Build to rent development

The continued expansion of the private rented sector has seen government show its commitment to increase supply by supporting build-to-rent development. The HCA Build to Rent fund was increased five-fold to £1 billion in the last Budget as a response to high levels of demand from public and private providers.

A first round of 45 projects, a quarter of which are in London, are currently going through the due diligence process. Those that make the grade will soak up between £500 million and £600 million of the funds. This leaves a sizeable sum for the second round of funding later this year or early next year.

The Government has estimated that the first phase of activity will deliver up to 10,000 rental homes. This in itself will not transform the market. But the proof of concept these deals provide – setting out the models that work for all parties – will create a new market for residential property investment.

We are also beginning to see evidence of large scale investment into the private rented sector from institutional investors. Recent acquisition by PRUPIM, now renamed M&G Real Estate, of Berkeley Homes private rented property portfolio and the tie up between APG Asset Management and Grainger plc on a £349 million portfolio, are a significant step forward.

How to make it work

1. Know your market

Research is essential to gauge local demand. Though the census data suggest the private rented sector accounts for 18% of all households across England and Wales and an estimated 11.6% in Scotland, levels tend to be concentrated in urban areas.

Establishing the profile of your likely tenants is key. Consider their earnings and the split between private and social renting in the area and their income. A high proportion of private tenants receiving housing benefit could have a significant negative impact on rental returns because of welfare reforms. The challenges of renting to private tenants differ from social housing. Tenants paying market rent have a different set of expectations and demands.

2. Understand your partners

Investors

Institutions have traditionally been put off by the granular nature of the residential sector. Although the private rented sector is worth about £840 billion, much of this housing is in the hands of small buy-to-let landlords. Less than 1% is owned by major corporate landlords. This is changing. Build to rent offers economies of scale that appeal to large institutions.

Rental income is also an ideal liability match for investors such as pension funds seeking long term value growth. Unfamiliar with building and managing a residential portfolio of scale, most seek to set up joint ventures with existing developers and operators in the residential sector.

Developers and Housebuilders

From the perspective of housebuilders, build to rent has the potential to increase market capacity otherwise constrained by low levels of housing sales transactions. It also has the ability to de-risk large development sites, that are otherwise stalled. There are downsides, a straight swap from private sales to market rent would reduce land value. A mix is more desirable.

3. Make it viable

Trade offs between the number of affordable, market and privately rented units is essential to make the model stack up financially. Planning authorities may need to provide greater flexibility on planning consents, and agreement over the length of private rented sector provision and Section 106 demands. Working across higher and lower value areas may help balance the trade-off.

As Table 1 (below) illustrates, neither substituting homes for private sale with homes for private rent nor creating a development that is letting-only will bring land foward for development. A mix of all three tenures is essential.

4. Risks and returns

Over the past 20 years, UK residential property has outperformed commercial property and other mainstream asset classes on the basis of total returns.

In the past low yields have been cited as a major barrier to wide scale institutional investment. This is changing as lack of opportunities for investment in other asset classes, together with prospects for rental growth, are prompting a broader range of investors seeking long-term steady income to look at residential property.

Savills forecasts rental growth of 20% between 2012 and 2016. But rents will fluctuate over this period and growth will vary between region, neighbourhood and sectors of the rental market.

We expect stronger growth in London and the South East, particularly in areas with a high density of affluent renters. Where there are high concentrations of tenants on housing benefit, growth is likely to be reduced.

Rental yields reflect the high cost of housing in the South compared with the North. Savills Investment Deals database shows that the average gross yield varies from 5.3% in London (where medium term capital growth prospects are strongest) to 8.9% in the North West (where income returns are expected to make up the majority of total returns in the next five to ten years).

Planning ahead

After an initial period, you may need to plan for modernisation or replacement. Should demand for rental homes fall or your objectives change, selling the portfolio to an institutional investor is an option to explore. The cost of voids, maintenance and repairs must be weighed up against the prospects for rent and possible capital gains. Those aiming to sell must ensure that all records are transparent and include details on rents, voids and tenant profile. Portfolios which include tenants on housing benefit are less attractive to institutional investors than those without. To get the most out of market rent, an asset management approach is advisable.

Taken from
Market in Minutes: Market Rent Opportunities