
The private rented sector has been expanding steadily over the past decade, with London leading the way. As a nation, the proportion of households living in privately rented accommodation has risen from 10% in 2000 to 15.6% in 2009/10 – equating to 3.4 million households – and continues to rise.
In London, the Mayor’s Office estimates that around one in five households is currently in privately rented accommodation, with rates of private renting more than twice as high in central London as they are in the outer boroughs. Moreover, the private rented sector now accounts for more than half of the home moves that take place in London each year.
The question for many is whether this represents a longer term structural shift in attitude towards residential property occupation or is it merely a temporary blip in response to the prevailing harsh economic climate in which affordability issues are exacerbated by difficulties in accessing mortgage credit. Clearly, some of the rental demand of the past few years can be classified as “necessity renting”.
However, there is anecdotal evidence to suggest that the “renters of choice” category is growing and the fact that the PRS was already expanding well before the recession tends to support this. This latter category comprises students, corporate tenants on fixed term contracts, lifestyle renters and convenience renters who are looking for short term accommodation while they await an anticipated change in their situation, be it looking for the right property or perhaps awaiting a job relocation.
A final characteristic of the UK residential market suggests that longer term growth in both capital and rental values is likely. The longstanding structural mismatch between supply and demand in both the owner occupier and rental markets will take many generations to balance: the peak year for housing development (2004) saw just over 153,000 dwellings completed nationally and just under 18,000 in London.
Against this, the Government projects annual growth in households of 232,000 nationally and just over 36,000 in London over the next two decades which implies upwards pressure on values given a healthy underlying economy.