Click here to read the full paper including graphs: The UK Residential Market
The UK residential market has not typically attracted high levels of institutional investment interest, instead being dominated by owner-occupiers and private landlords. For some time, interest in areas such as build to rent has been growing, but only now are many investors waking up to the opportunities offered by the residential sectors.
Rapid population growth has seen housing become one of the biggest challenges facing the UK over recent decades. According to ONS data, over the past 10 years the number of UK households has increased by almost 10%, with an average of 240,000 new households expected to form each year over the coming 20 years. This is in addition to pre-existing pent-up demand, created by historical supply shortfall. Estimates of the total backlog of housing needed range from 2 million to 4 million new homes.
As a result, the UK residential sector represents a huge opportunity. The market is maturing quickly, investor attitudes are changing and barriers to entry are in turn reducing. The sector has also remained one of the most resilient within the property market during the COVID-19 pandemic, further illustrating its appeal.
An untapped opportunity
The Investment Property Forum (IPF) has estimated that the total stock of residential property in the UK in 2018 had a value of £6.8 trillion, approximately seven times the value of the commercial property universe. With only 0.8% of this being held by institutions, even a modest transfer to institutionally managed accommodation would result in a large proportional increase in the size of the sector. In fact, Knight Frank estimates that the residential investment sector will be worth £146 billion by 2025.
The residential sector itself has an enviable track record of returns. Long-term, it has outperformed other property sectors by some margin, returning an average of 10.3% over the past 20 years, well ahead of the 7.5% delivered by All Property. Residential returns also have a different composition to commercial sectors, as they are more capital growth driven. Over the past 20 years, two thirds of the residential total return has been capital growth, whereas for other sectors, capital growth would only account for around one third, with the rest being income.
Low depreciation and refurbishment costs further help support high returns in the residential sector. The requirements of living space have changed less over time than the requirements of commercial space, while residential buildings can also be expected to be more resilient to tech disruption. New technology adopted in homes tends to easily fit within existing building infrastructure and so does not lead to obsolescence.
Sustainable, sustainable returns
As well as a cemented resilience through economic downturns, the UK residential sector also provides ESG-compliant opportunities.
While ESG concerns typically fall outside of traditional financial metrics, they are of increasing importance to investors, and institutions as a result. The residential sector provides investors with an opportunity for ESG-compliant investments, both through the environmental benefits of providing sustainable buildings and the social benefit of providing safe, high-quality and affordable housing.
This heightened focus on environmental impact has increased the likelihood of a future system that will see “the polluter pay”, with incremental costs to both companies and homeowners as a result. For example, as energy costs rise and as priorities shift ever further towards carbon neutrality, residential projects that focus on offering energy-negative homes today provide investors with future proofed investments for tomorrow. By investing in sustainable, affordable housing, as policies change and combating climate change becomes ever more key, strong returns are ever more likely in the long term.
Another consequence of COVID-19 has been the restored importance of community. With most countries living under various levels of lockdown, loneliness, and its impact on public health, is more acute. Residential housing projects that place community and social interaction at their heart are more attractive than ever and are likely to remain so for the foreseeable future.
Impact investing is going much further than the label ‘sustainable’ or ‘ESG’. Investors are looking for products that have the intention to create impact, set clear targets to create additionality , (which is identifying inputs, activities, outputs and outcomes, as well as specific targets and key performance indicators aligned with relevant impact themes) and have transparent measurement and reporting in place. Residential investment can be deliberately tailored to deliver a measurable social impact, contributing further to its appeal.
The sector should not however be considered as ‘one size fits all’. Residential offers a wide range of investment strategies that can cater to a variety of investors and investment objectives, across sub-sectors and via different investment approaches.
Different residential segments have different economic drivers of demand, while some parts of the market are also more sensitive to new supply than others. Furthermore, some sub-sectors are more mature and liquid than others. This provides opportunities that will cater to a variety of investors and investment objectives.
We believe residential has an important role to play in UK real estate portfolios, with our forecasts suggesting that the strong track record of risk-adjusted returns is set to continue. Diversification benefits, resilience through economic downturns, and ESG-compliant opportunities all add to the sector’s appeal.