A 32% return in 12 months might be expected to send any investor dancing all the way to the bank. But this rosy picture painted by the first index of institutional-standard residential property has raised as many questions as answers.
Analysts eagerly awaited the London Residential Investment Index, compiled by the Investment Property Databank and Cluttons Daniel Smith. Big investors have long demanded a benchmark and hard evidence of returns as a price for venturing into the sector. They appear to have got both.
The inaugural report showed that a £770m portfolio spread among 18 funds racked up total returns of 31.6% in 1997. Overall rewards are running at their highest level since records began in 1990 and outstripped all other main asset classes last year - including commercial property. Active managers also proved their worth, producing a margin above the underlying market return of 27.3% for standing investments. 'But this is not going to send institutions running around flapping chequebooks,' said one investor. New money has its eyes on shorthold tenancies, yet these make up only 12% of the index. The bulk is ground rents (44%) and statutory tenancies (19%). These distort the picture is several ways.
The bulk of performance comes from from capital growth. Part of this is due to the reversionary nature of ground rents, reductions in discounts on statutory tenancies and increasing sales through leasehold enfranchisement, says the Index.
Income returns ranged from a mere 2.3% to 4.1% over the last eight years - far less than the 8% from commercial property. They also fell from from 4.1% to 2.6% in the two years to 1997. Such figures could send prospective investors screaming back into their shells unless advisers explain why they are 'irrelevant', says Nick Jopling of Allsop & Co's Residential Investment & Management group. 'In the real world, net yields are more like 5.5%,'he says.
The weight of low-yielding ground rents in the combined portfolio means the income yield underestimates returns from shorthold tenancies, the Index admits. But the distortion was almost inevitable because of the structure of the three biggest members of the index - the Grosvenor Estate, the Church Commissioners and the Welcome Trust. They are heavily involved in ground rents.
'The new index is a vital step forward for the market,' says Jopling. 'But it is also vital that it divides out sectors so investors can judge returns on areas like shortholds that interest them.'
The problem is not lost on the Index authors. Roland Cullum, head of residential asset management at Cluttons, says the project is in its infancy and should be able to separate tenancies as it matures.
'The next stage is to recruit more funds so we get enough property to break down into tenancy types and locations,' says Sarah-Jane Topping of IPD. Another big name is expected to sign up soon and the hope is that other funds will join after seeing the first results.
Even then there could be problems. The onus lies with investors to divide property into categories and many may not be willing, or capable, of doing that. 'Residential data is not as sophisticated as for commercial property,' says Neil Chegwidden, head of research at Cluttons.
A fundamental problem of calculating yields also has to be solved. 'We can't go on without some ruling whether factors such as service charges and bad debts are included,' says Jopling. 'The IPD should take the opportunity to set this standard if it is to create a relevant benchmark.'