With a steady cash yield and the potential for capital appreciation, the private rented sector is building a strong following among institutional investors. Lynn Strongin Dodds finds out more.
“One of the biggest challenges is that unlike other countries, the infrastructure does not exist. It has to be created from scratch. This is not easy to do, which is why we are seeing fund managers forge partnerships with developers to build new homes.”
Richard Levis
After years in the wilderness, the private rented sector (PRS) is generating quite a buzz in the institutional community. There has been a spate of fund launches as investors search for income alternatives to the barren fixed income landscape and greater variety in their traditional real estate portfolios. The challenge is finding institutional quality assets but those who get on the ground floor now will benefit from first mover advantage.
The positives are numerous and in many ways PRS is an institutional investor’s dream. The sector not only offers a steady cash yielding investment but also has the potential of capital appreciation. For example, in the 2000 to 2013 period, IPD research showed that capital growth for UK residential real estate was 6.7%, substantially higher than the 0.9% for all commercial real estate. The main reason is down to the ageing characteristics of offices, industrial and retail buildings. They are also subject to the whim of changing occupier preferences.
By contrast, residential assets rarely depreciate and prices often rise depending on where the building is located. In addition, the performance is not always a pure investment play in that the rental market can strengthen even in an economic downturn. This is because people may not be able to afford to move or decide to delay buying a house. The asset class can also provide a moderate inflation hedge although the correlation increases over an extended timeframe, which should suit pension funds with long-term liabilities.
Although there are several fund managers exploring various routes, the most popular method for institutions to gain exposure to residential is currently through short-hold tenancy which invests in PRS. It ratcheted up around £4.39bn followed by institutions providing the finance for new residential development projects at £3.06bn. Student accommodation, which some consider a subset, came in third at £1.98bn, according to research from the Investment Property Forum.
This is not the first time though that insurers and pension funds have tapped into residential’s potential. They played an important funding role in the last century until rent controls came in under the 1974 Rent Act. The Thatcher government abolished them in the following decade but it favoured home ownership which resulted in a sharp increase in the individual buy-to-let investor. They are still a dominant force which explains why only 1% of residential stock in the UK is owned by institutional investors, compared with about 10% to 15% in continental Europe, according to a UK government housing strategy report published in November 2011.
APF research shows that institutions have been steadily increasing their allocations over the past three years to £12.7bn in 2014 from £7.6bn in 2011, but it is still a proverbial drop in bucket compared to the total real estate assets under management of £204bn by the end of 2013.
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