For Legal & General (LGEN), the provision of sustainable housing has long been a passion project of chief executive Nigel Wilson. In 2013, the insurer clubbed together with private equity investment house Patron Capital Partners to buy a housebuilder, Cala Homes, from Lloyds Banking Group (LLOY). This appears to have been a decently-timed investment, with Cala's £11m in pre-tax profit in the 2012 financial year expanding to £48m in FY 2015, or £51m before exceptionals. But L&G's stated intention for the offer was equally about building the homes the country needs. Cala's longer-term strategic land bank numbered around 5,400 plots at the time of acquisition, which has since expanded to just over 11,200 plots.
It is worth dwelling on this recent history because of what it tells us about the changing flow of capital into this crucially important sector. Consider HBOS, whose over exposure to housebuilders burned it badly during the financial crisis, eventually dragging its acquirer Lloyds into the mire of a taxpayer bailout (listen to our podcast telling that story here). Their fingers burned, banks have sought to reduce their exposure when the market has allowed. Hence Lloyds sold Cala. This also gives other holders of longer-term capital such as insurance companies the chance to buy in at a time when ultra-low interest rates are suppressing the income from traditional fixed-income holdings.
Taking a stake in a housebuilder is one thing, but the insurer went one further last month with a 'build to rent' partnership with Dutch pension fund manager PGGM, which will eventually build more than 3,000 rental homes. L&G contrasted the 'cottage industry' of UK housebuilding with European and US markets where "institutionally-funded and managed rental property markets have developed to increase the supply of homes, lower prices and provide better quality products and service".
Prudential (PRU), via its investment management arm M&G, is already on the case. In November, it announced a partnership with Crest Nicholson (CRST) to build and rent 227 private rental homes near Crawley in West Sussex. In all, institutional investors have £15bn invested in the sector, which researchers at Knight Frank expect to increase to £50bn by 2020. If that seems like a lot, consider that the rental market is valued at around £1 trillion.
Housing policy is encouraging the shift towards insurers in hard hats. The imminent 3 percentage point increase to stamp duty for buy-to-let property purchases will not apply to larger-scale property owners - an exemption brought in to ensure that funds and corporates are not deterred from building the necessary properties. Smaller landlords are not pleased. There have already been complaints about earlier changes to tax relief, which stop landlords offsetting their mortgage costs, above the basic income tax rate, against their rental income to reduce their taxable profit. Two private landlords, represented by Cherie Blair QC's law firm Omnia Strategy, have reportedly written to HMRC to criticise the tax change and call for a judicial review.
But which is better for the housing sector: a small-scale private landlord or a big housebuilding insurance company? Indeed, landlords can make empty properties liveable and return them to the market. Their demand helps underpin the price rises thay buoy housebuilders. But, arguably, only an institution willing to provide capital to build the flats that will provide its rental income can hope to change the basic mathematics of the game.
Why did institutional investors not get onboard earlier? When Islington's local authority pension fund put £20m into a residential property fund in 2012, many in the industry thought a break-through was imminent: a mass of pension funds supplying badly needed local housing in return for good long-term income. But the construction, tenancy and other risks involved in residential investment deterred this wave of capital, which instead poured into direct company loans, infrastructure funds and other fixed-income alternatives.
The listed insurers feel like a better bet: in recent years, through their asset management divisions and partnerships with housebuilders, they have built up their knowledge of social housing and residential housing, in particular. But with the Solvency II regulatory era only just begun, their ability to manage the risks inherent in this activity will be crucial. Just ask HBOS.
