Residential property – the neglected asset class?

Rob Weaver, property director at Property Partner, looks at residential property as an asset class.

Many misguidedly believe your own home is an investment. It’s not. Owning a home is a lifestyle choice. That’s why very few of us make pure investment decisions when it comes to putting a roof over our heads.

But when you buy an additional residential property and you don’t intend to live in it, then it becomes an investment. You’re making decisions based on how hard the investment can work for you rather than what works for you personally.

Even so how many of us think beyond buying our own home and consider how much potential there is in residential property as an asset class?

UK residential property is a massive market valued at nearly £5trn. However, it is dominated by owner-occupiers, with just a fifth (£1trn) of that market owned as an investment.

Even still, this far outstrips the commercial property market, which comes in at a relatively meagre £0.4trn.

So given its gargantuan scale, is residential the forgotten asset class?

According to the highly regarded Investment Property Databank (IPD), residential property has been the best performing major asset class in the UK, offering the highest returns and second lowest risk after government bonds between 2001 and 2014.

Compared to equity volatility and poor income returns from bonds, residential offers an attractive mixture of rental income and capital gains. In fact, we estimate that between 1973 and today, the overall UK residential market has seen no 5-year period with negative returns, after accounting for both rental income and capital gains.

Any choice between residential and commercial property investments is largely down to what you aim to achieve. Residential is a ‘total returns’ investment, offering lower net income yields of around 3.5% over the last 14 years according to IPD, combined with the potential for attractive capital growth.

In comparison, commercial property has offered more attractive income returns of around 6% over the same period but with much lower capital growth.

It’s also important to remember that the yield from commercial will not reflect the need to amortise down to land value over time, by fault of the gradual ‘obsolescence’ of the building.

One advantage of residential property is that, even in a downturn, it is protected by the behaviour of its owners. As a market dominated by owner-occupiers, residential is largely self-regulating, as people won’t walk away in difficult times.

If values go down, people won’t sell; supply dries up, and prices begin to stabalise . This was demonstrated in the last economic downturn when residential property saw a percentage drop of less than half that experienced in commercial property.

In spite of these benefits, historically residential property investment has been hard to access, requiring considerable amounts of time and money.

The scarcity of residential property funds has also made it hard for investors to diversify their residential portfolio, unless they have considerable money to invest.

If you invest directly, and own one or just a few properties, a difficult tenant could mean months of lost income and escalating costs which seriously compromise your returns – all of your eggs are in one basket.

The difficulty of accessing residential, despite its attractive total returns and greater resilience, seems to be the key thing holding this asset class back.

With the emergence of ‘fintech’ disruptors, this is changing. Property is becoming accessible to everyone, and can finally take its place as a proven, powerful asset class.

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