Residential Property: time for a move
Estimated reading time: 6 minutes
Property has been considered a good investment proposition for a long time as the asset class has continued to offer relatively stable income, capital appreciation benefits and diversification from other asset classes. Institutional investors have historically gained their property exposure through commercial property, but residential property now has a place in investors’ portfolios.
The business case for residential property
The fundamental case for investing in residential property remains attractive.
- Low or negative correlation with equities, bonds and other property sectors
- Lower drawdowns and faster recovery in economic downturns
- Attractive net initial rental yields, typically ranging between 3-4%
- Chronic undersupply and increasing demand for housing
Added to this, concerns over the outlook for some commercial property sectors – especially the retail, leisure and hospitality and office sectors – makes residential property even more appealing.
The outlook for residential property remains favourable. Every year, there is a significant shortfall in new builds and there are no signs of this being solved in the short term. The government is attempting to solve this housing crisis by encouraging private investment into the sector through various subsidies and grants, which makes investing in the sector even more attractive.
Housing supply, 2001-2019
Source: Ministry of Housing, Communities & Local Government
Moreover, residential property has been relatively resilient over 2020. Stamp duty, holidays and pent up demand while the residential market were closed has kept demand up, which has contributed to keeping prices relatively stable. However, once the stamp duty holiday ceases and the effects of furloughs and permanent unemployment seep in to the market, it is likely that residential property prices will fall. We do not expect this fall to be significant, but expect it to represent a good opportunity to invest in residential property funds that are able to exploit this.
Finally, a benefit of the institutionalisation of residential property is the delivery of greater environmental and social benefits over time, directly contributing to the UN’s Sustainable Development Goals. Fund managers will either invest in and/or develop modern housing stock ensuring access to affordable, high quality housing where needed. It will increase financial well-being through reduced housing costs and the associated increase in occupants’ disposable incomes.
What to invest in?
Investors can choose from various forms of residential property. Whilst most residential property funds will focus on a single sector, there are funds that invest across a range of residential property.
The private rented sector typically involves investing in large purpose-built blocks of flats and then renting them out. These properties will typically consist of perhaps 200-250 units of accommodation available for rent. It is conceptually similar to investing in student accommodation. This is not a “landlord” strategy of buying a large, disparate portfolio of existing residential properties; instead it aims to commoditise (or institutionalise) the asset class to bring economies of scale to the management of such assets.
The majority of investments are “build-to-rent”, where land is acquired – freehold – in order to build residential property on it. Investors will not explicitly develop these properties themselves, but rather the development will be financed by the fund. “Built-to-rent” involves construction risk, but investors will usually have step-in rights through the property development phase.
Returns are expected to be generated mainly through rental income, though this will not be inflation-linked. Investing in the private rented sector has limited social benefits, particularly because rents are at market levels and there is no eligibility criteria to provide accommodation to those needing it the most.
Shared-ownership refers to a buyer purchasing an equity share of a home, usually between 25% and 75% (though the minimum initial share is potentially being reduced from 25% to 10%), while the housing provider retains ownership of the remaining equity. These schemes are available to households earning less than £80,000 per year (£90,000 in London). To take part, a minimum deposit of 10% of the value of the purchaser’s share is required with the remaining amount funded with a mortgage. They are then required to pay rent on the proportion of the home they do not own. They do then have the option to purchase additional shares and increase their ownership in the home over time.
Investors will be able to benefit from stable and long-term inflation-linked rental income as well as capital appreciation, which is realised through ‘staircasing’. This occurs when a shared-owner increases their proportion of the equity in the home. They will usually be buying at the market price whilst the investor would have bought the home at a significant discount because of government subsidies and bulk buying discounts from a housing provider.
Investing in shared-ownership housing is also beneficial from a social impact perspective. The government will set rent levels below market-rate levels, which provides a quantifiable social return and further, the scheme is able to help families and middle-income earners get onto the housing ladder.
There are various different levels of social and affordable housing. Social housing typically refers to the provision of accommodation alongside some form of care. This is generally for vulnerable groups including, but not limited to, the elderly, people with disabilities, people with mental health issues, those needing life-long care needs as well as homeless people.
The aim of affordable housing, however, is to support low to middle-income individuals or households with specific eligibility criteria i.e. key worker (healthcare, teachers etc.) households that are ineligible for social housing and struggle to find affordable accommodation elsewhere.
The returns from this asset class are driven by income but the extent of this will often depend on where investors sit on the social and affordable housing spectrum. Generally, income will be long-term and inflation-linked, though these rent levels, which are regulated, are exposed to changes in government legislation.
Both social and affordable housing are sectors within residential property where investors can make the largest contribution to positive social impacts, directly contributing to a number of Sustainable Development Goals. The asset class allows for the affordability and provision of housing at below market rents to a wide range of people, local community development as well as the energy efficiency benefits of new housing stock.
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Residential property is an attractive asset class for numerous reasons and the outlook for the sector looks favourable over the long-term. We believe it is worthwhile for investors to consider an allocation to residential property in a portfolio, alongside commercial property or as a standalone investment. If you would like to discuss residential property in relation to your institution’s investments, please get in touch with your usual Barnett Waddingham contact.
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