Risks are fading as pension funds grow more comfortable with build to rent, but don’t expect a rush of activity just yet
One of the greatest ironies about the emergence of Britain’s build to rent sector is that those very institutions which stood on the sidelines for many years were the very companies who owned much of the country’s original residential assets. At the start of the twentieth century, it was institutional, not individual, investors who dominated the U.K. rental market.
With traditional investments underperforming, many institutions are warming to some of the risks involved in moving back into housing, although some are more risk averse than others.
Our work in real estate and with pension funds gives us a 360-degree view of property risk, and we see many institutions are acting cautiously when it comes to placing their money.
While it would be easy to criticise the glacial pace that long-term investors sometimes move with, one has to consider that when investing for 30 or 40 years, a few years difference at the start means little. Given the global backdrop, a degree of caution seems wise: a hard landing in China, another debt crisis in Europe or political upset in the U.S. could all send the world economy into a nosedive.
Brexit certainly came as a surprise to many, but with the dust finally beginning to settle, many are starting to come to terms with life outside the European Union. And for those looking at the rental market, the fundamentals remain the same: demand continues to outstrip supply, with a lack of quality product standing out.
Although the E.U. referendum is now behind us, risks still remain. While the property industry continues to lobby hard on housing, political risk around rent controls or restrictions on density are still on the table.
That is why planning risk remains something few U.K. institutions will touch with a bargepole, and many have entered the market purchasing completed stock from developers.
However, bespoke developments could deliver higher returns than ‘converted for sale’ schemes, which is why the focus needs to be on creating new buildings designed specifically for rent that maximise efficiencies. Many of those backed by U.S. institutions, which have decades of experience in the multifamily sector, are already doing this. Those who are not, risk undermining their position if their assets do not perform as well over the long term.
The main insurable risks with bespoke schemes are during the build or conversion and relate to construction and environmental risk. But care should be taken to consider whether the coverage is correct for all eventualities, for example if the property does not perform for rent and the apartments need to be sold off, although this requires the provision of cost effective 10-year warranties to enable purchasers to secure mortgages.
Above all, managing operational risk is crucial to shore up returns. Given the long term holding of assets, any dent in the building’s performance could impact both operational costs and its ability to retain tenants. Most build to rent projects are offering fully inclusive services with small initial margins, but adverse weather could impact energy bills and undermine profitability. Cover is available to cap these costs and add stability.
Keeping tenants over the long run will be equally important. The traditional private sector is marked by short-term tenancies and while flexibility is required, preventing a high turnover of residents, in turn limiting the number of costly voids, needs to be a priority. Creating genuine communities in which people want to stay will be essential. Tenants can be persuaded to choose these properties over others if there is flexibility with deposits. For example, replacing funding requirements with insurance, which not only encourages the initial take up but also reduces the administrative headaches for landlords.
As the flurry of announcements at the start of the year demonstrated, interest from institutional investors in build to rent has certainly grown. Many now estimate there is some £50bn of potential investment in the wings. But don’t expect institutions to jump in with both feet yet.
This article first appeared in Estates Gazette October 29, 2016.