Following the mini-Budget that was anything but small, bond markets are now back in the headlines in a way unseen since the eurozone crisis. The yield for 30-year gilts climbed by 120 basis points in the three days after the ‘fiscal event’ – a jump that threatened to push some pension funds into a liquidity crisis, forcing the Bank of England to intervene.
Sovereign bonds had been steadily losing their status as a reliable investment long before the mini-Budget, with a combination of quantitative easing and crises such as Covid-19 pushing yields into ultra-low or even negative territory. As a result, institutional investors, such as pension funds and insurers, have been growing their exposure to alternative asset classes, such as real estate, in the hunt for liability-matching income streams.
Within real estate, they have increasingly been exploring the ‘living sectors’ – the different forms of homes, from student housing to private rented accommodation.
The scale of the opportunity is vast. Residential real estate in the UK is worth at least eight times commercial property, and is eight times the value of UK gilts. However, unlike commercial real estate and gilts, residential is marked by a low level of institutional penetration, with most properties in the hands of private owners.
Demand for rental housing will keep growing in advanced economies, as affordability issues and rising mortgage costs lock many out of ownership. Lifestyle changes and preferences will mean others delay or forego buying in favour of more flexible ‘living as a service’, just as Uber, Lime and ‘Boris Bikes’ have provided access rather than ownership in travel.
Beyond strong underlying fundamentals, residential for rent is appealing as an asset class, in absolute terms and relative to traditionally favoured fixed-income investments, for three reasons.
First, rental demand is counter-cyclical, meaning more people become more likely to rent than buy during a downturn. With a potential recession looming and signs of house price growth slowing or reversing, rental is a solid defensive play.
Second is the ability to better capture rental growth, and effectively hedge against inflation, compared with commercial real estate, thanks to more regular lease renewals. That said, rental growth will be limited by the cost-of-living crisis and stunted real wage growth. House prices tend to follow GDP movements, while residential rents track wages. Residential investors, therefore, need to balance their fiduciary duties with their role in providing shelter to millions of households.
Third is the opportunity to achieve significant sustainability outcomes. Residential properties are responsible for around one fifth of global emissions but the fragmented nature of ownership has slowed down progress towards net zero. By funding the modernising of rented homes, institutional investors could make headway in decarbonising the built environment.
Residential for rent offers institutional investors many of the same characteristics as fixed income, notably the promise of long-term, steady income to help match their liabilities, but with the added benefits of low volatility in values and the ability to have tangible ESG impacts.
The ongoing hunt for yield, combined with a desire to ‘do green and do good’, will see a growing number of pension funds become landlords – just as they were at the turn of the last century.
Samantha Kempe is co-founder of investment platform IMMO