Are institutions close to entering the UK housing sector? Robin Goodchild outlines the obstacles and solutions
The UK government has finally recognised that it is important for the country to have a vibrant privately rented sector (PRS). The PRS has increased from 10% of the stock in 1999 to 16% at the latest count. At the same time, social housing has reduced its market share from 20% to 17% and even owner-occupation has declined to 67%, having peaked at 71% in 2003.
And government knows these trends have to continue because there is negligible public money for more social housing, while owner-occupation is hampered by a lack of mortgage finance for first-time buyers and others with little equity.
The PRS therefore becomes the government's best hope for increasing housing supply, which is sorely needed both to meet a chronic, long-term overall shortage and to stimulate general economic growth as construction output is at a very low ebb with the UK economy stuck in a double-dip recession.
What are the government's options for stimulating new development through the PRS? They could provide more encouragement to the buy-to-let market that is dominated by individual landlords with one or two properties (less than 2% of the UK housing stock is owned by landlords with more than 100 properties); but this would require more accessible debt finance - a commodity in short supply today.
The alternative is to stimulate institutional investment in the sector. This has long been regarded as the Holy Grail and has been tried many times before, most recently in 2008-09, without success. Moreover, the government has provided some ‘carrots' already, notably through charging stamp duty land tax (SDLT) on the individual unit value in a portfolio purchase so that bulk investors, like institutions, compete on a level SDLT playing field with individual purchasers rather than incurring a 7% charge levied on all purchases over £2m (as a result of the 2012 Budget). The government has also responded to property industry requests to modify the detailed UK rules on REITs. However, to date these changes have not been sufficient to stimulate activity.
As a result, at the end of 2011, the government commissioned Sir Adrian Montague, chairman of private equity firm 3i and an experienced government adviser, to review the barriers to UK institutional investment in the PRS. In response to this initiative, the Investment Property Forum (IPF) decided to conduct its own survey of institutional investors to better inform its response to Sir Adrian. The results were published in July.
The survey comprised a sample of 54 pension funds, insurance companies, REITs and fund managers. Forty-two entities, managing more than £180bn of global property assets, responded, 28 of which own residential property in a variety of forms. The majority held PRS stock but there were also significant exposures to student accommodation, social housing and development land. Based on the sample of residential property within the IPD universe, which is valued at £3.9bn, residential investors were over-represented on the survey, but this was deliberate to capture the fullest range of views about the sector from experienced investors.
Notwithstanding, the survey revealed that only a minority of respondents held more than 5% of their property portfolio in residential. These can be regarded as the committed investors who favour the PRS principally for the profile of returns it delivers. A number of investors with a small exposure had acquired their residential assets incidentally - for example, as part of a mixed-use scheme.
This group was more ambivalent about the PRS, possibly because it had not established specific management systems, unlike those with more significant holdings. However, 68% of existing investors in the survey expect to increase their exposure to the sector, which could increase their total residential investment by over a third.
A third of respondents to the survey did not have any residential exposure. The main barrier to investment among these institutions is primarily management ("it is just too difficult") plus the level of yield and issues around achieving investment scale. Political and reputational risks were seen as much less significant.
However, over half of the ‘non-investors' expect to enter the sector over the next three years and could commit over £500m. If this investment is added to the expected commitments from existing residential owners, it would still not quite increase the residential exposure in the IPD universe to the 5% threshold for overall property holdings, at which level index tracking investors would begin to take notice and growth become self-generating.
The favoured ideas for helpful government interventions focus principally on tax incentives, especially relief on VAT on repairs and management costs, and changes to the planning system, notably in connection with affordable housing requirements. The planning changes the IPF proposed to Sir Adrian, together with the British Property Federation (BPF) and the Association of Real Estate Funds (AFREF), were formed to stimulate purpose-designed build-to-rent stock through adjustments to S106 requirements, in return for a commitment to let units for a minimum of 10 years. These changes should improve the net yield, which is seen as a crucial barrier to investment.
Sir Adrian's terms of reference specifically refer to the success of institutional investment in student accommodation and the lessons for the rest of the residential sector. Just under half of respondents own some student lets, reflecting the rapid growth of this sub-sector over the last decade, and totalling £1.2bn. Just as with market-rent residential, the returns profile is the main attraction but stability of income and leases formally indexed to the retail price index (RPI) are perceived to be important benefits too. The lack of S106 requirements for student accommodation is a key difference from conventional housing and enables investments with an attractive yield of 6% to be generated.
Overall, the IPF survey has revealed serious interest from some institutions to invest in the PRS. However, key barriers remain, the principal of which is internal to the industry - namely, management, which is just so different than when in relation to commercial property and requires skills that are not readily available. But the government can help particularly by adjusting S106 requirements to level the playing field between social and PRS housing.
Thirty years ago, US pension funds held small allocations, similar to their UK counterparts today. But those allocations have increased steadily as more institutions have come to recognise the sector's attractions (see figure). If build-to-rent projects can be facilitated through legislative change then, by 2040, UK portfolios could contain 25% residential exposures, just as has happened in the US.
Robin Goodchild is international director at LaSalle Investment Management