Written By: Richard Green
Richard Green of Venn Partners looks at the reasons behind the growth of the private rented sector in the UK and predicts its future development into an institutional grade asset class
“I like this place and willingly could waste my time in it” wrote Shakespeare in As You Like It. And it may be that the British are now getting to like a new kind of place to live in, one already much better known in many other parts of Europe and North America.
The Private Rented Sector (PRS), institutionally owned and professionally managed developments of rental homes (known as multi-family housing almost everywhere else, but what’s in a name) is now finally taking root in the UK.
A new product for the UK
Rental accommodation in the UK has traditionally been delivered by social housing providers and a fragmented army of individual and small scale buy-to-let investors – over two million of them. For the first time, in 2013 the latter provided more homes than the former as rates of social housing, as well as home ownership, continue to fall – a trend that has been dubbed “generation rent”.
Like the development of any new product, the trail has been blazed in only the last few years by a small but growing number of innovators and early adopters. Delivering housing however has a long lead time, and so their completed work has only recently begun to be offered to tenants.
The lack of familiarity with PRS by customers, which is very much what these new businesses focus on – tenants needs – means that the product has yet to become mainstream, but you can begin to sense the tipping point approaching in the next few years. As each new development is launched, it is often being fully let in half the time and at higher rents than projected. This will offer tenants a greater choice of options to match their lifestyle, and in a recent tenant survey over 80% of respondents said they find the idea of such institutional, branded providers as appealing.
Learning from Europe and the US
People in North America and many parts of Europe may be forgiven for wondering what all the fuss is about, given that a similar offering has been available on a large scale for decades. Not surprisingly there are now an increasing number of large established operators from these countries (especially the US, Canada and Germany) starting businesses in the UK alongside the domestic ones, who are often themselves flying out in the opposite direction to see what they can learn.
As you might expect, each country’s market has developed with its own particular characteristics. We see a broad range of business models being built in the UK, from providing tenants with a more basic box, to mid-market products with a range of amenities to highly-amenitised higher-end products, in- and out-sourcing of services, London versus regional focus, distinct designs, and a variety of lease terms. In common, many are focused on achieving scale, building retail brand names, operational efficiency, service quality, developing communities to help retain tenants, and making smart use of technology. Interestingly, to meet some of these aims some are recruiting from the hotel industry.
Tip of the iceberg
Importantly, the limited amount of currently visible finished product is just the tip of the iceberg. As the number of players in the market grows there is a deepening pipeline of projects at the different stages of development – in construction, in planning, in design, in acquisition or in a new business plan. This increasing competition means that land values for good sites, particularly around London, are rising and yields moderating, encouraging more to look at opportunities in other major cities and regions.
In every case, three core ingredients need to be mixed together. There need to be sites and development experience, operating experience and investment capital. There are a number of high profile joint ventures in the market, and in light of their success there is a dating game going on between parties with some, but not necessarily all, of these core requirements.
Accelerating institutional appetite
The theme underlying all of these developments is the long-term structural housing shortage in many locations across the UK, accentuated by the positive economic backdrop and a growing population – some forecast rental growth at 3-5% outstripping house price growth in the future. This situation is attracting institutional investors at an accelerating rate.
In addition, in terms of relative value it offers diversification from other asset classes and other types of real estate. Also on offer are benefits from government support, including the £3.5 billion PRS housing loan government guarantee scheme that we manage, which provides PRS operators with minimum 10 year investment loans that are funded by the issuance of government guaranteed bonds.
If this new PRS sector is able to continue its current trajectory, many believe it has the potential to play a significant role in addressing the UK’s housing shortage in the future. So far, domestic investors include the likes of M&G, L&G, Aviva, and Hermes and European investors include APG and Patrizia. North American investors include Realstar, Greystar and Ivanhoe Cambridge and Middle Eastern investors involve Qatari Diar and Abu Dhabi Investment Authority.
Most are private investment vehicles, with some existing corporate balance sheet investors. In time, as the market begins to mature, some of these businesses will begin to attract further capital through the public markets, as happens in other countries, including IPOs, REITS and other investment fund formats.
Towards a standalone asset class
The PRS market in the UK is at a crucial stage of its early development, and there are always hurdles, but it continues to gain momentum and the current direction of travel suggests it is moving towards the establishment of a standalone and institutional grade asset class within real estate investment – becoming a mainstream product.
In this sense, it may be compared to the student housing market in the UK, where increasing professionalisation over the past 15 years has created an institutional grade asset class.
The analogy ends there as many experts expect the PRS sector to be far larger, with some of the large valuation firms estimating that it has the potential to be £30-50 billion by 2020. Those building these businesses clearly then hope to create successful, scaled and stable cash flow businesses that create significant value for them.
It seems the British, like many others, will like these places to live in.