Britain desperately needs new housing and supply is being impeded by political wrangling. But it will only be a matter of time before the dam breaks, writes Kevin Moriarty.
The UK residential sector is under the microscope at the moment and this is mainly because of the industry’s structural problems. But while from an institutional investment perspective the sector can be seen as complicated – and heavily influenced by national and local politics – there are interesting returns to be made over the long term.
Lands improvement was formed in 1853 originally to facilitate lending to landowners so they could improve their landholdings. We have evolved since then to promote, develop and sell ready-to-build land to developers, primarily for residential development. This puts us close to some of the issues being debated in the media and we can offer some pointers for investors.
Clearly, the big investment opportunity lies in the huge latent supply-and-demand imbalance in UK housing, which has been com- pounded for too long by low levels of planning consents, a reduction in the volume of new homes built, a lack of investment in infrastructure and periodic changes in government policy.
It is only a matter of time before the UK’s supply-side dam breaks. Further political procrastination is not an option.
The current UK government started its term of office nearly four years ago with a fanfare of changes to the planning system and pledges to ensure decisions relating to development would be focused at a local level. However, the policy with the most impact has come on the demand side in the form of Help to Buy. The initiative has stoked demand, which has benefitted home- owners, house builders and property agents.
Both the main political parties agree that it is the supply-side where action is needed most urgently. Labour leader Ed Miliband recently highlighted the growing economic, as well as social, costs of the housing shortage. “it is also causing deep difficulty for employers, both in the public and private sector,” he said.
His comments echoed the Confederation of British industry’s (CBI) assertion that the cost and lack of suitable housing for skilled employees is the biggest threat to London’s position as one of the world’s greatest cities for business. Labour is now openly calling of the creation of four ‘new towns’ in the south-east, and across the political spectrum there is a real sense of a tipping point approaching on the issue.
So how can institutional investors take advantage? Historically, investment options in residential have been limited. You can buy equities in house builders and estate agents, and these have provided healthy returns over the past two years. on the debt side, residential mortgage-backed securities have re-emerged as a viable vehicle. Yet these options are highly sensitive to economic cycles and demand-side policy, as the last financial crisis showed.
For long-term investors, the most attractive options are in lower-risk specialist funds (and a handful of listed REITs) offering steady yield through exposure to student housing and local authority contracts. There are other options – new investment vehicles targeting the private-rented sector (PRS) are emerging and this does seem an interesting proposition – but it is not yet clear whether this new class of investment will become a tradable asset.
A common theme for all investment classes related to residential is that suitable land for development is a basic requirement. our approach is to focus on the supply-side, investing in a portfolio of land assets, promoting the land over the long term and carefully managing an exit. Taking this approach, consistent overall returns between 15-20% can be achieved. While there are risks, if the promotion of the land and investment in infrastructure is not properly managed, for investors with the right time horizons the return profile from the process of unlocking land is attractive.
Why does this approach work? in simple terms, we take two critical components of the supply-side value chain and own them. An important and often overlooked link in the chain is infrastructure. Local roads, transport facilities, utilities and community facilities such as schools all need to be in place before building can start. The key challenge here is one of timing – to build a house can take a matter of months but the local infrastructure can take years to plan and deliver. Lands improvement creates value by delivering major local infra- structure improvements alongside the planning process, so house building can take place almost immediately following planning consent.
The other key link is the planning system. This starts with ‘promotion’, which involves working with the local authority and its plan for the area, understanding where they see development and which sites are suitable. This in itself can be controversial locally, with politicians sometimes conflicted by the need to build houses and the desire to be re-elected. Central government policy, meanwhile, has changed direction from ‘top-down’ to ‘bottom-up’ approaches. so planning is an area that needs careful navigation. A bespoke strategy for each local authority and the creation of a successful planning application – so that years are not wasted through rejection – are very important.
It is only a matter of time before the UK’s supply-side dam breaks. Further political procrastination is not an option if social problems are to be avoided and the major political parties know it. A major house-building programme of the kind we at Lands Improvement foresee within the next decade will create numerous options for investors and the best returns will be made by those who position themselves early.
Lands improvement has an interesting dilemma. Policy to simplify the planning process will open our area of expertise to increasing competition, so we might be expected to support the status quo. But we sincerely hope the planning regime does open up to become less complex. if house-building is to increase substantially – as it eventually must – then those with specialist skills will be among the winners.
In the meantime, expect more headlines and arguments on the housing crisis and how to solve it – the political debate will continue to heat up, with the future of the green-belt shaping up to be a key battle ground.
Investors who are thinking beyond the historic opportunities for new ways to generate returns from a changed landscape will be those who generate some of the best long-term returns in UK real estate.
Kevin Moriarty is managing director of Lands Improvement