Is it safe to come out yet? Since last autumn the real estate sector has been collectively hiding under the duvet covers waiting for the all-clear. Now that the industry is re-emerging, blinking into the light, it is worth taking a moment to reflect on the turbulence of the last few months.
As we returned from our summer holidays, the warning lights on the dashboard were flashing red. September’s mini-Budget debacle had added 120bps to UK 30-year gilt yields. By October, inflation had hit 11.1%, and by December, the Bank of England had hiked interest rates an unprecedented nine times to 3.5%.
Christmas provided a welcome respite from waves of negative data but by then the damage had been done. Global investment committees had materially curtailed the activities of their investment professionals. Investors scrambled to predict where yields would settle while simultaneously undertaking what the industry euphemistically called ‘price discovery’, but in some cases is really just ‘price chipping’.
Perhaps unsurprisingly, that which happened first in the public markets, then in commercial real estate, took its time to reach the slower-moving residential single-family rental (SFR) sector. Cue a stand-off between funders, who had decided the world was going to hell in a handbasket, and housebuilders, who had been happily enjoying perpetual house price inflation.
So it is with cautious relief that 2023 brings with it reasons to be optimistic. The UK political environment has stabilised, the mini-Budget has been scrapped and inflation is finally in reverse − ending the year at 10.5%. Interest rates are now at 4% (forecast to peak at 4.5% but tapering thereafter) and UK 10-year gilts are at 3.5%, down from a high of 4.5% in October. Finally, and whisper it quietly, development finance is now beginning to look accretive again.
“So it is with cautious relief that 2023 brings with it reasons to be optimistic.”
So, what does all this mean for the SFR sector? Like all real estate, yields have moved out, but only by circa 25bps, which is significantly less than other asset classes. And the sector continues to do what it says on the tin by providing inflation-matching income streams.
However, a recent statistic by Cushman & Wakefield stated that on average renting was now cheaper than the cost of servicing a 75% loan-to-value mortgage, which according to Bloomberg now eats up 40% of average income.
The average five-year fixed-rate mortgage is now above 5%. But the inconvenient truth is that this inversion is a recent phenomenon. In fact, since the global financial crisis, home ownership has remained stubbornly cheaper than renting due to the collapse of interest rates, which were required to prop up global economies.
The picture is more nuanced and ignores things like the ‘all-up’ cost of home ownership and the challenge of raising the necessary deposit. Nevertheless, this rental-versus-ownership affordability inversion represents further reasons for SFR investors to be cheerful.
So, is it time to throw off the covers? We certainty think so. The perennial challenge for SFR investors has always been bridging the ‘bid-ask’ spread between the investment and vacant possession values. A combination of historically low interest rates and government subsidies like Help to Buy have fuelled rampant house price inflation at the expense of this emerging sector. However, the end of cheap money and the expiration of demand-side subsidies heralds a new era of expansion for the SFR sector. So get up, get dressed and get out there.
Jonathon Ivory is managing director of Packaged Living
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