Rent – the next big asset class
A new style of renting is coming to Britain. A far cry from the awkward Victorian conversions and unresponsive landlords that bedevil the image of traditional renting, these purpose-built, large-scale properties offer longer-term tenancies, more predictable rents and shared services such as a concierge or rooftop garden.
Welcome to the age of the professionalised private rented sector (PRS), where big institutional investors are homing in on an industry until now dominated by amateur buy-to-let landlords.
Drawn by rising urban populations and the promise of stable, long-term returns, pension funds and other large investors are increasingly either buying up blocks of existing rental accommodation or embarking on so-called “build to rent” — a trend familiar to investors and tenants in the US, Canada and continental Europe.
The development of a PRS in the UK could give tenants an alternative to the traditional small landlord — and may also create opportunities for UK investors to put their money to work in the rented sector without the risks of buying a property themselves.
Institutions are making significant investments, mainly in London and the Southeast. The value of rental property deals for large-scale investment rose from £1.6 billion (Dh9.9 billion) in 2012 to £2.5 billion last year, according to Savills, the property agent. “It is happening in a bigger way,” says Jacqui Daly, Savills’ director of residential research.
One of the largest build-to-rent projects is the construction of 1,439 properties in the former Olympic Village at Stratford, east London. Delancey, the developer, is teaming up on the project with Qatari Diar, the property arm of the Qatari sovereign wealth fund. The flats will be rented out on long-term three-year tenancies, with no management or agents’ fees.
Elsewhere, the real estate arm of M&G Investments last year bought 534 homes for rent from Berkeley Group, another developer, in a £105 million deal. The majority are one or two bed flats in 13 different locations mainly in London and the south. Other deals completed by the group include 401 rented homes at the Stratford Halo development beside the Olympic Park and 233 homes, some for rent, at East India Dock.
Ready-made blocks of rented homes such as those offered by Berkeley are the preferred target for institutions, as they avoid the upfront costs and risks associated with planning and construction. At this kind of scale, however, they are few and far between.
Alex Greaves, M&G residential fund manager, says: “If we have the opportunity we’d like to buy another one but the reality is they don’t come up that often. And if you can’t buy it, you have to build it.”
Much investment to date has come from overseas, where the model of large-scale managed rental properties is already well established. Essential Living, a UK specialist in PRS development, is backed by M3 Capital Partners, which in turn is funded by US pension schemes. Fizzy Living, a private sector arm of the Thames Valley Housing Association, is funded by Australian investor Macquarie Capital.
“Investors are increasingly aware of this market. It feels like there’s momentum in it,” says Andrew Allen, head of global property research at Aberdeen Asset Management. He expects the fund manager to be “significantly more invested” in five years.
APG, the Dutch pension fund group, has invested in a £430 million fund with Grainger, the UK’s largest listed residential landlord, for developments amounting to 1,700 homes. And Akelius, the Swedish pension fund group, which owns 34,000 flats in Sweden and Germany, has invested £200 million covering 950 homes.
Several factors lie behind institutional investors’ sharpened appetite for the private rented sector. Housing supply in Britain remains well short of demand, keeping prices high.
First-time buyers face high barriers to getting on the housing ladder: average earnings have not kept pace with house prices, mortgage lenders require larger deposits and monthly repayments are higher in the absence of lower-cost products such as interest-only mortgages.
Data show Generation Rent has been growing fast in the past decade. More than half of under-35-year-old low- to middle-income households now live in rented accommodation, up from just over a quarter in 2003-4, according to research from the Resolution Foundation think tank.
But quality in rented accommodation is often poor, with tenants complaining of damp conditions, low quality fixtures and fittings and landlords who fail to fix problems, respond promptly or return deposits. A Savills survey in 2012 found that a quarter of tenants left their last rental property because of poor management.
Conditions would appear ripe for big investors to commit to the large-scale rental market. But for some, talk of an ownership revolution in Britain’s tenanted accommodation is overblown. Vidhya Alakeson, deputy chief executive at the Resolution Foundation, says the efforts to bring City money into the rental scene have been ongoing for several years. “But the number of actual deals going through is very limited,” she says. “It’s going to be a slow burn.”
She believes the biggest hurdle is changing the mindset of institutions. “Build-to-rent falls between two stools. It doesn’t have the low-return but highly secure nature of social housing investments but nor does it have the high returns that equity investors typically look for. Traditional property investors don’t quite know where to put it.”
City institutions do have a history in the sector. For much of the 20th century, they owned rental properties as part of their portfolio of investments. But they departed after the advent of rent controls in the 1970s and the pool of PRS management skills dissipated. Margaret Thatcher scrapped rent controls, but pursued ardent promotion of home ownership for all. That effectively left the field clear for individual buy-to-let investors.
Institutions may be keen to return to the fray but other obstacles remain. Sir Adrian Montague, chairman of an independent review into the barriers to institutional entry to PRS, identified a dearth of large-scale sites as one. Another was the planning system, which developers say favours for-sale projects rather than construction that delivers its return over 20 or 30 years.
