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Yield Compression & ESG

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Discussions of ESG often fail to note the relationship between yield compression and capital value. But this is of central importance to investors, who fundamentally make decisions on the basis of risk and reward. Yield compression describes the way that, over time, perceptions of risk alter the value of an investment. In simple terms the lower a percentage figure of net yield, the less risk. An investment with lower net yield would be regarded by the market as stronger and more secure.  

If a development is established in an untested area where occupancy rates cannot be guaranteed, investors will pay less because they are taking more of a risk. If after five years the development proves to have high occupancy rates and low occupant turnover, then their investment will have paid off and the perceived risk of the investment will decrease. Investors, therefore, must always seek reassurance that demand will exist in the years ahead, so that they benefit from yield compression. 

This is where ESG comes in. Buildings with high ESG ratings have been shown again and again to attract and retain occupants more than lower-rated equivalents. The reasons for this are obvious but worth summarising: improved occupant health and wellness, targeted cleaning regimes, improved security, personalised amenities, and simply living in a greener building that contributes fewer harmful GHG emissions are all an attractive proposition for residents. This means that ESG compliant buildings command a premium on rent prices as well, further altering the risk-reward balance for investors.  

If investors decide to sell after those five years, there is a high likelihood that buyers will be attracted by an established history of high occupancy rates, high occupant satisfaction and low churn rate. In short, the attractiveness of long-term income security means that the investment will be perceived to carry less risk than before. Resultant yield compression entails capital growth since income at a lower net yield will be worth more.  

Prime yields for Build to Rent (BtR) in London currently sit at around 3.5%. Elsewhere in the country the figure is nearer 4%, a relatively stable number after nearly a decade of yield compression. Colliers observes:  

With yields as low as they are, it may sound bullish to suggest they could compress any further, especially while the UK is still in lockdown. Still, there have been some interesting trends indicating that investor demand for BTR stock is mounting.6 

It is worth bearing this in mind as we consider the significance of ESG reporting. As we have seen, the BtR sector typically remains robust during period of economic uncertainty. During the COVID-19 pandemic, it has been able to provide strong returns: Gatehouse, for example, tell us in their August 2020 financial summary that rental rates have remained at 98%, occupancy rates have continued to increase, arrears have remained low, and new lettings have been achieved.7 All this stands not only to the credit of BtR but to ESG reporting, which the sector has led on.  

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