A vision of the future: how the rental sector can reward investors

Institutional investors, such as pension funds and investment funds, have been debating whether to dip their toe in the residential property market for years.

Such investment is the lifeblood of the UK’s commercial sector, but despite much talk, institutions have very little exposure to residential property. This fact has often been blamed on factors such as difficulties finding scale of stock, sourcing suitable management companies to run residential blocks and modest income returns.

A new report from Knight Frank suggests that most of these hurdles can be overcome, and argues that recent policy changes by the government could be a tipping point for institutional investment in the residential sector. The Residential Investment 2012 report says that the recent changes to stamp duty for multiple purchases and the upcoming amendments to the Real Estate Investment Trust rules which will make it cheaper for REITS to start up, and relax the rules around ownership could encourage the development of residential REITS. This in turn could make it more attractive for institutions to funnel their money into residential property.

While the luxury property agent says that near-term investment is likely to be opportunistic, it adds that the rule changes could lead to a significant shift in the medium-term. But what can institutions do about suitable stock? James Mannix, head of Residential Investment at Knight Frank, shares his blue-print for residential investment in London.

Zoe Strimpel

Amajor problem facing institutional and other investors who are keen to get involved in the private rented sector is that income returns appear poor. A major cause of this is that the units are designed for the needs of the sales market rather than the rental market. The issue of poor income becomes acute in prime areas since the sums tenants will pay in rent varies relatively little between central areas. This contrasts with the sales market where buyers are driven by emotive factors rather than strict calculations of monthly outgoings as in the rental market. As a result, sales prices can vary significantly between areas and depending on their position and aspect. A flat with a river view, for example, will sell for much more than a flat in the same building without a river view. This variation does not exist to the same degree in the rental market. Most young professional tenants in good areas of central London have a budget of between around £200 and £350 per week per person and will not be prepared to exceed their budget. Once prices exceed these levels, the prospective tenants are likely to look elsewhere for cheaper accommodation whether it be a smaller flat, or an alternative location.

As a result of these dynamics, rental yields in good areas of central London look low. So what is the answer to the problem? Given that location and the cost of land cannot be controlled, and ignoring any planning or tax break that may provide a short-term (and unreliable) solution then the answer must lie in the type of accommodation which is being provided. The challenge for investors is to design a building for the rental market in London which caters for the demands of the tenants and produces good income return. This building will need to disregard the safety net of the sales market and may, as a result, look very different from the residential buildings which are currently produced.

Most of the units would be for solo (or couple) living, and be around 175-250 sq ft to keep the price low. There would potentially be some larger units on the higher floors, designed for households sharing rent. Tenants would enter through a large hotel-style lobby on the ground floor. In addition to the concierge service, tenants would also benefit from other services such as basement storage, large lifts for moving furniture and Wi-Fi access. Other services available for a charge would include laundry, room service, gym and food deliveries or fridge stocking. The income from these services would help boost revenue.

While most of the units would be let on standard AST leases, there would also be a short-let licence to enable a proportion of units to be booked on an overnight, weekly or monthly basis, again generating higher revenue. This type of building will substantially increase the rental returns offered over traditional apartments.