The IPF has been promoting the residential agenda among UK institutions. Robin Goodchild and Pam Craddock highlight the main issues
As the real estate markets of the world become more integrated, national anomalies become more apparent. The UK residential market is an excellent example. In most countries, institutional property portfolios include a meaningful exposure to the residential sector but in the UK it is negligible. While there is a significant variation in exposures, the global norm is around 15%.
It would be reasonable to expect that the main reason for this lack of investment is poor risk-adjusted returns. However, this is not the case, based on all the available evidence. Residential has delivered highly attractive long-term returns relative to the other main UK asset classes at modest volatility as well as low correlation. This would suggest that residential is an ideal asset for institutions to own.
Another reason could be political risks, which are always greater with residential than commercial, because shelter is a human right, so special government intervention has to be expected. For a long time strict rent controls were in force in the UK and private renting was positively discouraged. During this period, a number of insurance companies had bad experiences as private landlords, leaving deep scars in the memories of institutional investors.
However, the rules have changed markedly since the introduction of assured short-hold tenancies in 1989 and, as important, the Labour government of 1997 actively encouraged the private rented sector, in marked contrast with previous socialist administrations.
As a result, the climate for institutional involvement is today very different from the 1970s or 1980s. Institutions have been slow to respond, while individual investors have embraced the opportunity. The buy-to-let mortgages market has grown from nothing to over £150bn (€180.2bn) in the past 15 years.
This sum is comparable with the whole Investment Property Databank (IPD) commercial property universe. Moreover, the UK coalition government has continued to promote institutional activity by adjusting stamp duty land tax, so portfolio transactions are taxed at the same rate as individual units, not the total purchase price, so levelling the playing field between individual and bulk purchasers.
The Investment Property Forum (IPF) has been keen to facilitate the debate around institutional investment in the sector. As a result of member interest, the IPF established a residential special interest group in 2009, under the leadership of Peter Pereira Gray, deputy CIO at The Wellcome Trust - an experienced investor in the sector.
In line with its mission, the IPF seeks to enhance the understanding and efficiency of residential property as an investment, including public, private, debt, equity and synthetic exposure, for its members and other interested parties, including government, by:
• Undertaking research and special projects and ensuring effective communication of this work;
• Providing education;
• Providing a forum for fellowship, discussion and debate among members and the wider investment community.
The IPF published research on the subject in 2007, ‘Large-scale Investor Opportunities in Residential Property: An Overview', by Professor Michael Ball, a leading academic in the field. The study identified a number of challenges in residential investing for institutions, as well as significant attractions. The IPF will be commissioning further research on more specific issues, for example, the impact of valuation practices on residential investment, as part of its 2011-15 research programme.
The residential special interest group held a seminar last year that was well received, and a series of workshops is planned for 2012, including sessions on social housing and on experiences from European investors in managing continental residential portfolios.
The group will also continue its interaction with the government. It played a leading role in drafting the Property Industry Alliance's response to a formal consultation paper, ‘Investment in the UK Private Rented Sector', released in 2010. While the initial reaction from the Treasury was unhelpful, subsequent interaction has been much more productive resulting in the changes to stamp duty land tax, as well as enhancements to the real estate investment trust (REIT) regime that will encourage investment in property generally.
There are a number of genuine obstacles to institutional investment in UK residential property. However, other issues are more perceived threats than real ones. The UK residential sector is in crisis with supply at its lowest output in peacetime since 1923; this level is inadequate to meet current needs, never mind future demand from an increasing population. Furthermore, supply is tightest in the area of greatest demand - London and the South East. The potential for institutional capital to fill this gap is enormous.
There is also considerable scope for institutions to increase standards in residential management. There would be considerable benefits to society in having responsible, reliable management that treats tenants as customers. One concern among institutions about residential investment is reputational risk. An undertaking to adhere to a management code of conduct, with rewards in the form of tax breaks to those landlords that comply, could be a win-win for all.
UK institutions have resisted the benefits of residential investment for some time, but market and political events suggest this could change over the next few years. The IPF intends to play an active role in promoting the debate around increasing institutional involvement in the sector, which could have significant benefits for both investors and government.
Robin Goodchild is chair of the IPF residential special interest group and Pam Craddock is IPF research director