by Charles Ferguson Davie
Since 2022, real estate equity investment has not looked attractive on a relative (or absolute) basis and for many has lost its purpose, no longer delivering a higher income return than bonds and with values in decline.
However, real estate is cyclical, and whilst some other asset classes, including technology/AI-related stocks, gold and indeed private credit, are showing signs of overheating, the prospects for real estate are improving.
In some real estate sectors, there is both proof of inflation linkage and a deep-seated structural undersupply, despite there being substantial demand. This is especially the case in the UK living sectors, where a lack of development activity is leading to even lower levels of much-needed new supply. This means that rents will continue to grow, and we anticipate that once gilt yields reduce and capital values start to increase, the cycle will turn, and real estate will once again attract greater investment.
In the meantime, we see significant opportunity to fund the development of build-to-rent/multifamily, co-living, single-family and purpose-built student accommodation to create best-in-class assets. This can provide new future-proofed homes, which are popular with both residents and institutional investors due to their design, use of technology, building safety features and energy efficiency.
As such, early movers with the know-how to navigate development risk will be able to deliver properties in high demand with consumers and investors. There is a generational opportunity to partner with experienced developers, with proven track records, in order to deliver best-in-class living assets. Once completed, these investments will command a scarcity premium among institutional investors seeking residential exposure, due to the sector’s strong underlying fundamentals, inflation-hedging qualities and defensive characteristics.
For some in the market, the headwinds facing new-build residential development in the United Kingdom remain too great, given supply- chain disruption, capital intensity, planning dysfunction, cost and material inflation, and tax and regulatory burdens. Yet these headwinds mean newly developed buildings will be in short supply and highly sought after.
By embracing structured risk-mitigated development whilst in a less capital competitive environment — where many equity providers are still cautiously sitting on the sidelines — select and disciplined investment can be rewarded. Through a focus on how partnerships are structured to de-risk development, while at the same time offering an attractive solution to developers, investors can benefit from defensive opportunities that also provide for very attractive returns. This is undertaken whilst also contributing to the social benefit of delivering much-needed housing. Often this will also involve a public-private partnership to help unlock development viability and where reputation and relationships are vital in order to be seen as a trusted and reliable partner.
By participating in structured risk-mitigated development at this point in the cycle, and by working in aligned partnerships with experienced developers, investors can achieve an attractive yield on cost that is expected to lead to substantial capital growth once the investment is leased and stabilised, while also delivering a cushion of safety in case yields rise.
Generally speaking, investors are looking to increase exposure to the living sectors, as well as to avoid the ongoing disruption in traditional mainstream sectors such as office and retail. In this environment, our conviction remains that purpose-built residential rental stock that is high quality, well located and energy efficient will prove highly attractive to core institutional capital.
Charles Ferguson Davie is CEO and CIO at Moorfield Group.
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