Matching growing investor appetite for residential with the realities on the ground
Property Week
The appetite to invest in residential property by commercial investors is at the highest level I have seen for two decades. Several factors are at play - poor performance from traditional investments is pushing investors to so-called alternatives of which residential is one. Weak demand for owner-occupied housing and constrained mortgage lending are hindering growth in new housing supply and putting extra pressure on the rental sector. As a result, house builders are having to consider how to broaden the pool of demand.
While demand for rented housing remains robust and rents continue to rise, it comes as no surprise that build to rent has crept up the agenda. A central theme of the recently published Montague Review, build to rent has the potential to kick-start new housing development and support economic growth. Put simply, Sir Adrian Montague’s recommendations have created a clear policy push for more rented housing and new sources of funding. The stars may be lining up but there is still plenty of hard work to be done before commercial landlords can begin to compete with private investors. Private investors continue to spend bilions a year buying direct into the market with mortgages or cash.
Rents are rising but the headlines are often misleading. The fact is, rents today are broadly in line with where they were four years ago (see figures 1 and 2). London is the stand out exception. Here rents, over the same period, are 14% higher. The sheer scale of demand in the capital has meant that rents have grown at an average rate of 5% per annum over the last two years, while elsewhere rental growth has averaged 1 – 2% per annum.
One central driver of rental growth has been higher levels of occupancy for private rented homes compared to the owner-occupier market. Over 50% of market rented homes in London are fully occupied compared to just a fifth in the owner-occupied sector. This means that there are often multiple household incomes in a residence to help pay the rent - the luxury of having a spare room is a thing of the past for many tenants in London. Across the rest of the country occupancy levels for private rented homes are three times higher than for owner occupation.
The pressure on households unable to access outright home ownership shows little sign of improving in the medium term. The net result is that away from London tenants are paying a monthly rental premium of 5-10% over the cost of buying a property - the cost of not having sufficient equity to buy a home. In markets with high capital values, renting is still cheaper than buying but with high absolute rental values. In London the average rent of a two bed home is three times higher than that across the rest of the country.
A modest bounce-back in residential capital values over the last three years has encouraged private investors to enter the market. Buy-to-let investors account for around 7% of all residential transactions, down from a high of 11% in 2007 and lower still in absolute terms. The credit crunch has not squeezed this market as hard - maximum loan-to-values are 70% and lending margins are wider. Cash buyers are often ignored but now account for over a third of all residential transactions c. 320,000 in the last 12 months.
There is no definitive data but I would not be surprised if there were more investors buying with cash than with buy-to-let mortgages at present (see figure 3). Assuming a quarter of cash buyers are investors, then together with buy-to-let landlords, these private investors have bought residential assets with a collective value of over £25bn in the last 12 months. Questions are being asked as to whether capital values might be distorted in some markets where investors dominate. There seems little evidence of this although capital values remain generally more volatile than the long run trend. While rental supply has been growing at an accelerating rate over recent years we don’t expect rising supply to materially impact rental growth in the short term. The over-riding strength of demand means we expect rents to keep rising but growth will be capped by affordability constraints.
While private investors have invested heavily in the residential market this highly disparate demand is not sufficient to pump prime the delivery of new housing which is a key Government priority. Widening the sources of demand for new housing from just private buyers and housing associations is vital to enable the delivery of more homes. The Montague Report and the recent announcements by the Government to help stimulate the supply of rented housing are important for a sector that has in the past failed to be seen as part of the solution. This is a very important signal from Government. Debt guarantees of up to £10bn and a £200m equity fund to pump prime schemes will help but the delivery of more rented housing seems inextricably wrapped up in the thorny topic of land viability.
House builders have not embraced the build to rent model. The reality is that the value of a private rented home is around 75% to 80% of open market value on a net present value basis. No builder plans to sell private housing at this level of discount. The Montague recommendations were that local authorities review their affordable housing requirements and consider developing private rented homes. These attract a lower discount to open market value than affordable homes without any capital subsidy (typically up to 70% from open market value). Alternatively there is the potential to take developments with a mix of private and affordable housing and deliver 100% private rental schemes.
Montague recommended a Housing Taskforce to assist local authorities with build to let appraisals. The question is whether local authorities will be prepared to forgo the delivery of new affordable homes in exchange for other tenures that enable housing delivery in their local markets. At least until the wider housing market starts to register a sustainable recovery which will then start to slowly unwind the viability challenges facing many schemes.
While there has been a welcome shift towards the role that the private rental market can play, and growing investor appetite, the sector is not a panacea for the greater ills facing the housing market. The single biggest reason is that the private rental sector is not a viable tenure in many parts of the country. Seventy five percent of lettings in the last year were concentrated in just a quarter of the UK by area. Hometrack has developed a rental market classification (see figure 4). So-called ‘mature’ private rental markets with high concentrations of rental supply and strong turnover have a differing regional coverage. The rental market will continue to grow but this growth will be concentrated in urban locations where there is a deep pool of demand. Using the private rented sector to stimulating housing supply in other markets is less of an option and getting investment into more ownership forms of housing tenure such as shared equity or shared ownership will form the primary solution.
Hometrack’s Rental Market Report is used by housing associations, local authorities, developers and investors to gain a clearer picture of what’s happening to rents at a local level. Click here to find out how Hometrack’s Rental Market Report| could help your business