Property, an alternative asset class

When the Private Rented Sector Initiative (PRSI) was created by the government in 2009 institutional investors in the UK were slow to take up opportunities presented.  Since then increased focus on housing supply and a recognition that overseas investors –  familiar with this model in their own countries– have benefited from UK schemes, have highlighted some very real prospects.

Over 20% of UK households live in rental accommodation, a figure that has more than doubled in the last two decades and continues on an upward trajectory.  The demand for housing nationwide continues to vastly outweigh supply and the government is committed to building 240,000 per year by the end of 2016 a figure still 8% below the estimated need.

RISK AND MITIGATION

With existing plots ‘ready-to-go’ the trend is for investors to forward-fund construction of PRS schemes with housebuilders, who have a ready-made supply chain, rather than take on the additional risk involved in the purchase of development land.  Investors who engage in these opportunities can see a return far quicker than when starting from scratch.

Void periods come with the territory in rental investment and research from the Association of Regulated Letting Agents (ARLA) in July suggests the average length of voids is 3 weeks, exactly where it was 5 years ago.  But as average tenancy lengths in the UK have risen from 6 months to 18 months, and rising, the frequency of void periods has reduced by 66%.

graphPlanning consents continue to be a barrier to PRS schemes, classed in the same category as open-market property which puts PRS developers at a disadvantage when the obligation is to maximise the value of a consent but there is hope that with a new mayor, a new prime minister – with a strong social leaning – and a new team in the department of housing we may well see new conditions in favour of PRS, potentially allowing PRS in lieu of affordable housing obligations.  This is purely speculative but worth watching as the landscape changes.

Ongoing scheme management to maintain capital values has been a concern but today there are a growing number of professional PRS operators available to ensure long term security.

The largest question mark is perhaps around SDLT and the punitive 3% surcharge now applicable to all ‘second home’ or ‘buy-to-let’ investments.  During the consultation phase the British Property Federation (BPF) proposed an exemption for institutional investors with 15 or more units but this was thrown out by the last Chancellor.   Again this is worth watching in the new political environment as calls to review the latest SDLT reforms get louder across the entire real estate sector.

TAX

The recent surcharge impacts a £30m scheme of 100 units with a £900,000 rise in tax payable; that valued at £50m has an increase of £1m in SDLT.   But research from the world’s leading real estate adviser CBRE suggests that the lower deals accepted by a number of housebuilders in order to maintain liquidity is effectively compensating for the SDLT.

Commercial stamp duty also rose in the last budget jumping at the top rate from 4% to 5% and impacting land deals but this might be the lesser of two evils.

Backers who structure the deal as forward-funding can mitigate tax liability by buying the land and funding development in a series of costs during the build.  This means that the tax is paid on the land, at commercial rates, rather than on the value of the completed development.

Additionally those purchasing six or more units can choose to pay tax at commercial rates to avoid the residential surcharge but if the average property price is less than £275,000 it is cost effective to pay the residential rate plus 3% and apply Multiple Dwellings Relief to reduce the applicable duty.  If the average price is £333,000 or more commercial rates of SDLT with no additional charge is the cheaper option.  (source KPMG)

It should not be ignored that the secondary market will still be impacted by the surcharge but when seen as a long term prospect, by the initial investor, the SDLT can be absorbed.  In the last month the London-based housing association with the largest PRS development programme in the UK, L&Q, has confirmed its commitment to buy or build 5,000 market rent homes by 2026, absorbing the SDLT into contingency funds across a ten-year plan.

Notting Hill Housing has also confirmed its plan to build 700 market rent homes by 2021 – these on sites already owned so the SDLT has been paid.  Going forward offers on land purchase will need to take SDLT rates into consideration but it is a relative scenario across the market.

THE ZEITGEIST

What makes this the end user a long-term proposition?   A number of factors underpin the reality of ‘generation rent’, most prominently the lack of supply which has pushed capital values beyond the reach of the average home-buyer while earnings are static and banks are adopting increasingly strict lending criteria.

The increased normality of renting has also triggered a positive trend for renting among the upwardly mobile as much as for those forced into it.  We are seeing a European model of flexibility develop as property ceases to be readily available or even moderately accessible.

Prices aside, the next generation wants to be nomadic to follow the best career moves.  Trends today follow a ‘work hard, play hard��� theme and status symbols increasingly include quality cars, exotic holidays and high-living over bricks and mortar when that which is affordable to relatively high earners no longer correlates with the areas convenient for work or preferable for lifestyle.

Family considerations have also changed.  The average age for a woman and man to have their first child are 31 and 36 respectively – way beyond traditional ages which used to dictate the first rung on the home-ownership ladder.  Many have become comfortable with a flexible tenure and are happy to avoiding the high costs of selling and buying as families grow and school catchment areas become a consideration.

Independent real estate consultancy Knight Frank estimates that the UKs growing build-to-rent sector will be worth £50bn by 2020.

SUMMARY

Stability, consistency and opportunity support investment in PRS for portfolio diversification.   Comparison with other alternative investments over the past 20 years show the strongest returns and investment underpins housing developers, associations, building firms and even modular construction.

Uncertainty around the stability of the pound has created new prospects for institutional investors as housebuilders look to sell completed stock at prices to mitigate increased SDLT for long-term prospects.  In addition, the new political climate just may feel the pressure to reform punitive tax measures and ease up on planning restrictions down the line.

PRS operations in management are increasingly widespread and the end user looks here to stay.  While banks hold back their lending and rents continue to rise investors stand out as the key beneficiaries.

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