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Build-to-rent gathers momentum

A new model is emerging to offset the UK's chronic housing shortage - but what does it mean for property investors?
November 18, 2016

The one fact that unites political parties, investors, builders and tenants is that there are not enough homes in England. Plans to build 1m of them in the current parliamentary term will need to embrace all manners of schemes if this number is to be achieved, and one sector that is attracting growing attention is build-to-rent. At the moment, there are more than 60,000 units in the pipeline; that’s worth more than a third of the annual build-for-sale completions.

Several factors have increased the attractions for institutions of becoming landlords, not least of which is the paltry return offered on traditionally safe investments. The trouble is that pension funds may be very good at investing your money and keeping it safe, but they’re not very experienced when it comes to building homes. But as necessity is the mother of invention, suitable conduits are now being established that circumvent the problem.

Institutions are now working in partnership with local authorities, housing associations and even housebuilders as a means of bringing about a system whereby a pension fund can realistically look at achieving a return on its investment of 3 to 5 per cent. That’s hugely attractive, especially when considering that any investment will be a long-term commitment providing significant earnings visibility.

The rise of renting

The drive to provide a better organised and more cost-effective source of rented property was given further impetus earlier this year when measures were introduced that left the traditional smaller buy-to-let landlord with significant disincentives. As well as a 3 per cent stamp duty levy on second homes, the government also introduced a tapering on the established tax relief on mortgage interest payments. Almost overnight, this raised the barriers for prospective landlords entering the market. And apart from raising funds for the Treasury these measures did nothing to address the supply/demand imbalance. This gap has been exacerbated by two key factors. The first is that aspiring home owners have to find large deposits to get on to the first rung of the housing ladder. The second is an increase in the number of young people opting to rent rather than buy as a lifestyle choice. In some cases this is prompted by a desire to live in an area close to work, but where the cost of buying is prohibitive.

Increasing interest by pension funds has given rise to a new breed of residential investment managers, such as Allsop, that act as a conduit between the investor and the tenant. The attractions for a tenant are considerable. Purpose-built flats located in the right area – and including modern amenities such as Wi-Fi and leisure facilities not readily associated with an old house split up into apartments – offer a much better deal, especially when the landlord is a professional and, crucially, more accountable.

Property companies are also moving into the sector. Grainger (GRI) the UK’s largest private landlord, is planning to build a 600-unit build-to-rent scheme in Salford Quays, while specialist developer Essential Living, backed by US pension money and other investors, has been given the go-ahead to build more than 500 homes exclusively for rent in North Acton. Perhaps the highest profile build-to-rent scheme is the London Olympics village, managed by Get Living London. This provides 1,439 rental homes close to central London, offering a range of different tenancies. A three-year agreement is the most popular deal, with rent increases linked to the consumer prices index. Tenants can give two months notice after the first six months.

The next challenge is to secure sites for development in an environment where there is already keen interest from traditional build-for-sale housebuilders, not to mention increasing demand for office and other commercial space. Local authorities can help here by giving greater support for applications from build-to-rent schemes. And it’s in their own interest to do so. For as well as the fact that several local authority pension schemes are investing in build-to-rent schemes, councils can generate revenue by leasing land to a build-to-rent provider. There is no instant cash receipt that would have come from an outright sale, but the leasing route provides long-term income from their share of the rents, while retaining ultimate ownership of the land.

Big money for build to rent

Institutional investment is gathering pace. Around £15bn has already been invested in the sector, and estate agent Knight Frank estimates that this will grow to nearer £50bn by 2020. The big investors at the moment include Legal & General (LGEN) and M&G, the asset management arm of Prudential (PRU), where its UK Residential Property Fund, launched in 2013, already has £300m of assets under management. Legal & General has teamed up with Dutch pension fund manager PGGM a year after L&G made its first foray into the sector, and earlier this year announced plans to invest £600m for the construction of 3,000 apartments in Bristol, Salford and Walthamstow. L&G has already invested £8bn in UK infrastructure, direct investments and urban regeneration projects, and aims to get this up to £15bn.

Foreign investors are already in the sector too. Dutch pension asset manager APG, which manages pension assets of around £375bn, is backing a 44-storey build-to-rent tower block as part of the Elephant & Castle regeneration scheme.

L&G has also been investing in rented student property in partnership with universities, which is good news for the likes of Watkin Jones (WJG), which specialises in constructing purpose-built student accommodation. The business model has two main attractions. All schemes are forward funded, so there is less risk for shareholders. And for institutional investors it offers a one-stop solution, with Watkin Jones controlling the whole development cycle from site procurement, planning consent, construction and delivery. At the same time, it offers a post-completion management service facility, so institutional investors have little more to do than sign the cheque.

East London focused housebuilder Telford Homes (TEF), which already has more than half of its targeted revenue for the next three years in the bag, has also shifted its focus more towards the private rental sector, with around a quarter of all sales now made to institutional investors. Also working on a forward-funded basis, it has sold a site in north London to London housing association L&Q for £67m and another site to M&G Real Estate for £63m.

A nasty surprise in the last Budget came with the news that institutions buying more than 15 homes for rent would not be exempt from the 3 per cent stamp duty surcharge, and at the same time the top rate on commercial stamp duty was hiked to 5 per cent. However, the large investors appear to have taken this in their stride, weighing up the increased costs against the fact that investments are designed for the long term. There are other ways of minimising costs through a forward-funded transaction, whereby the purchaser buys the land and makes a series of payments throughout the development cycle. This means that stamp duty is paid on the cost of the land rather than on the completed property.

What could go wrong?

Engaging with an experienced manager is key because void rates have to be kept to a minimum to maximise income. At the moment, this is not likely to be a problem as demand easily exceeds supply. Interest rates are another governing factor. Institutional money searching for a decent yield could revert to more conventional asset allocation if interest rates were to rise significantly, to 6 per cent for example. But we see this as unlikely in the near term. Furthermore, investing in build-to-rent is a long-term commitment offering the sort of investment return visibility that more conventional assets currently lack.

The approach makes sense for all concerned, not least because it encourages young workers to stay put in their community rather than leaving to live somewhere that they can afford. More than half of private renters are under 35 years of age, and more than half have no dependents, so they are unlikely to qualify for social housing, even if there were any available, which there isn’t. And there are other economic benefits. According to the British Property Federation, around £1.2bn would be generated from the construction of 10,000 homes through stamp duty land tax, value added tax, the community infrastructure levy, and corporation tax. In short, build-to-rent is here to stay.