Big investors target sector, but rewards so far are thin on the ground, reports Doug Morrison
The UK’s private rented sector has become Europe’s top destination for overseas and domestic institutional fund managers, even though its hard-earned rewards are, for some, a triumph of hope over expectation.
In theory, the market dynamics of UK housing help PRS beat all other asset classes hands down.An acute supply shortage and lack of affordable housing for young people have marked a shift from home ownership to renting, reinforcing long-standing superior returns to those of commercial property.
This lifestyle shift offers the prospect of higher returns than German rental stock, Europe’s longest established and still the most liquid residential investment.
CBRE said earlier this year that £20bn of capital is heading towards the UK PRS from the US, Canada, mainland Europe and the Middle East, while last month the British Property Federation (BPF) reported £10bn of “firm commitments” for bespoke rental stock development and up to £30bn in the next five years – a ‘build-to-rent’ movement.
How much of that capital will actually be deployed remains to be seen. Real Capital Analytics’ investment volume figures for the year to 30 September show the UK’s €8.7bn was a distant second to Germany’s €17.3bn.
The fact that capital far outweighs UK investment stock led the BPF to establish a build-to-rent committee and publish a “manifesto” for the UK government to make it easier to develop and hold rental property, including greater access to public land and relaxing the tax rules around residential REITs.
Germany has no such obstacles, yet an extraordinary roll call of mainstream managers and operators have openly declared their intentions for the UK without fear of failure. M&G Real Estate kick-started the UK institutional move into PRS two years ago and has been followed by Invesco, Aberdeen Asset Management, Aviva and a Hermes/ Countrywide joint venture.
Continental European capital has come from leading German landlord Patrizia and a joint venture between Dutch pension fund APG and the UK’s largest listed residential landlord, Grainger. LaSalle Investment Management and Internos Global Investors entered the fray this year, while leading US players Greystar and a Rockspring/Atlas joint venture have made their first PRS buys.
M&G shows the way
M&G leads the pack, with £200m spent on build-to-rent schemes and commitments for a further £100m. Investors in M&G’s residential fund include mainstream UK institutions and local authority pension schemes. Its manager, Alex Greaves, says capital also comes from Germany and the Netherlands and he is talking to prospective institutional investors from Asia Pacific.
Capital deployment appears to be accelerating, largely because M&G’s latest project, a joint venture with Crest Nicholson, is part of a “framework deal” by which M&G will fund schemes for rent on a further 12 of the housebuilder’s sites.
Patience is a virtue in the UK. Internos launched residential funds in the UK and the Netherlands this year, but the latter, a joint venture with Mahler Corporate Finance, is much further advanced and has already lined up 2,300 units worth €500m. Both funds are primarily targeting income rather than capital growth, even though the latter has been the main reason for UK residential’s sustained out-performance.
Internos is pitching the UK fund at UK institutions only and expects the Dutch fund’s capital to come from German, Swiss and North American investors – but not domestic institutions, because, says Internos chairman Jos Short, they are overweight at home. He adds: “[income] returns from PRS are not stacking up relative to other asset classes but we think that will change.There will be a whole generation of renters that need to rent, not own.”
Internos has surveyed 62 European real estate investors and found a clear intention to increase residential investment in the next five years, underpinned by “inexorable urbanisation” across the Continent. Survey respondents saw residential as a long-term play, ideal for matching their liabilities, as is borne out by their modest return requirements – nearly three-quarters expect 5-10% ungeared returns.
Internos manages €3.5bn of assets and is targeting €10bn by 2020, of which €2bn will be residential, says Short. Its survey said the biggest barrier to investment is lack of stock, which Internos says shows a need to take part in development, especially in the UK. However, since winning the UK general election in May, the Conservative government’s rhetoric on housing has been overwhelmingly about boosting home ownership.
Greaves says: “It’s disappointing there hasn’t been further promotion of private rented housing and getting more institutions involved. It’s not as high up the agenda as we hoped it would be.”
The BPF is putting its lobbying weight behind build-to-rent – the target for most institutional money – as distinct from the wider PRS, which includes individual buy- to-let landlords. Andrew Stanford, LaSalle’s UK residential fund manager and chair of the BPF committee, says the institutional build-to-rent movement is “well beyond theory and into reality”. LaSalle has set a £1bn target for its fund and Stanford says: “I would be disappointed if we haven’t deployed the £1bn in five years.”
He adds: “You can’t build to rent with the click of a button. It takes time to get things going and this [BPF] manifesto reinforces to government that build-to-rent can speed up the housing supply and also, importantly, deliver tenant choice.”
But there are notable absentees from the UK build-to-rent market, including US developer and fund manager Tishman Speyer. Michael Spies, senior MD and co-head of Europe, says: “Ideally we would be involved with residential where you do 200 units at minimum in a building; a pretty big complex by UK standards, but as an investor, that’s what you’d want to be investing in, because you can efficiently operate at scale. These types of properties will be of more interest to the capital that wants into the sector too.”
Tishman Speyer’s European residential investment is restricted to two mixed-use developments in Frankfurt. One of them, completed 18 months ago, created the first housing in the city’s banking district, tying in with the local authority’s policy of bringing housing back to the city centre.
“It was also a mitigator of risk for us to a degree, because the income stream from rental housing is valued differently to that of offices – the yield is lower,” says Spies.
Global investment manager Heitman likes residential as an asset class. But last year, when it came to diversifying beyond Germany, where it has much experience of the sector in a joint venture with Grainger, Heitman favoured the Netherlands over the UK. Round Hill Capital, too, has made the Netherlands its next big target after amassing 50,000 German rented homes.
Round Hill, Heitman and Internos are all in the Netherlands to exploit reforms that are both liberalising the rental sector and encouraging cash-strapped housing associations to sell large portfolios.
The Netherlands is a far smaller market than the UK – RCA recorded €2.9bn of deals in the year to 30 September – but as Heitman said following its first acquisitions earlier this year, its market offers a relatively swift “scaleable investment opportunity”. LaSalle is also invested in Dutch residential.
A pan-European strategy
Patrizia is different again, adopting a pan- European strategy while acknowledging that each market has different strengths and weaknesses. As co-investor and fund manager, Patrizia has diversified out of Germany, buying big in the Netherlands and preparing to play the long game in the UK.
Residential accounts for €7bn of Patrizia’s €16bn of total managed assets and it is also present in the Nordics, Spain, Belgium and Luxembourg, and this year made its first acquisition in France – 1,000 homes sold by CBRE Global Investors. This deal also highlighted the fact that residential remains unloved by some mainstream investors, as it marked CBRE GI’s exit from the sector in France. Though it said little publicly about the sale, CBRE GI is known to regard France’s rental market as over-regulated.
A research paper from Patrizia shows that Sweden, the Netherlands and Germany have Europe’s highest level of regulation, which has not stopped capital flowing into those markets. But it does make detailed knowledge of regulation essential.
According to Patrizia, since 2000, the UK and Sweden have recorded the highest total returns, at 12% and 10% a year respectively – double those of the Netherlands and Germany, which are driven mostly by solid income rather than capital growth. But, Patrizia argues, residential yields remain “an attractive bond surrogate” as long as interest rates remain low.
Dr Marcus Cieleback, Patrizia’s head of research, says: “Our German clients still want to go into German residential, despite talk of very aggressive pricing. If they go for good locations, they can still have sustainable cash flow. It might be low, but it’s stable, whereas the office or retail sectors are a little riskier.”
As Patrizia’s paper argues, this spread of return means investors “can diversify in European residential according to their risk and return preferences very well”.