For most of us, buying our own home is an important decision but how many of us truly consider residential property as an asset class for investment?
UK residential property is a massive market valued at nearly £5 trillion however, the market is dominated by owner-occupiers, with just £1 trillion owned as an investment.
Nevertheless, this far outstrips the commercial property market, which comes in at a mere £400bn. Given its scale, is residential property really given the consideration it deserves as an asset class?
According to the 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 property offers an attractive mixture of rental income and capital gains. In fact, between 1973 and today, the UK residential market has seen no five-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 per cent over the last 14 years according to IPD, combined with the potential for attractive capital growth.
Commercial property has offered more attractive income returns of around six per cent 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 investors. 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 bounce back. This was demonstrated in the last economic downturn where residential property saw a percentage decrease 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 funds to invest. If you invest directly, and own a single 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. Although 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.