While other investors target rented housing, UK institutions remain wary, writes Alex Catalano
Americans do it, continental Europeans do it; but what will it take to get UK institutions to invest in privately rented housing? “This is a Mom and Pop industry but it is open to large-scale investment,” says Nick Jopling, executive director of Grainger, the UK’s biggest private landlord.
Jopling is clearly an interested party, but he is not alone; some of the UK’s most entrepreneurial commercial property companies are targeting residential.
“We think the sector provides opportunity and our business is to seek value where we think it exists,” says Delancey chief executive Jamie Ritblat, who last year bought London’s Olympic athletes’ village.
Opportunity funds and foreign/global institutions have also zeroed in on the private rented sector. Qatari Diar is Delancey’s partner on the Olympic village conversion; Apollo and a Canadian pension fund have teamed up with Residential Land to set up a London PRS fund; and AXA would like to invest in the UK private rented sector.
Britain’s biggest asset class
At about £4.3tn, housing is the UK’s largest asset class. In the past decade, the private rented sector has boomed and now accounts for 16% of the housing market, and is worth £839bn. “Our little private rented sector is 50% bigger than the commercial property sector,” says Jopling. “The scale is there.”
Some of this growth has come because many cannot afford to buy now; the squeeze on mortgage finance has pushed them into renting. But even if the credit crunch eases, demand and supply are badly out of kilter, especially in London and the south-east.
There is a housing shortage and longer life expectancy, more single-person households and net immigration are putting further pressure on the market. Renting is also losing much of its social stigma and becoming another stepping stone in tenure. ‘Generation rent’ is here to stay.
However, private landlords are largely small-scale amateurs. Most of them own less than five properties; only 1% own more than 100, equating to under 2% of the UK’s housing stock.
Much of what is available is not good only 16% was built in the past decade and nearly three-fifths doesn’t meet the government’s ‘decent home’ standards.
Size and clustering matter
To run rented housing cost-effectively, size and clustering are crucial, to provide economies of scale in both management and services.
“In large blocks, you get efficiencies by having one set of contractors looking after the communal areas and the inside of a block; the electrician understands how the block works,” says Neil Young, whose Young Group manages £150m of its own and clients’ rented housing.
Plus, by building properties specifically for letting, the quality can be controlled and yield-boosting efficiencies designed in.
The management headaches and reputational risk involved in being a residential landlord are often cited as deterrents. However, Young argues: “If you are responsive and keep your tenants happy, they’ll stay longer, you won’t have the voids and your life becomes easier. A lot of it is communicating well and first impressions.”
He says the risk of reputational damage the proverbial pensioner being evicted on Christmas Day – is overstated. “I’m not saying you can zero it out, but you can mitigate it by doing everything by the book.”
Richard Simpson, managing director of property at student housing specialist UNITE, says the quality of the organisation is the “absolute key”.
He told the BPF’s residential conference last month: “The investor is not looking for you to be a proxy for the performance of the residential asset class, but to understand where the risks are and have a plan, an expertise to navigate around them, and spot key opportunities to outperform.
“When you can demonstrate that with a good track record, do it credibly and bring a balance sheet that gives greater comfort to investors, co-investment starts to flow really well. That has been developed in the student sector in the past decade. It’s a really important part of creating a proposi-tion that attracts institutional investment.”
The investment case for residential also stacks up. IPD’s index shows it has outpaced commercial property and equities over the long, medium and short term. While capital growth has driven much of this perform-ance, income return from rented housing is not as low as most people think.
IPD’s headline figure for rented housing returns is 2.9%, but outside central London’s priciest areas (tracts of which are owned by the great estates), the average net income return is 4% – still less than commercial property, but not dramatically so.
However, this may not be enough to attract UK institutions. “If yields are 3%, you have to be pretty confident of house price growth to get to an attractive return of say, 7%,” says Mark Callender, head of property research at Schroders. “We just don’t believe that over the next 10 years we’re going to see much house price growth in the UK, mainly because of the unavailability of mortgages.”
Callender argues that UK house prices are being sustained by very low interest rates and are still overvalued relative to income. Equity-poor, first-time buyers cannot get onto the housing ladder and they underpin house prices.
“The owner-occupied market dictates prices for private rented accommodation, as it is the exit route for investors to sell to occupiers,” says Callender. “You’re not going to get house price inflation for five years or maybe 10. So you’re left with income of 3%, which isn’t attractive to us.”
However, Schroders is thinking of investing in key worker housing. “It is a completely different part of the market, but one where we think you probably can get a reasonable yield and potentially get some income growth as well,” says Callender.
London dominates the market
Most of the current investment interest is focused on London and much of it on prime, central areas. But London is a ‘world city’ with an economy disconnected from the rest of the UK; foreign equity has flocked in to invest in what it perceives as a safe haven.
As Savills notes, prime central London housing has bucked the national trend, with prices now 9.7% above the former 2007 peak, while prime regional markets are still 16.3% down. It forecasts 6% average UK house price growth in the next five years, but expects London to outstrip this with 19.1%.
But whatever the indices say, a new force is compelling institutions to look at the private rented sector: IPD is incorporating housing into its annual UK index.
Robert Houston of St Brides Strategic Advisors thinks this could be the single most significant event driving them into the sector. “Every quarter, every consultant and manager has to answer the questions: ‘How much have you got against residential in the benchmark? Residential seems to have outperformed – why are you underweight?’ They’ve never had to do that before,” he says.