In the second half of 2011, Paris took over from London as the most expensive city in which to rent. If rental levels are an indication of healthy fundamentals (that is, occupier demand), then Paris, London, Hong Kong and New York look sound. The strong occupier demand in these cities and the relatively low capital values of Paris, London and New York make them look fairly valued – especially New York which ranks among the cheapest world class cities to buy.

Rents outperform

Rents increased at a faster rate than capital values in the second half of 2011, up 2.3% across the whole index.

‘Old world’ rents were up 2.8% in the second half of 2011, compared to increases in the ‘new world’ of 1.8%. There are rental-return-motivated investment opportunities in the ‘old world’. These are already well documented in cities like London, where mainstream rental growth has outstripped capital value growth leading to growing investor interest in the sector.

In Shanghai, lack of purchaser affordability has pushed some demand from the sales market to renting at the lower tiers of the market. Landlords in Shanghai are seeking better yields in the anticipation of weaker capital growth going forward. This has already pushed rents up by 2.2% (H2 2011) against capital value growth
of 0.1%.

Corporate demand

A key driver of rents in all of our World Class cities is corporate demand. Uncertainty surrounding the global economy and job security is leading to more relocating employees (who might previously have bought) to rent.

In some cities, such as Shanghai, increasing numbers of secondments and rising housing budgets have fuelled rental rises. Singapore’s introduction of additional stamp duty for foreign buyers in December 2011 is likely to further benefit the rental market. Rents here grew by 5% in the second half of 2011, compared to 4.4% in the first half.

Countering this is the prospect of shrinking expatriate budgets and corporate belt tightening, although Singapore’s middle markets should remain immune.

To rent or buy

In some countries, the cost of transacting and occupying are so high that these costs, over five years, amount to almost as much as rental on the same property (before taking into account mortgage or capital buying). In countries where additional tax is charged on short-term holds, it is more expensive to pay these costs than to pay the rent over the entire period.

Mumbai and Shanghai both have high transaction costs in relation to (relatively low) rents, meaning that it is significantly cheaper to rent than to buy when the cost of capital is taken into account. It would take 4.3 years in rented accommodation in Mumbai, and 4.1 years in Shanghai before the cumulative cost of rent outstripped the costs associated with the buying and selling transaction alone.

This means that demand for owner-occupation is more likely to wane at times when little or no capital growth is expected, making capital value growth more volatile. These low-yielding, high volatility markets are more likely to be found in oriental new economies than occidental old economies.

It takes just over six months renting in Moscow to cover the cost of purchasing in the city, meaning it may be more cost effective to purchase. In Sydney and London it may also be more cost effective to purchase early on. Here it takes just 1.6 and 1.4 years’ worth of rent to equate to the cost of transacting.

We expect yields to move out in most locations over the next two years due to rental growth and falling capital values.

Taken from
Insights: World Cities Review Spring 2012