Shayla Walmsley explores why pension funds should invest in UK residential - but not just yet.
Here are two good reasons not to invest in UK market-rent residential - at least not for the next few years. First, to deliver income, yields need to be considerably higher than their current 3% when commercial yields are around double that figure. Second, the return will depend on the acquisition and sale price - and house prices will likely fall next year, pushed down by unemployment, weak earnings growth and a near-absence of mortgage finance.
That, in short, was the case made by Schroder Property research head Mark Callender at the recent IPD/IPF Property Investment Conference. Even if the rented sector is growing, with 71% of new households moving into the private rental sector, Callender described the UK housing market as "sclerotic", characterised by "frustrated buyers and accidental landlords".
Distinguishing between housing demand and housing need, he said the UK residential market was still fundamentally overpriced and that mortgage deposits required by first-time buyers were close to annual earnings. Although he welcomed the government's announcement of what amounts to a 95% mortgage guarantee, Callender told IP Real Estate that the UK would still need 80,000 new buyers coming into the market each year and that, in recent years, the number has been closer to 40,000.
His conclusion? "Now is not the time to invest in market rent residential."
But is he right? He's certainly not alone. Asked whether he saw traction in private-rented residential funds at a British Property Federation event this week, Helical Bar chief executive Mike Slade said: "Why not? Pension funds want to do it. Every other country does it. But there is evidence in the marketplace of the private rented sector overheating. Renters will suffer the same problems as owners."
The difference between optimists and pessimists for the UK residential market is timing. Callender hasn't given up on UK residential in principle. In the long term, demand and a chronic lack of supply will make residential more attractive, "but that's five years hence".
In the optimists' camp, CBRE executive director Chris Lacey claimed investors were "seeing an opportunity in the UK residential market far greater than they've ever seen before - but it needs new funds and allocations to soak it up". In the US, he said, residential is already a significant part of the market, pointing to the growth of multi-family build-to-let. Yet fewer than two decades ago, the US was in a similar position to the UK's now.
Also on the optimists' side is what Grainger executive property director Nick Jopling has identified as a demographic culture shift away from home ownership, for decades a secular national religion. "Once [the shift] starts, it will be the way forward," he said.
But that's another longer-term trend. In the meantime, there is much talk and a little activity around residential funds. "Within 12 months, we'll see a few of them," said Lacey. "It's like the first call in student housing: the first move is always the hardest."
In fact, there are already signs of investor activity. At the prime end, Cordea Savills prime London residential fund is targeting Asian investors with a model based on joint ventures and pre-construction commitments. But even some prime developers are sceptical that bubbly Mayfair and Belgravia prices can continue to rise, and central London, driven by One Hyde Park, has upped the pricing ante for not-quite-as-superprime assets.
Somewhere in the middle, an eight-year £150m (€170m) build-to-let fund announced by UK property firm Grainger and French construction firm Bouygues is targeting the commuter belt around London with 1,000 new units, avoiding prime sites to mitigate the yield-damaging impact of prohibitive upfront costs. Construction of the first assets will begin in Q1 2012.
Other fund managers are looking at non-traditional strategic options for generating yields above 3%. The paucity of balance-sheet equity and bank debt provides an opportunity for pension fund and other institutional investors to participate in the residential market either via forward commitments or joint ventures - much as Cordea Savills has - then keeping the asset once it is built. For developers, it offers a de-risking opportunity. For investors it gives access to assets at scale - and, as a result of sharing in the developer's profits, a potential yield of 4.5-5%.
Even sceptical Schroder Property reckons a government policy to donate local authority land to housebuilding could provide an opportunity for it to participate in UK residential. If land accounts for a third of the finished unit price, Schroders is looking at funding the development of units that local authorities would subsequently sell in the private market. It gives the institution an exit and involves profit-sharing with local government.
"It's potentially attractive because housebuilders at the moment are not prepared to pay for sites," said Callender. Although the model is as yet unproven, if Schroders opts for it, it will do so within the next year or two.