Wise real estate investors will choose the ‘winning cities’ that are able to attract talent, because it is in those cities that rents will rise, according to a new report by Savills.

real estate investors will be pick cities that attract talent and rental growth savills

Real Estate Investors Will Be Pick Cities That Attract Talent and Rental Growth Savills

This will become the crucial factor, because income will be the main reason for investing in real estate in the next few years, as interest rate rises will mean lower capital growth.

This is the future according to ‘Impacts: the future of global real estate’, a new report published on 29 November by Savills. ‘The next ten years will be about security of income in a low interest rate world, with investors increasingly shifting their focus towards rental markets in world cities,’ said Yolande Barnes, head of Savills World Research. ‘Risk needs to be measured differently, as security and scale of income becomes the major driver.’

Quality of income
The focus on quality of income is a permanent shift in Europe, where investment funds must pay pensions to ageing populations in a low inflation, low interest rate era.

Whether investors are looking for capital growth or stable income streams, the behaviour of rental markets is key, Barnes said: ‘Rents don’t lie: they are a function of two market fundamentals: occupier demand and supply conditions. In many global investment markets, there is very little scope for further yield compression, so capital growth can only come with rental growth.’

The winning cities are fast-growing future economic powerhouses and centres of innovation that are magnets for the young and talented. Savills’ analysis of prospects for rental growth across different sectors has identified some of the cities that are poised to provide security of income and potential rental growth over the next decade.

The cities where the Gen Z (15-34 year-olds) to Gen X (50-69 year-olds) ratio is forecast to be highest in the next decade are Shenzhen, Jakarta, Auckland and Austin on a global level. In Europe, the winning cities are set to be Edinburgh , which by 2027 will be the UK’s most youthful city, and Oslo, set to be the most vibrant city in the Nordics.

Millennials have a distinct preference for city living, Savills says: cities are important because many young people now choose where to live before they even look for a job. The winning cities are therefore coming under extreme pressure because supply cannot match demand.

One example is Cambridge, in the UK, a centre of learning just chosen by the pharmaceutical giant Astra Zeneca as its global headquarters, where staff are struggling to find suitable housing. Cambridge is one of Savills’ top five dynamic cities in Europe, along with London, Paris, Amsterdam and Berlin. Dynamic cities are chosen for their performance across six key categories – investment, innovation, inspiration, inclusion, interconnection and infrastructure.

Rental wave
The new Impacts report introduces the ‘Savills rental wave’, which describes all the possible stages of rental growth – early upswing, late upswing, low valley, high plateau, early downswing, late downswing - in order to help understand where cities sit in the cycle.

Early upswing markets have the most scope for further rental growth, but Savills warns that intense competition for stock may lead to yield compression and high prices. Prime offices in Paris and prime retail in Dublin fit into this category.

‘Rental growth prospects do not necessarily indicate a ‘buy’ status, particularly if the price is too high, or if an injection of new supply could tip a sector into oversupply and a rental double-dip,’ said Barnes. ‘To correctly understand real estate risk, it’s imperative that investors understand markets at a city, and even at a neighbourhood level, and how that applies to each individual real estate sector.’

Late upswing markets include Berlin residential, which has seen a 53% price rise in the last ten years, and also Dublin and London mainstream residential. London prime resi falls into the late downswing category.

London prime offices, in the City and the West End, are the perfect example of high plateau, at the top of the rental curve, as is prime retail in Frankfurt. However, Savills points out that even at the top of the wave these markets can offer a safe harbour for investors as rents could stay at the ‘high plateau’ level for some time yet.

‘A high plateau positioning should not necessarily discourage investors,’ says the report. ‘The combination of economic stronghold and relative economic and political stability can augur well for those more concerned with stable and secure incomes than rental-driven capital growth in sectors such as prime offices in London.’