Where next for residential investment?

The appetite for investing in residential is the strongest it has been for decades.  This appetite is translating into a growing volume of deals.  Not just new investment in fully let private rental portfolios but sale and leasebacks and even stakes in private house building companies. 

 

The case for residential has been made on the back of strong returns over time, with capital growth a key driver of returns historically.  As more money flows into the UK residential market so a greater understanding is needed of the total return dynamics of different markets.  Figure 1 shows the investment characteristics of 15 major urban areas across the UK.  It compares gross yields for private rented housing today against the long run capital growth rate.

Fig 1: Total return drivers – major city postcode areas

RD EG June 2013 Fig 1.2

Long term, London has delivered the highest rates of capital growth with surprisingly limited variation between East London and the more established, higher value markets of SW London.  Yet in terms of yield there is a 1.2% differential.  At the other end of the spectrum there are markets such as Liverpool and Glasgow where rates of capital growth may have been below average but yields have been above.

As the market for investing in housing evolves there will be a much greater emphasis on cashflow and tapping into the long run relationship between rents and earnings/inflation.  Figure 2 shows the long run average growth rate of rents since 1995 compared to average growth over the last four years.  The long run trend is clear with rental growth averaging just over 3% per annum.  More recently we have seen a significant increase in demand for renting but with sustained downward pressure on household incomes, rents have been doing well to rise.  The average level of growth over the last four years has been 2% per annum nationally.

Fig 2: Residential rental growth p/a

RD EG June 2013 Fig 2

The private rental market may have undergone rapid growth in the last decade but as a tenure is still considered immature.  Seven in ten rented homes are owned by private landlords, whose housing stock comprises standard property types.  However, as the sector begins to attract new sources of finance we are likely to see the emergence of a new type of rented housing designed to meet the needs of tenants while optimising income and minimising management costs.  Affordability constraints at a local level will set a cap on how high rents can rise but investors will look to maximise net operating income from rents as well as additional services.

In the near term the primary risks to rental growth across the mainstream market will come from an improvement in mortgage finance for first time buyers or a rapid expansion in the supply of homes to rent.  The final chart illustrates rental growth across Great Britain against the level of new supply coming into the market (inverted).  It shows the decline in rents in the early part of the downturn as owner occupiers unable to sell became accidental landlords and pushed new supply into the market.  For the last few years new supply has remained in check while rising demand has kept rents under upward pressure, a trend we expect to continue over 2013.

Fig 3: Rental growth and new rental supply

RD EG June 2013 Fig 3

Article courtesy of Hometrack

RentPro property management software for letting agents and landlords.

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