With the UK pension market receiving further adverse publicity surrounding Equitable Life, investors are increasingly turning to property as an alternative investment.
The past couple of years have seen unprecedented private activity in the property sector, with a significant increase in UK and international investors in commercial property and a substantial degree of growth in private investors in residential property. We may be on the cusp of a new era where, despite property being a relatively cyclical investment sector, it becomes an element of the hard core portfolio diversification of the more sophisticated investment groups – whether institutional or private.
To a large extent, this is fuelled by the shift to a low interest rate environment, combined with the increasing availability of gearing on attractive terms to enhance the returns available. Combine this with the relatively solid yields available in the sector – and the prospect of capital growth – and you understand why, for the longer term investor, property is an increasingly attractive option.
As a long-term investment, it is difficult to understand why more institutions and individuals have failed to move into this sector. This is probably attributable to the historically poor quality of UK property management, leading to high real gaps between gross and net yield. Management standards are now much improved and the intrinsic tracking of rental yields to wage inflation suggests residential property is a very good retirement investment vehicle.
Whether institutional or individual, the ability to invest in an asset class with yields tracking wage inflation and with the bonus of potential capital appreciation is becoming increasingly attractive.
Given the recent flood of activity in this sector, one cautionary note is necessary. Individual investors have piled in without doing sufficient due diligence on long-term rental yields. All too often the prospect of short-term capital gain is driving the investment decision, rather than the attractions of the total return over a longer period. Residential property, even more than commercial property, should form the long liquidity end of an investment portfolio. To be forced to sell in an illiquid property environment is terribly unattractive. For the long-term holder, however, the natural hedge between rental yields and property inflation produces a very attractive picture.
To the inexperienced investor, obtaining the right financing is paramount in securing the overall performance of the portfolio. Competitive pressures have lead to high loan-to-values being available, but given the risk of voids driven by the shorter letting period of assured shorthold tenancies, and the higher spread between gross and net yields, leverage above 75 per cent of the property value is not advisable. It is better to pursue rate – the attraction of five-year fixed rate terms from as low as 6.35 per cent represents a more sensible option than pushing for gearing. In a fast-moving market, independent debt brokers are the place for the inexperienced investor to go.
In 10 years time, residential property will be seen as a natural part of the portfolio of every institution and private investor. Within the Savills Group, we have seen a very significant increase in investor appetite over the last three years, almost always on a reasonably geared basis.
Private investors are using the medium for portfolio diversification, as a long-term pension substitute (unlike traditional pensions you do not have to sell the asset base into an annuity on retirement) and as a way of hedging property inflation for their children.
Mark Harris is a director at Savills Private Finance