Interest is growing in financing UK ‘build-to-rent’ housing, writes Jane Roberts.
In the east London location of Barking, 30 minutes by public transport from the heart of the capital, an old-hand at residential investment is trying something new. Grainger, the UK-listed housing owner, trader and manager which has operated for over 100 years, has opened Abbeville Apartments, a 100-unit block hard by Barking’s station, designed and developed solely for rental.
A price of £975 per month gets you a one-bedroom flat with access to communal amenities like a free fitness studio and concierge service. If you want to share with friends, the two-and three-bed flats are configured with just that in mind, with all the bedrooms equally-sized doubles. The company even ‘road-tested’ the space, by sending 20 staff to spend the weekend there last year.
Grainger is a long-standing client of lender Barclays and the bank’s head of corporate real estate lending Dennis Watson says his team are “watching the evolution of the Grainger model with great interest. Their Barking scheme is a different configuration and design to what we have seen in the market so far. Most schemes we have seen to date have been tradtional configurations which just happened to be let rather than sold.”
Abbeville Apartments was acquired by Grainger back in 2013 but remains one of the few PRS (private rented sector) blocks – buildings purpose-built to be owned and managed purely for rent – completed in the UK market. The pipeline, however, is growing fast, with around 42,000 units with planning or under construction across the country according to CBRE’s London residential research head Jennet Siebrits. A proportion will be funded with all-equity by funds developing for their own long-term portfolios, but others will need or opt for development finance and Barclays isn’t the only lender interested in the nascent opportunity.
Among the UK clearing banks, Royal Bank of Scotland was an early mover and this year established a PRS team under head of residential development Phil Hooper, run by Chiara Zuccon. The bank provided £52 million of development finance in a club with the Homes & Communities Agency last year to Essential Living for 300 PRS homes in Archway and Bethnal Green in London and Maidenhead.
Lloyds has been tracking the market and, with Barclays, was in a four-bank club which provided a £620 million facility to Canary Wharf Group last year for the development of four residential towers at Wood Wharf next to the Docklands office complex. Two of the four will be PRS. Lloyds expects to lend more in the asset class, and is putting in place an internal risk framework for PRS financing; it has a facility for another client to fund development of five PRS sites around London due to close shortly.
“Many of the people developing PRS will be our existing clients or contacts,” says the commercial bank’s head of developers Graeme Alfille-Cook. “It’s a specialised asset class. The people we want to support are the operators who have the wherewithal to deliver successful schemes. The sponsor and their operational platform or partner are very important,” adds Madeleine McDougall, the bank’s head of institutional clients.
PRS less risky
Unlike build-for-sale residential, where in the UK lenders can lay off some risk through requiring an element of pre-sales, PRS is speculative; no income comes in until the scheme is completed and letting starts. “Dealing with the speculative point was interesting and has similarities with another specialist asset class, student housing development, where there is typically no certainty of cashflow via lettings prior to starting funding the development,” says Alfille-Cook.
However, banks are taking comfort in the granularity of the product and the huge inherent demand from renters. Lloyds is including a sponsor guarantee to cover the letting, or ‘stabilisation’, period, on its deals. Furthermore, if letting doesn’t work banks see the flexibility of an alternative exit: selling the flats as a backstop, mitigating risk.
Andrew Wheldon, a senior director at CBRE Residential Capital Markets, says: “A lot of lenders are looking at PRS development in the same way that they would student housing, which will often be speculative. But they are probably carrying less risk with PRS, because new student housing needs to hit a letting window in time for the September student year.” He points out that one exception would be if a PRS developer agreed a corporate deal to pre-let a large number of flats to one employer – which hasn’t happened yet.
At Barclays, says Watson, “we don’t really see PRS as being speculative. It’s not the same as commercial speculative development where, in our opinion, you need to be much braver around a lending decision, because you don’t know whether that office block or that industrial unit is going to get let and you feel more exposed to occupier demand. In contrast there are so many residential buyers and renters in the UK and it’s such a liquid market. So long as you’ve got the right product in the right place at the right price, it’s going to get sold or it’s going to get rented.”
For lenders who are comfortable with development, the commensurate reward is higher margins and fees than for investment lending on stabilised PRS or for other property asset classes. Margins have ticked up for all kinds of residential development finance this year, borrowers and brokers say; for PRS development at 60-65 percent loan to cost, they sit at about 325-350 basis points over Libor with arrangement fees typically around 1.5 per cent.
UK clearers need the higher returns to compensate for the higher risk weights on development under slotting. For German banks, familiar with the asset class from their large domestic multifamily market, and interested in financing UK PRS development, a particular issue is ensuring loans can go into the pfandbrief covered bond pools from which they draw funding. It can be done, but one German bank had to pull out of an agreement to finance a large PRS scheme in the north west for this reason.
German banks active
Germany’s pbb Deutsche Pfandbriefbank provided development finance for one of the UK’s first PRS schemes, Delancey and APG’s first phase of its mixed-use scheme at Elephant & Castle. The bank is thought to be in negotiations to finance a second London scheme, is also active in the regions and is one of a number of banks potentially interested in being involved in Lone Star’s PRS development at Wembley, north London. Deutsche Hypo has also bid on regional and London projects.
US insurance lenders such as TIAA-CREF, MetLife and Pricoa, which also know multi-family inside out from their domestic lending, are very keen on the asset class. But most can only provide investment finance and as yet there are almost no stabilised investments for them to lend on.
Pricoa is an exception. The US mortgage lender is working up a fixed-rate product, akin to US ‘construction-to-perm’ loans, which would finance a UK PRS project’s initial development then convert to a long-term investment loan.
Lenders are gradually “getting their arms around PRS” says one borrower active in PRS. As with the concept itself, everyone is learning. As Lloyds’ relationship director and PRS specialist Jonathan Monnickendam says: “Which kind of PRS works best for the UK? Is it the American full-service model? Or is it a more utilitarian North European approach? If you talk to people who have been to the States they claim to know exactly how it’s going to work over here, your gross to net is going to be this, and so on. And you think, ‘that’s great, but you’ve really got to prove that’s going to work over here.”
New asset class is also a challenge for valuers
Valuing UK PRS projects for development finance, like much else about the asset class, is new.
Lenders and their valuers will consider what flats are letting at in the local market and employ a yield based on net rental streams. PRS yields are low because investors are buying for long-term, stable income and in central London, they are between 3.5 and 3.75 percent. So the debt provider will allow room for a downturn and employ a higher yield, perhaps 4.5 percent.
A cross-check is considering the project’s equivalent value if the homes were sold.
One of the trickiest calculations is deciding the correct gross to net value as the deduction on gross rent can vary considerably, from 20-30 percent and there’s little evidence yet.
“Most lenders are looking at PRS like development and stabilisation fundings, with perhaps two years for development and one year for stabilisation. They will take a view and roll interest during the term of the development facility and stress test their exit,” says CBRE’s Andrew Wheldon.
Interest shortfall guarantees are standard, as are margin enhancements or penalties tied to letting targets.