Build to let has long been vaunted as a major part of the solution to meeting the housing requirements of ‘Generation Rent’ and increasing levels of house building to deliver economic growth from the construction sector.

A silver bullet?

These, together with a desire to improve the choice and standard of accommodation for the burgeoning so called ‘Generation Rent’ are key goals for the Government.

From the perspective of the house building industry it has the potential to increase market capacity otherwise constrained by low levels of housing transactions. It also has the ability to substantially de-risk large development sites, that are otherwise stalled.

However, there are questions over how it would impact on the wider fi nancial viability of such sites by affecting developers profit and ultimately land value.

From an investment perspective, there is little doubt that there is an appetite for residential investment, though the ability to deliver that at scale in a way that meets investors requirements has been less clear.

Government intervention

The Government now has the opportunity to unlock the potential of build to let. In its simplest form it can provide public sector land specifically for such development. It can also provide tax efficient investment structures, such as REITS, to develop and hold that stock.

More fundamentally, to deliver product at scale, it has the opportunity to use the planning system to bring forward the delivery of dedicated private rented sector stock. Consequently, this stock is valued on an investment basis (thereby meeting the requirements of the investment market), in return for lower levels of affordable housing (thereby protecting the financial viability of development). But the financials need to stack up.

Investor returns

In order to understand how gross initial yields translate into internal rates of return we have produced a working example taking a notional investment of £100 (including purchaser costs), assumed operational costs of 30% and an investment period of 10 years with an investment sale exit at the same initial rates.

Table 3 sets out IRRs related to variations on gross initial yield and potential annual rental growth. In terms of understanding how build to let can be made to work from an institutional perspective we need to move away from the concept of a discount to vacant possession value and consider residential in the same way as commercial real estate assets.

This means developing transparency around operational costs to arrive at net operating income and matching these to investor requirements based on net initial income yields and internal rates of return dependent on the intended investment hold period.

Short-term investors will continue to be driven by capital growth where capital growth prospects exist but longer-term investors will be more reliant on income growth and running yields. With rental growth projected to outperform house price inflation in many mainstream markets, there is an opportunity for longer-term investment in the sector.

Short-term investor appetite can be absorbed by existing stock portfolios (acknowledging a degree of aggregation will need to happen to achieve scale) however, as the sector matures the build to let model will become increasingly in vogue.

Taken from
Spotlight: Rental Britain as an Asset Class