INVESTORS have long enjoyed a love/hate relationship with property. An asset class dominated by commercial real estate, it delivers diversification and a reasonable yield in the good times. But in difficult times, upward-only rent reviews vanish, and fund managers are left wrestling with high voids and bad debts.
Residential real estate, meanwhile, has largely been shunned by UK investors, despite its historic outperformance and the steadily growing demand for private rented homes. A typical low to middle income household would now need to save for 22 years to afford the deposit on their first property. Small wonder that a home let by a private landlord is often the only option for members of the new “generation rent”.
With more families shut out of home ownership, private rent looks set to dominate. The UK housing landscape will likely become more like that of the US, where the private rented sector accounts for over 30 per cent of housing stock. In the UK, it is currently a mere 17 per cent.
But despite this apparently compelling growth profile, institutional investors continue to consign residential real estate in general, and the mainstream private rented sector in particular, to the box marked “too difficult”. What explains their caution? Partly it is the lack of scale, a historic dependence on capital appreciation, and a heady combination of development, stabilisation and reputational risk. But above all, it is the uncertainty over the returns they can expect.
However, a new project we at the Resolution Foundation have run with financial intermediary Social Finance suggests that investors can construct a portfolio of scale, fully let, and with limited development risk, and can expect a low-risk income return of at least 4.7 per cent. On these terms, investment in private rented developments begins to look like a stable and competitive proposition. At the same time, this model could provide good quality rental homes within the reach of families on modest incomes – as low as £22,000 for a couple with one child.
So how would this type of investment work? It draws on the expertise and access to preferential borrowing of housing associations that are already building large-scale developments for private rent. Investors would buy a portfolio of these completed developments, already fully let, and take the rental income while the housing professionals continue to manage the homes. By offering three-year tenancies and rent increases pegged to inflation, they would give tenants a security and stability too often lacking in the private rented sector, while keeping maintenance costs and voids low to maximise an inflation-linked return for investors.
This isn’t just theory. The project we ran with six housing providers carefully modelled the returns on a portfolio of almost 800 properties, either already built or in development. Run on these terms, the model demonstrates that the income return on a selected and well-managed portfolio would reach 4.7 per cent, rising to 7.3 per cent on total returns (assuming sale of the properties).
We hope this can help to kickstart a UK market in the private rented sector of the type that already flourishes in many other developed economies. Currently, the private rented sector is dominated by small buy-to-let landlords who own just one or two properties. It is, as the chief executive of Legal and General describes it, “a cottage industry”.
Transforming the housing landscape in this way won’t need new legislation. What it does need is joined-up thinking from local authorities and planners, and leadership from Whitehall and local government. Some public land could be designated exclusively for private rented sector development; planning guidance could set different obligations on private rental developments than on developments for sale (recognising that they work to a different economic logic); housing associations could be given greater flexibility to balance market activity and their core role of social housing in the current government review of their remit.
Institutional investors have begun buying a handful of private rental developments in recent months, yet most of these are in London, where returns are largely predicated on continued capital gains and strong rental growth. This activity is on nothing like the scale that will have an impact on Britain’s chronic shortage of housing; especially housing that’s affordable for lower-income working families. What’s needed is the blossoming of a whole new market in the private rented sector – something to make investors fall in love with property again.
Katie Blacklock is an associate at independent think tank the Resolution Foundation, and a former fund manager.