This Reit is a smarter way to be a buy-to-let landlord

Landlords have the advantage over tenants. A surge in immigration combined with years of government failure to build any housing means that scores of tenants compete for a dwindling number of rental properties. The result is rent rising at its fastest pace on record, yet the data from Savills shows this is still not enough for landlords to push their paltry profit margins higher.

Is there a way to generate better returns from catering to this high-demand, low-supply market? Enter PRS Reit (PRSR). The real estate investment trust is an enormous buy-to-let (BTL) landlord with more than 5,000 UK properties.

Rather than dealing with the hassle of BTL, would-be BTL landlords can instead buy a stake in PRS Reit, whose shares currently generate a dividend yield of over 5 per cent. And, instead of having equity in one BTL property, PRS Reit shareholders have equity in thousands, reducing the risk of falling property values. True, PRS Reit is not without its challenges, but the potential rewards for investors are worth considering.

BTL, BTR and PRS

PRS takes its name from the acronym for the private rented sector, a growing corner of the property market in which institutions are looking to become BTL landlords. Blackstone (US:BX), the largest real estate company in the world, owns swathes of residential rental properties. The model is stylistically different from build-to-rent (BTR), which focuses on apartment blocks, whereas PRS focuses on houses – but the fundamentals are the same.

PRS Reit is not Blackstone, though. The UN has criticised the private equity giant for creating a housing crisis by buying up existing houses, claims that Blackstone vehemently denies. PRS Reit is free of those criticisms. It does not buy existing homes but funds the development of new ones. In other words, the company is not reducing for-sale housing stock and replacing it with for-rent stock in a way that the UN and others have said is pushing up rent and house prices; instead, PRS is ploughing money into creating rental units.

PRS says its new homes are better quality than older houses and are 25 per cent cheaper to run than properties built between 2007 and 2011 and up to 74 per cent cheaper to run than older buildings. High energy efficiency helps, with the whole portfolio achieving an energy performance certificate (EPC) of C or above, 85 per cent achieving B, and 1 per cent at  A. The company is well ahead of the government’s proposals to raise the minimum EPC for residential rental properties to C from 2025 for new tenancies and 2028 for existing tenancies.

The properties are also affordable for the tenants. The portfolio's average rent as a proportion of household income is around 25 per cent, which, the company notes, is “well within Home England's stated affordability target of 35 per cent”. Such affordability is not offered out of the kindness of PRS Reit’s corporate heart. It has the benefit of attracting tenants to the product. Despite growing at a rate of knots, from 595 homes at the end of September 2018 to over 5,000 today, demand for its homes remains high, with occupancy levels at 97 per cent.

Perhaps because of its 'affordability' rating, PRS Reit has been confused with the controversial model used by the suspended Home Reit (HOME), Civitas Social Housing (CSH) and Triple Point Social Housing (SOHO). We have highlighted the issues with this model at length, as have government committees and short-sellers. In a nutshell, those companies do not let properties to people directly. Instead, they typically let them on long leases to homeless accommodation providers, many of which have been branded low-quality by regulators, have thin balance sheets, and are often linked with each other.

By contrast, PRS is purely a BTL landlord. It lets buildings directly to their end users, typically families. Despite this clear distinction, the company tells us the reputational contagion from the Home Reit implosion has hit market sentiment towards the residential sector.

Whatever the cause, PRS's share price has had a miserable 12 months, falling 30 per cent to its current 76p. But the bad news for PRS Reit is good news for would-be investors. Its dividend yield is much higher now than when the shares were trading at over 110p last year, and the share price is 38 per cent below forecast net asset value (NAV) for the year just ended. 

We reckon such a discount to NAV is unwarranted. It is most unlikely PRS Reit's NAV will drop that far. True, in its first-half results for 2022-23, pre-tax profit was slashed by well over half because gains in property values slowed to £6mn compared with £31mn in the previous first half. Yet this was still a usefully better performance than many of PRS's Reit peers, which swung to losses because their valuations reversed so heavily. 

PRS Reit’s relative success could be the combination of its rapid portfolio expansion and resilience created by market dynamics. There remains an overwhelming imbalance between supply and demand for rental homes. That market is unlikely to wobble. And even if it does, homes are easier to sell than commercial assets because house prices have not fallen as much as commercial asset values.

PRS is also performing well operationally. Even with its commitment to affordability, net rental income was up 20 per cent in 2022-23's first half, and its margin of cash profit (earnings before interest, tax, depreciation and amortisation) to income has surged to an all-time high of 64 per cent, having grown each year it has been trading (see chart).

The figures all point to a company going in the right direction. Its return on average total equity puts it among the best-performing UK Reits. Shares in the handful of companies that beat it are more expensive on a price-to-NAV basis, and one of them, Industrials Reit (MLI), which we tipped last year, is being taken over by private equity. PRS Reit’s metrics and deep discount to NAV might also make it a target. If retail investors do not clock its value, private equity might.

Not everything is perfect about PRS, of course. Its rapid expansion has been funded heavily by debt, which stood at £364mn at the end of December. While this may not have been a consideration when the company started in 2018, it will be an issue for the business now as it attempts to continue expanding into this hot market, and its loans reach maturity over the coming years. What's more, the aforementioned dividend is not fully covered by earnings (see table). Investors should watch this as well as its high gearing, but we feel the possible rewards outweigh the risks. Buy.