The build to rent development pipeline has grown almost five-fold (478%) over the past five years and there are clear signs of the sector becoming a mainstream asset class, according to a new report from Savills, Investing in Private Rent.
Over the past year alone, the amount of operational build to rent stock has increased by over a quarter (26%) and the amount under construction by a third, bringing the total number of homes completed or under construction to over 50,000.
Last year, over 70 per cent of deals were forward funding and forward purchase deals, as investors shift their approach to risk and accept a lower risk-free premium. Savills anticipates that risk-free rates will rise over the next five years, putting upwards pressure on yields.
“Rising interest rates will put pressure on values across all asset classes. Where build to rent stands out is its ability to mitigate that by driving rental growth and reducing the risk premium as the sector matures,” says Lawrence Bowles, Savills residential research analyst.
Evidence from recent transactions suggests investors are assuming a yield discount of as little as 50 basis points when funding development rather than acquiring operating assets. This is a small discount, given the additional indirect construction risk, the direct market risk when letting an entire development, and indeed on the sheer delay to the income stream of a large scheme.
“As the sector matures, we expect the risk premium attached to build to rent to narrow,” Bowles says. “Residential property in the UK has a long track record of rental value growth. Rents are projected to continue to rise and that will underpin capital growth of build to rent assets, while growing rental demand will secure the income stream.”
Developers recognise the chronic undersupply of good quality, well-managed rented homes, Savills says. They are banking on institutional investor demand for secure, long-dated income meaning there will be a ready market for stabilised rental portfolios when they are ready to sell.
The private rented sector opportunity is huge. It is currently worth around £1.5 trillion, equivalent to 21 per cent of total UK housing value, and has more than doubled over the past decade. It is home to around a fifth of all households, up from 10 per cent in 2001, but over 9 in 10 are owned by private landlords, a sector now coming under increasing pressure from a less favourable tax environment.
Returns from UK residential investments have previously come from capital value growth. But faced with lower house price growth, investors are increasingly committed to the truly long-dated income streams residential portfolios can deliver. “They are letting go of the comfort blanket offered by potentially flipping stock back into the ‘for sale’ market, which they have banked on in the past,” says Bowles.
Historically, income from residential assets has made up a much smaller proportion of total institutional investor returns than other property investment classes. The mature purpose built UK student housing has a proven track record in the UK, a market predicted to attract over £5.2 billion of investment in 2018. The scale of this more mature market indicates the potential scale and importance of build to rent as that market gathers momentum.
“Many of the investors who will dominate the UK build to rent – most notably pension funds - may well not yet have entered the market. In ten years’ time, it will be surprising if your pension doesn’t include at least one build to rent asset.”
Five years ago, the lack of oven-ready portfolios of scale, the challenges of developing without recognition or support from housing and planning policy, the granularity of the asset management and the need for new finance models, were all factors holding back what Bowles describes as the ‘much-vaunted wall of money’.
There was no single catalyst for the changes seen since 2013, Savills says. M&G’s acquisition of the Berkeley residential portfolio that year was evidence that UK funds were in the game. Delancey grasping the opportunity presented by the Athletes’ Village at Stratford was perhaps an even more important moment, giving proof of concept.
This has been supported by a group of pioneers such as Sigma, Quintain and Long Harbour who have worked through the issues of planning, design, delivery, management and branding, while long term players such as Grainger have evolved nimbly to keep pace in a changing market.
Build to rent has gained much greater recognition within planning policy over the past five years, a reflection of much greater political acceptance of the need for more rental homes, especially as pressure grows on private buy to let landlords.
To read the full report please click here.