Sponsor’s position paper by John German, Invesco Real Estate
The UK residential market is made up of a diverse universe of sub-sectors. However, we believe the UK Private Rented Sector (PRS), a sub-sector with an estimated value of £1.16tn1, is one which currently offers potentially attractive opportunities for institutions.
Residential markets are typically impacted by two variables: population growth and the supply of new homes. Today, the UK is facing a demand and supply imbalance in its housing market. Demand for housing is under pressure with an increasing population, which is one of the highest in the EU, and with house prices rising, (the average house price being £198,0002), owner occupation has become less affordable, making many people turn to the rental market. Coupled with the fact that about 100,000 too few houses are being built annually across the UK, this suggests that the UK is potentially facing a 1.1m housing deficit by 2020, if supply isn’t increased from current levels.
We believe the current opportunity lies in developing intelligently-designed rental accommodation, which will be professionally managed and seeks to meet the needs of this growing population who need to rent. From an investment perspective, the sector potentially offers the opportunity to match liabilities, through income streams, which provide a correlation to inflation; potential diversification within multi asset portfolios; as well as the potential for total return, all attributes important to institutions.
Lessons from the US
An integral part of the opportunity is to provide modern rental accommodation for the next generation, which is in low supply. Research shows that 48% of the current PRS housing stock in the UK was built before 1945, with only 18% built in the last 25 years3. There is therefore an opportunity to kick-start a process that began in the US some 30 years ago and which has grown into that country’s huge multifamily sector of today.
In considering the UK PRS as an asset class, an initial comparison with the multi-family rental market in the US, which is now a well established institutional investment class, provides a useful guide. We analysed the UK IPD Residential Index (“UK Index”) and the US NCREIF Index (“US Index”), which measure the market value of institutionally owned residential investments in these respective countries. In 1982 the UK Index amounted to £15.6m and the US Index was £88.4m. However, by 2014, the UK market had grown to £5.8bn, whilst the US market had increased to £62.2bn.
The US Index has remained at or around ten times larger than the UK Index over this time frame. Given that the US population is circa five times that of the UK, the UK Index is significantly under represented. This suggests that there is an opportunity for institutions to increase their exposure to the UK residential sector. A further factor to consider is the historic performance of the UK Index. Analysis of the UK and US indices shows that from 1982 to 2014, the UK Index had average returns of 13.9% per annum, whilst over the same period the US Index has delivered 9.5% per annum. Over this period, the UK outperformed the US in 22 of the 33 years.
And performance against other real estate sectors?
An investment in residential is an investment not only into a property market that is recognised globally, but also into a strategic market sector, which has been less volatile than other more ‘traditional’ real estate. UK residential has been a long-term out performer against traditional commercial real estate in the UK (office, retail) and has outperformed gilts and the IPD All UK Property Index over all periods measured and UK equities over longer periods (5/10/15 years).
Size of the UK PRS market
Relative to the IPD All UK Property Index, the UK PRS market is materially larger. The estimated value of the PRS is about £1.16tn compared to £187bn in the IPD All Property Index6. The bulk of this market is held by private investors who have a small number of units, typically on a buy-to-let basis. Based on the 2015 Investment Property Forum (IPF) survey of 47 UK institutional investors, 38 of the investors owned a total of £15.4bn in the UK PRS with an average holding value of circa £428m at the time of the survey in May 2015.
Why consider the UK PRS market?
Our research shows that despite rented residential being the fastest growing tenure and has historically been the highest performing real estate asset class in the UK (see Figure 1), today under 5% of the UK PRS is owned by institutions7. We believe this provides potentially attractive opportunities for institutional investors as it has the potential to act as a diversifier in a balanced real estate or mixed-use portfolio due to: its track record as the best performing, largest UK real estate sector; its low correlation with other UK real estate sectors8; the current supply not meeting housing demand, creating an increasing under supply; UK population growth being one of the highest in the EU, creating demand; demand for rental product increasing; historic relative stability of income and capital values; and its development potential.
We believe that the demand and supply imbalance present in today’s UK housing market has the potential to lead to positive outperformance and, as such, provides an opportunity for investment. UK residential, however, does require in our view, specialist expertise to access and assess opportunities that have the potential to deliver attractive returns over the longer term.
Sources: 1 Department for Communities and Local Government (DCLG), June 2015. Latest available data. 2 Nationwide, January 2016. 3 English Housing Survey Headline Report 2013/14. 4 IPD/NCREIF, July 2015. Total returns in sterling. 5 IPD, 20 years to end of 2013. Latest data available. 6 DCLG, IPD, Savills, IRE as of June 2015. 7 2016 ARLA, DCLG, July 2015. 8 Total return: IPD and Datastream, 14 years to December 2014. Latest available data.