Return on investments
While returns from PRS have been dwarfed in recent years by rises in capital values, institutional investors such as pension funds see attractions in matching their long-term liabilities to a steady income stream. M&G is targeting a return of 7-9 per cent on its residential investments, while a study by Resolution Foundation looking at a notional portfolio of rental property found a total return of 7.2 per cent per annum over ten years.
To sweeten the market, the government last year unveiled a series of measures aimedkick-startingting institutional build-to-rent. These include a £1 billion equity fund to trigger development; £10 billion of loan guarantees for the social and private rented sector; new draft planning guidance on build-to-rent projects; and a Whitehall task forceorce overseeing the fund and loan guarantees.
Jacqui Daly of Savills says the loan guarantees in particular will boost confidence in the market. “The guarantee could have a huge impact on how quickly the market matures. It will help to improve the returns.”
But while the main political parties are aligned on the need for more housing of all kinds, policy gaps are emerging. Landlords and developers reacted with fury last week to proposals from Ed Miliband, Labour leader, that rented homes should be subject a system of rent rise caps and three-year tenancies, in a bid to provide a “fairer deal” for tenants.
Richard Lambert, chief executive of the National Landlords Association, said changing the structure of tenancies would create uncertainty among landlords and lenders, dealing a “devastating blow” to investment in housing. Others said the move would stall institutional growth in the sector. “This has the potential to put the evolvement of the private rented sector using institutional equity back 40 years,” said James Coghill, director at Savills.
Future asset class?
Political uncertainty notwithstanding, could build-to-rent eventually become a new asset class for retail investors? The market for student accommodation has been opened up to public investment over the past 20 years, with the emergence of listed providers such as Unite and funds specialising in student properties. Some believe build-to-rent could become the next new addition to the marketplace.
Real estate investment trusts — listed vehicles that gain tax advantages in return for paying out 90 per cent of their rental income as dividends — are one of the most likely options. But at present, few residential portfolios have the scale and yield required to turn themselves into a Reit.
Nick Jopling, executive director of property at Grainger, believes this will change as purpose-built rental communities come into being. “We are at a real turning point in the market ... In time, the rented residential sector will be an investable asset class of scale just as most other real estate asset classes.”
‘Home starts at the front door’
It is hard to envisage Archway Tower, an unloved 17-storey office block overlooking a notorious gyratory in north London, as an exemplar of the new rental nirvana. But Essential Living, a developer, is planning to reclad and refurbish the block over the next two years, creating around 100 homes with access to a “roof terrace, winter garden and club room”.
Shared spaces are a common feature of build-to-rent. A tenant in a studio flat, for instance, might be able to reserve a communal upper floor flat for a dinner party for 10. Barbecue areas might be booked in advance or bikes repaired in an on-site workshop. Scott Hammond, Essential Living managing director, says: “The idea is that your home doesn’t start at the door to your flat, it starts at the front door of the building.”
Others cite “build to rent” advantages such as a concierge who could take in parcels for delivery or allow workmen into the flats under superviWiFi. Wifi or multichannel television, bought in bulk, could be offered to tenants at discounted rates. But building a block for ownership over 15-30 years, during which many tenants will come and go, requires different specifications from those that operate in the for-sale market. The Urban Land Institute, a property industry thinktank, last month published a guide for developers in the sector which sets out recommendations on design, engineering and the use of materials that can be “robust, durable, maintainable and replaceable”.
Instead of giving every apartment dweller their own balcony, it suggests developers consider a communal roof terrace or garden. Prefabricated “bathroom pods” might be installed to save time and reduce costs.
Hot and cold running water should be sourced centrally, rather than from individual boilers, and kitchen cookers vented centrally where possible.
Ways to invest
If the private rental sector takes off to the extent its adherents hope, it may eventually provide a new asset class for retail investors, through listed vehicles or a residential real estate investment trust. Until then, there are still a number of options for those wishing to take a stake in the residential property market without signing up for a mortgage.
Quoted companies. Grainger, the UK’s largest listed residential landlord with over 20,000 properties in Germany and the UK, has operated in the private rented sector for over 100 years.
Student accommodation. With student numbers growing in the UK, options are widening for investing in the construction and management of their accommodation. Listed student accommodation groups such as Unite are one option; a real estate investment trust such as GCP Student Living is another.
Property funds. Those seeking exposure to bricks and mortar can invest in funds that specialise in residential property, such as Hearthstone Investments, which last month won a £30 million mandate from Falkirk Council pension fund to invest in social and affordable housing. London Central Portfolio has four funds focused on high-end property in the capital.
Social housing. In 2012, housing associations issued nearly £4 billion of bonds on the public markets — half the total they raised in the previous 25 years. Places for People and A2Dominion have raised money on the investor-friendly Order Book for Retail Bonds since 2011.