The narrative is changing as the residential investment market matures, says Swiss Life’s Jos Seligman
The property market has a habit of categorising assets by applying theoretical definitions, the most common of which is ‘prime’ versus ‘secondary’. However, such binary terminology can mislead as, over time, the evolution of supply and occupier demand causes property market sectors, locations or asset specifications to move fluidly between definitions, and often more rapidly than expected.
In recent years, structural trends driven by economics and societal change have forced rapid evaluation of the definition of prime real estate. Consider the divergent fortunes of the largest sectors of the property market over the last decade; offices, industrial logistics, high street retail and living.
The UK institutionally owned residential market is experiencing rapid growth and now represents 20% of all investment transactions, double the proportion 10-years ago, from a position of being non-existent 20-years ago. The reasons lie in a cultural shift to more renting over owning, due to reduced affordability fuelled by increased mortgage costs, constrained supply, and tax and regulatory changes. What can we expect in the next decade as the UK residential market matures and becomes more like that of continental Europe and the US?
The conditions are ripe for investment into a wide variety of towns and cities at affordable rental levels.
Jos Seligman, Swiss Life
The most recent example of rapid growth in a UK property sector was the industrial market, which has seen sustained growth for over 15 years. As the growth trends became apparent, increasing numbers of investors participated. New investors in industrials quickly understood that for most industrial occupiers, excellent transport links and efficient building configuration/specification were far more important than being in traditional central business district locations.
In response, the market supported the creation of better stock, at equally or more affordable rents in a wider variety of locations. Some of those locations, such as the M40 and A14 corridors, became winners by securing the critical mass to justify infrastructure improvements and further enhance their appeal. Locations once labelled secondary were re-rated to prime. Well-informed investors determined which locations could support growth and were rewarded with higher-than-average rental growth and yield compression as the market matured.
Residential support
The growth drivers in the residential market will be no different. Today, there is opportunity for locational re-rating and the use of data to identify places with the best prospects. The UK has a particularly acute shortage of rental properties as it is only in the last 20 years that focus has shifted from home owning to rental, preceded by 80 years where the trend was going the other way.
Consequently, the legacy supply of rental properties is severely lacking in quality and amenity, while demand is rapidly expanding, and new supply is nowhere close to keeping pace. In the UK, only 3% of rental stock is owned by institutional investors, compared to 37% in Germany and 41% in the US. Furthermore, the number of rental houses available has remained static, despite growth in demand that has led to residential rental growth of 4.9% per annum over the last five years, compared to 2.3% per annum for all property sectors, according to ONS data.
To date, most institutional investment in UK multi-family and single-family housing has focused on the major cities, with the result that although total demand is generally greater, the supply/demand imbalance is not as acute as it is in smaller centres. Additionally, the higher cost of construction has pushed many developers to build higher-end buildings, which further challenges affordability locally. The Joseph Rowntree definition of an affordable rent is less than 30% of gross household income, but the average rental property in the UK demands 36% of gross household income in rent, with many new build schemes in large cities above 40%.
The conditions are ripe for investment into a wide variety of towns and cities at affordable rental levels. The data shows that there are hundreds of well-connected urban locations with exceptional demand, which, when mapped against current supply, results in significantly more available renters per unit than in the major cities.
The challenge for developers in these locations has been viability. However, this can be overcome by developing productive partnerships between the public and private sector. Local authorities desire high-quality new housing that will make residents proud and foster community – and by leveraging private capital alongside their own investment, the public sector can deliver more houses and boost local economies.
Public funds will only be entrusted to experienced developers who can demonstrate successful placemaking, which delivers positive and measurable social and environmental impact. Partnerships between these developers and fund managers with operational expertise will attract long-term capital, rewarding investors with a stable and growing income return in locations anticipated to deliver above average capital growth as they mature.