As a result, institutional-quality rental housing is still seriously lacking in the UK, which limits the number of access points for institutions to enter the market. Today, the opportunity in the asset class is dominated by ‘build-to-rent’ development, rather than secondary trading of assets.
Not all investors are comfortable with the development aspect of UK residential markets, not least because it can involve risks unique to development and construction, and can lengthen the time between allocation and yield generation. Certain parts of the development process can be mitigated, however, using fixed price construction contracts, for example.
Investors are also able to chose whether they want exposure to those risks, which come with higher returns. Invesco’s Hills says: “Build-to-rent projects have been producing around 8% where investors are not taking planning or construction risk. Where they are willing to take those additional risks, like a listed house builder would, return on capital can be around 20%.”
As more development takes place and the market gets larger with more secondary transaction taking place, institutions will find it increasingly easy to find a suitable access point, creating a virtuous cycle of investment attracting more investment.
M&G’s Greaves says: “Over the next five to 10 years we’ll see a big expansion in the number of access points.”
As with most ‘new’ investment classes or strategies, however, there is an early mover advantage available to those willing and able to invest in the early years.
SUPPLY AND DEMAND IMBALANCE
Today, the tailwinds for the UK residential market are strongly in favour of investors. Supply and demand fundamentals are compelling and unlikely to balance in the short to medium term.
As Greening says: “There has been a failure to build enough housing over the last 20 to 30 years. From the investor’s point of view, they are moving into an asset class where there is a shortage of supply that will be there for many years.”
The UK housing deficit is forecast to grow to 1.1 million houses by 2020 as the number of new homes developed annually is around 150,000, well short of the 250,000 required.
As house prices continue to rise, young professionals want more flexibility in their housing arrangements, move jobs more frequently and are finding it harder to source a deposit.
Occupancy levels are also falling. Over the last 30 years occupancy has fallen from 2.6 people to 2.2 people, Greaves says. “Across 60 million people the requirements for more households is going up meaningfully,” he says. “People are also living longer and immigration means the population is growing. This creates a lot of pressure on demand and supply is not keeping abreast.”
POLICY OBJECTIVES
The government, keen to address the housing shortage and drive the professionalization of landlords, is also moving policy in favour of residential investors. “Central and local government are very supportive of the development of the institutional PRS market,” Invesco’s Hills says, pointing to an increased use of covenants (Section 106 agreements) by local authorities putting conditions on planning permission to include a certain amount of private rented houses.
“We are seeing a growth in this, especially in London, which provides good support for the asset class,” he says.
That said, the Chancellor’s recent Budget announcement dealt a blow to institutional investors in residential real estate, who had largely expected the government to exempt them from a 3% additional rate of stamp duty for those buying additional properties. Jayasingha says the decision is a “set-back and will likely slow institutional interest”.
In simple terms, the impact of an additional 3% stamp duty as a one-off cost over 10 years is 0.3% per annum, however, as Jayasingha says, that may be considered a “modest cost relative to the diversification and income characteristics” offered by the asset class.
ON YOUR MARKS…
With institutions expected to increase their allocations to the private rented market in the coming years, drawn to its characteristics of stable income, inflation protection and diversification, the asset class is likely to see some compression of returns.
The same phenomenon is well documented in other areas of investment and, as such, early movers are likely to benefit from the best pricing and ability to negotiate fees and terms with managers, while the asset class may become increasingly correlated to commercial real estate in the future.
“I would encourage other investors to get on with it,” Islington’s Greening says. “It takes a long time to get past the hurdles and necessary due diligence so it makes sense to get started.”
