NYC Falls Behind Tokyo in Residential Investment Value: Study of Top Global Cities

New York—Residential rental growth in the world’s leading cities outperformed office rents in the first half of 2013, making residential real estate look a viable investment asset class, according to international real estate advisor Savills. But, the firm cautions, low-yielding cities, where house prices are not underpinned by rental income, could be overvalued.

The firm has been tipping New York for some time, but the surprise finding of its latest analysis is that Tokyo now also looks like a ‘buy’ for investors seeking income. Rental yields in Tokyo look extremely attractive in relation to the extremely low returns available on government bonds in Japan and the city tops the Savills world cities investment ranking, ahead of New York. Paris and London are ranked 3^rd and 4^th respectively.

To understand the true appeal of residential as an asset class in each city, Savills has compared the gross rental income that investors receive in each city ‘net of gilts’. This gives a measure of residential yields across its world cities, taking the return on 10 year government bond yields in each country away from gross rental returns. This measures the extent to which real estate income is performing against the local risk environment. Savills findings reveal that some world cities, particularly in the ‘new world,’ and most notably Moscow and Mumbai, look overvalued. By the same measure some ‘old world’ cities look good value.

New York now offers the strongest gross residential yields, at 6.2 percent, against U.S. government bonds at 3.4 percent. Also, rents are rising—up 2.0 percent in the first half of 2013. By way of contrast, gross yields in Moscow are also high, at 5.8 per cent, but well below the 7.4% available on government bonds making the city’s residential assets look expensive – especially in relation to its relatively modest rental growth of 3.3 per cent in the first half of 2013. New York offers a 3.6 percent upside, whereas Moscow has a -1.6 percent downside against gilts.

Savills believes that their ‘net of gilt’ yields measure sheds light not only on where income investors might put their money but also on how out of synch with underlying occupier demand a city’s residential values might be. “Some of the lowest-yielding cities have seen little or no rental growth while capital values have surged”, says  Yolande Barnes, director of Savills World Research. “If there is insignificant rental growth in future, these capital values may look overheated and this could trigger an adjustment.

“By the same token, if capital values have not moved as fast as rental values, this may indicate some room for capital value uplift. New York has the potential for over 60 per cent capital growth if average yields were to move in to the same extent as London yields have. This assumes that rents stay stable and interest rates don’t rise.”

Savills believes it is realistic to look for 30 per cent growth in average New York residential capital values during the next three years.

The potential capital value uplift in Tokyo is even greater but Savills says it is unlikely to be realised because it is a more domestic and less internationally invested market than New York and London.  Nevertheless, the firm believes that substantial, double digit, growth is possible over the next three years in Tokyo too.

Source: Savills World Research

Savills SEU Resi Yield (Gross) net 10 year Government Bond Yield Ranking

Savills SEU Resi Yield (Gross) net 10 year Government Bond Yield

Source: Savills World Research

“We tipped New York as a ‘buy’ last autumn, and the city’s residential real estate continues to appear a sound investment both for income and capital growth potential,” says Barnes. “Tokyo now looks a surprise but convincing ‘buy’ for investors, offering a gross yield at +3.9% over government bond rates. By contrast, Mumbai is unlikely to see substantial investor activity in the near term, combining negative rental growth with pitifully low ‘net of gilt’ yields.”

Residential and commercial rents have been growing more modestly than capital values in many cities in the Savills index.  “Rental values reflect the fundamentals of occupier demand, while capital values are a good indicator of investor activity,” says Barnes.  “We now expect the slowdown in many of the emerging and recently-emerged world economies to have a more profound impact on real estate values than legislation and taxation. In fact, we are seeing a re-balancing in the performance of real estate in the old world with the new world as these changes occur.”

Prime and secondary office rents remain down -12 percent and -2 percent since the second half of 2008, but while the more established ‘old world’ prime office rents are now +3 percent over peak, ‘new world’ rents remain -25 percent down, raising questions over the fundamentals of demand and supply in locations such as Singapore, Mumbai and Moscow—even in prime commercial.

*  Savills uses a core business unit measure, the Savills Executive Unit. This is a seven-person strong staff team representative of a start-up business, designed to be a comparable measure across all cities