IPD says there’s no place like homes for investors’ returns

Figures show housing beats commercial property for both risks and returns, writes Alex Catalano

As an investment, residential property beats commercial property hands-down, over both the short and longer term, figures from Investment Property Databank show. It also does pretty well at beating equities and gilts and stands at a good place on the risk-reward spectrum.

“UK residential delivers higher total returns at lower risk,” says Mark Weedon, head of IPD’s UK residential services. IPD measures £2.2bn worth of market-let investments, which last year produced an 11.3% total return. That consists of 8.2% capital growth and an income return of 2.9%; rental growth was 4.5%.

One problem most UK institutional investors have with housing is the low income return compared with commercial property. Most of the performance is driven by capital growth.

But this reflects the high and buoyant value of central London housing, which accounts for 60% of IPD’s index by value. IPD tracks 15 big, professional investors and  the traditional estates – Grosvenor, Cadogan, de Walden – dominate central London. They are in the ultra-prime West End neighbourhoods, like Mayfair and Kensington.

“Those portfolios don’t represent a realistic investment opportunity but a lot of the characteristics residential is criticised for on the back of our numbers comes from the estates’ performance,” says Weedon. Outside this central London hotspot, housing typically produces a much higher income return of 4-4.5% (see fig 3).

To drive this point home, Weedon analysed a virtual UK residential fund, stripping out the traditional estates and measuring the performance of IPD’s remaining £957m of UK market-let housing, which is owned by property companies and funds. Over the past decade, the income return from this more balanced, regionally-varied sub-set is a more robust 4%, while total returns outperform every commercial property sector by at least 140bps (see fig 2).

Moreover, this 4% net income return doesn’t involve a lot of income leakage in terms of costs and empty properties from between the gross yield and the net yield “Residential is quite often criticised for having far too much income leakage,” says Weedon. “People in the commercial sector seem to think their income fall-away is much, much less than in residential.

“In fact, the difference isn’t as much as they think, because they’re not counting the voids and rent-free periods as income they could have received.” The gross yields cited for residential typically do include these Weedon’s analysis shows that, on a like-for-like basis, the 1.7% of income yield that leaks out of residential compares well with 2% for offices and 1.8% for industrial; only retail does better at 1% (see fig 4).