The annual inflation rate in the UK jumped to 3% in August 2021, the highest since March 2012, with the Office of National Statistics predicting it to hit 4% by the end of the quarter. As we re-emerge blinking into the sun in a post pandemic world which has suffered sustained economic and wider market volatility, we ask the question: where should the UK investor turn in their search for yield?
One of the core principles of investment strategy, which is drummed into us from a young age, is that high yield equals high risk. Yield is relative, it transcends markets and sectors and is understood globally as a like-for-like measure of the risk / return equation. It is at the heart of understanding the measure of investment returns.
With 10-year and 30-year UK government bonds (“gilts”) offering 1.01% and 1.38% respectively at the time of writing and the current dividend yield on the FTSE 100 index at around 3.51%, should investors who normally shy away from the perceived “high risk” of the property market look to the long term income returns that can be achieved in UK real estate, and in particular the living sector?
Perhaps surprisingly, long-income UK commercial real estate can offer attractive yields when compared with more traditional low risk alternatives like gilts, without necessarily heightening the risk curve exponentially, whilst also outperforming the expected dividend yield from FTSE 100 investments of a similar risk profile. The living sector in particular can offer some surprisingly stable long term returns and with the added benefit of capital growth.
Generally, in the UK real estate market, long term income is defined as anything with a 15-30 year life span, so it is comparable with the investment return profile of the long term bond market. Unlike bonds, investing in real estate does put both capital and income at risk, however with a proper understanding of sectors and strict investment criteria, those risks can be mitigated with proper assessment and due diligence on the asset itself and the covenant of the entity underpinning the income.
The desired outcome is to ensure a genuine risk matrix that compares favourably with low risk investment but is underpinned by an appreciating property asset. In today’s market, it is also key that the target property asset is a newly built ESG exemplar property to ensure long term capital value resilience.
With recent reports outlining that investment yields in three of the core living sectors - housebuilding, student accommodation and hotels - are achieving yield spreads averaging between 3.35%-5.5%; 3.5%-8% and 3.75%-8% (Source: CBRE UK Beds Sector Report, September 2021). It is therefore no surprise that many traditionally low risk investors are turning to the real estate market and the living sector in particular.
Living assets are incredibly sought after at the moment. Later living, particularly the long income from 35-year care home leases, is having a real moment. The ‘build to rent‘ market has seen a massive inflow of capital over the last 18 months, with many commentators predicting this will continue to rise exponentially. While a year of lockdowns saw transactions in most areas of commercial real estate put on ice, investment in BTR is expected to top £5bn in 2021, up from around £1bn in 2015. With normally risk averse pension funds such as L&G and Lloyds Banking Group entering the BTR market, it is safe to say that the search for yield has very much come “home”.
This article appears in our Investing in Living report. To access the full report, please click on the link to the right of this page.