Capital growth cannot outpace rental growth indefinitely in world city residential markets

Slowing capital growth in the world’s leading residential city markets during last year and the first half of this year have allowed rents to catch up. Consequently, yields have been pushed out.  As buyers’ appetite for risk slowed against the backdrop of global economic uncertainty, rental growth exceeded capital growth in many cases.  

Average growth across the Savills World Cities rental index averaged 4.1% in the year to June 2012, compared to 2.1% capital value growth putting average yields at 4.4%.

“The top world cities are continuing to attract people to live and work and, even if investor and owner-occupier appetite falters for a period, incomers will still need accommodation and will continue to become tenants,” says Yolande Barnes, director of Savills Global Research.  “The fundamentals of demand for accommodation remain strong and the outlook for the rental market is positive across the index.”

New York, ranked number 6 in terms of capital value growth, dominates the rental yield table, grossing 6.9% by mid 2012, way out ahead of bottom placed Shanghai, with an average yield of just 2.4%.

“New York’s market illustrates the permanent tension between rents and capital values,” says Barnes.  “There comes a point when high yields become a compelling ‘buy’ signal.  New York seems at or close to that tipping point.”

World Cities ranked by Gross Yield - June 2012 (JPG)

“By contrast, capital value growth cannot outpace underlying rental demand forever, and rents eventually catch up as incomers flood into the high demand world cities.  In Mumbai and Shanghai landlords are looking to push up rents as capital value growth falters, driven by an inevitable investor desire to boost income returns after a sustained period where capital growth has hugely outpaced rental growth.”

This trend has improved Shanghai’s investment fundamentals, Barnes believes, but there has been a huge gap between rental growth and capital value growth over the past five and a half years. Rents have risen by an average of just 10.3% while capital values have risen 137.3% due to investor speculation in real estate price growth rather than income creation strategies. This is the most extreme polarisation of rents and values in any world city market. 

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NOTES ON THE INDEX:
The Savills World Cities Index differs from other international real estate indices in that it measures not just the prime markets of each city, but takes account of the mainstream by measuring a basket of properties – dubbed the ‘Savills Executive Unit’ or SEU – to give the truest possible indication of all market price movements on a like-for like basis.  Importantly, it has been designed to allow international audiences to compare the cost of accommodating a core business team in each city, a vital consideration for any business with international operations or aspirations.