I saw a study at the end of 2015 that showed only 4% of UK institutional property holdings were in residential, compared to about 22% in the US, and 44% in the Netherlands. Meanwhile, a different set of data predicted that institutional investment would reach £50bn by 2020. So what makes the private rented sector a compelling investment opportunity and why are we so far behind other countries?
Simon Redman: We’re an active investor in PRS – or multi-family, depending on what you want to call it. We’re active not only in the UK, but also in Germany and have been managing residential investments in the US for over 30 years, where it has grown from approximately 2% of the institutional market in the early 1980s to over 25% today. The drivers that caused such growth in the US are probably stronger in the UK today, so it could grow more quickly here.
What were those drivers?
Redman: Pension funds in the UK did historically invest in residential, but rent control regulations particularly in the 1970s, resulted in reduced allocations. While controls were removed in the Thatcher era, it has taken until recently for the investment environment to become attractive to institutions in the UK. An under-supply of accommodation, a growing population, the growth in demand for rental versus ownership are all catalysts to institutionalise the sector.
Antony Barker: The crucial point is there’s been both a cultural and a market shift in the UK and there is now an investible opportunity, which wasn’t previously available. In much of continental Europe – and to a lesser extent, the US – people have habitually rented, perhaps as it was a much more transitory population, perhaps because they preferred apartment living to having their own piece of land to build a castle on. The next generation coming through is renting cars, houses, etc. and is not looking to acquire stores of wealth any longer – which is slightly ironic in an almost zero inflation environment. This creates an opportunity set that wasn’t previously available in the UK, but why would a pension fund want to do it now? Pension funds have been looking at the residential sector for decades, but it was the reputational risk of managing the portfolio that put them off. Having the responsibility, on one hand, for providing benefits and welfare to your own pensioners, but then throwing the proverbial Mrs Miggins out on the street for not paying her own rent seems a little incongruous. So, people steered clear of it.
They then looked at mortgage-backed securities as an indirect play as it has a natural inflation and longevity hedge to it. Now the opportunity set – or at least the theory of the opportunity set – has developed. That said, what you want to invest in and can invest in hasn’t quite reached the point of perfect harmony.
Redman: We need to bridge the gap between the environment today, where in large cities the average age of housing stock is very old – from the 1940s and 1950s – and was never really fit for purpose as it was converted from original dwellings like terraced houses, to high quality built-to-rent accommodation. We are now at that stage where the overall supply of the investible income producing stock simply doesn’t exist and the only way it will occur is for it to be created. The size of the sector is bigger than all the commercial sectors put together – it’s enormous, but it is dominated by individual landlords rather than well-managed, institutionally-owned blocks of purpose-built rental flats.
Barker: Especially if you realise that the actual universe is a lot wider than most people’s original definition. Student housing comes into this, as does social housing. Even some of the sort of ‘Staycity’-style apartment living; wherever somebody’s looking to rent accommodation for more than one night and is looking for a kitchenette and a range of TV channels.
James Walton: It is interesting watching the sector move from theory to practice. Reputational risk would always shut the conversation down, but there are so many new funds and institutional players, it is now well bedded in. You can have a proper conversation, and find ways to mitigate that risk.
Redman: There’s a good precedent for how this works in the US and Canada, and while there will be nuances in the UK, they’re not that different. Institutional investors don’t need to think it’s a huge leap of faith, because you can see the model works well.
Paul Jayasingha: Part of the compelling attraction is the fit within a broader real estate portfolio, as it has typically had a low correlation and acted differently from some other property sectors. In the US, it has been reasonably defensive, so the distinction between the ‘for sale’ residential market and the rental market is quite important. In the downturn, a lot of people were renting because the idea of buying a house was impossible because they couldn’t get a mortgage. And in an environment where property prices were falling, they were happy to rent. So rental levels were quite defensive and in the context of income stability, that is incredibly attractive. If you have an office building and you lose a tenant, there’s potentially a big gap in your income if you include the rent free period. In a residential property, you can manage the lease at a much more granular level, and that leads to a much more defensive income profile. There’s obviously an issue of getting institutional quality stock, but there’s an element of first-mover advantage here and we think PRS will become more acceptable, as it has in other countries.
