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Private rental investment opportunities emerging

Attempts to grow the private rental sector are starting to deliver results
May 19, 2017

Hard-to-ignore investment ideas don't appear all that often. So imagine a company engaged in the construction of private rented houses, working closely in co-operation and with the approval of the local authority and with construction and construction risk taken by the leading housebuilders building the houses. That's not to mention the government having a 9.9 per cent stake in the operation. Welcome to PRS REIT, a real estate investment company that is expected to float later this summer. It's the first of its kind dedicated to the private rental sector, with a view to financing the construction of homes for private rent.

The flotation is targeted to raise £250m - with an option to raise a similar amount again within a year - with gearing up to 45 per cent. The investment adviser will be private rental home provider Sigma PRS Management, a subsidiary of Sigma Capital (SGM). The Homes and Communities Agency has already pledged to put in £25m via the IPO.

There are two avenues along which PRS can travel to deliver rented homes. The first is to enter into a fixed-price construction agreement managed by Sigma. Sigma procures planning, design and build contracts and underwrites all the pre-development costs, thus removing any development risk for PRS. Sigma receives a fee equivalent to 4 per cent of gross development costs, half of which will be re-invested by Sigma in PRS REIT shares. The second avenue is to develop new homes on its own balance sheet. Sigma again funds pre-development costs, and the completed sites are sold to PRS. Sigma uses the proceeds to build more homes for PRS.

PRS has a symbiotic relationship with local authorities. The latter see part of their quota of rental homes being built with absolutely no cost to themselves, while PRS benefits from an accelerated journey through the planning process. Consent is normally granted within 12 weeks. Around 40 per cent of the land used comes through its relationship with the local authority. The building process also includes another key ingredient - speed. On a typical market for sale site, a housebuilder will seek to sell between four and six units a month. However, the investment adviser to PRS expects to take delivery of as many as 14 rental units a month.

PRS is the first real-estate investment trust designed exclusively to build private rented homes. However, as part of a wider development site where houses are sold on the open market, its rented houses look the same. The vast majority of construction focuses on family homes with a full 10-year guarantee. This is good all round because it reduces maintenance costs for the landlord, PRS, and reduces costs for the tenant as well. Careful scrutiny is made of each potential site, which must have good transport links and good schooling nearby.

PRS is looking for an initial dividend yield of 5 per cent. Construction will centre on regional conurbations, notably in the midlands and North Yorkshire, with the houses built on a value range if sold in the open market of between £135,000 and £245,000. Rents will range, depending on the size of the property, from around £475 to £1,100 a month, and a typical tenant will have an annual income of at least £20,000, with more than half having a household income in excess of £36,000.

In the 1950s institutions owned most of the housing stock let out to rent. However, tightening rent regulation and other legislation eroded the investment case for institutional landlords. Recent financial disincentives introduced as a means of taxing private landlords, mean that the need for more purpose-built rental accommodation can only rise. While there is a wall of institutional funds looking for a way of generating a decent return in today's low interest rate environment, there has been little effort to effect a significant conduit.

The private rented sector in the UK is worth over £1,400bn, but 98 per cent of this is tied up in property owned by small landlords. This highlights the need to expand the development of new private rental sector assets, much in the same way as has already taken place in the US. But the market in the US took 20 years to establish, while the UK sector is only seven years old. During that time its expansion rate has been desultory at best. So while the funds are there, it is likely to take a while before the private rental market gains sufficient scale to accommodate large-scale sums of institutional funds.