Returns from UK commercially owned residential property reach six-year high

By Bridging Loan Directory -

 

Returns from commercially owned residential property in the UK increased to 14.7 per cent during 2013, a six-year high, as demand from investors and residents reached new heights.

The IPD UK Annual Residential Property Index shows that rents from market rented homes rose by a cumulative 32.9 per cent over the last ten years, compared with 5.9 per cent from commercial property, and far more closely aligned to inflation of 38 per cent and wage growth of 32.4 per cent.

During 2013, residential rents increased by 3.5 per cent, compared with 1.0 per cent across the UK commercial property sector.

As demand for residential property is driven by social-economic and demographic changes – as opposed to demand for luxury retail or City office space – institutions are increasingly looking to develop large blocks of market rented homes. Recent investors into the UK market include Essential Living, which is backed by M3 Capital Partners and APG, the Dutch pension fund.

The latest findings of the English Housing Survey for 2012/13 show that of the estimated 22 million households in England, four million (18 per cent) were renting privately, while 3.7 million (17 per cent) were in social housing.

The latest IPD report highlights how commercial demand for residential stock is seeking to take advantage of this strong structural imbalance in the market place, which has driven continued growth in the sector.

This competition for assets meant capital growth continued to dwarf rental increases. Values rose by 11.7 per cent last year, their highest annual growth since 2007, leading to further yield compression, with income returns 2.7 per cent.

Despite this, institutional investors will be buoyed by the fact that a long-term trend in declining management costs has meant net income has been increasing as a proportion over time. Management costs have declined from almost 40 per cent of income in 2009 to 32 per cent in 2013, meaning improved management efficiency on large schemes has helped investors secure income.

This has allowed income returns to average 3.2 per cent per annum over the last decade, remaining relatively unchanged despite the extremely high capital growth.

Management efficiency is also leading to increased length of lettings, with new analysis from the index finding the average tenancy length three years in a commercially let residential unit.

Although residential property generally has a lower yield than commercial property, its differing investment qualities make it attractive for investors seeking to diversify risk and with continued rental growth, this remains a positive sign for long-term investors.

The strongest districts for overall returns were to be found outside of prime Central London, with returns in inner London (zones 2-3) and outer (4-6) the highest in the UK, driven by a combination of rental and capital growth.

Inner London delivered total returns of 17.5 per cent in 2013 and saw rents rise by 2.8 per cent, while Outer London saw returns rise by 17.0 per cent and rental growth of 4.6 per cent. Central London (zone 1) delivered 14.7 per cent to investors, while rents increased by 2.4 per cent.

Outside of London, returns for residential stock, where demand is less acute, were considerably lower, though the South East saw a turnaround in performance – in part driven by the extremely expensive South East housing market, which is driving more people into renting.

Comparatively, commercial real estate returned 10.7 per cent in 2013 and unlisted property funds 9.0 per cent, according to the IPD UK Annual Property Index and the IPD/AREF Property Funds Index. Bonds and equities returned -5.2 per cent and 18.5 per cent (JP Morgan 7-10yr and MSCI UK).

Phil Tily, executive director and head of UK & Ireland, IPD, said:

“The latest returns will add further impetus to the growing number of developers and institutions looking to enter the PRS in the UK, where returns are some of the highest of any UK real estate type asset – with a far superior risk/reward profile than bonds, equities and commercial real estate.”