PRS – Challenges for growth and funding
The private rented sector (PRS) is currently one of the most talked about residential markets in the UK.
The sector has more than doubled in the last 14 years and all trends indicate that demand from “Generation Rent” is here to stay. Despite this, there is still caution when looking at buy in for the next step – institutionally funded, large-scale, professionally managed private rented developments of purpose built apartments with investment at the build (to let) stage. Boodle Hatfield gives its perspective on the challenges for further growth and funding in the sector.
Historic concern with low yields has been one of the most significant stumbling blocks to the growth of PRS. Low yields stem from a combination of factors. From a London perspective, the high capital values of land in London drag income yields down. High management costs associated with residential (as compared to commercial) further weaken net yields. A long-term strategy (dependant on income returns) is, therefore, required for PRS schemes to be viable along with relatively higher rents or lower land, construction, and management costs (or combinations of each).
Whilst concerns about low yields continue to hold back investment to some extent, the attraction to institutions looking for long-term income investments is growing due to the acknowledgement of various factors (strong performance of residential, the continued growing demand for private rented specifically, greater acceptance that many rolling tenants can provide security and an understanding that schemes must be in the right location and at the right price to ensure yields do match investment requirements).
Competition for land (particularly in London) continues to be a major obstacle. PRS developers say they cannot compete in the open market in acquiring land against those acquiring for build to sell. Some successful PRS schemes have benefitted from land subsidies from the public sector to make them viable (e.g. partnership and JV deals with local authorities). The reality is that in most cases build to sell continues to be more lucrative. Acquiring land or stock for PRS is problematic except in special cases such as sites with hostel use and PRS business models with small unit sizes.
Large ready-made blocks of rented houses and flats are the preferred target for institutions, as they avoid the upfront costs and risks associated with planning and construction and provide a scale investment. At the desired scale though, opportunities have tended to be few and far between and one of the main obstacles for investors is the ability to acquire a critical mass of stock in one location. Institutions do not want to buy a scattered portfolio of individual assets and prefer large developments, where they can minimise management costs and other overheads. As interest for build to let grows, it is clear that closer co-operation between the stakeholders (government, investors, local authorities and registered providers) is required to see that interest transformed into actual investment. This is something we are seeing being explored more and more between the stakeholders now as a means to access the land (and scale of sites) required to meet the growing private rented demand.
Failures in the planning system continue to hamper development generally (and, in many common areas, PRS schemes). Specific to PRS though, whilst the distinction is starting to be understood (and National Planning Practice Guidance now recognises this) the planning system has not uniformly grasped the differences in the PRS viability model versus build to sell. This continues to create challenges for the developers in accessing land on equal terms to build to sell. Planning authorities that do understand the viability differences for PRS development are being more flexible in the application of planning obligations where schemes can demonstrate policy-led S106 expectations are unviable. However, the inconsistent approach by planning authorities will continue to create uncertainty and hamper the creation of larger schemes sought by institutions.
Lack of track record has been a key factor in the struggle to bring forward and fund PRS on a significant scale. Local authorities may understand the drivers for PRS but not be familiar with how to put the wheels in motion. From an investors’ point of view, lack of data creates nervousness – some investors also blame a lack of suitable partners and general shortage of expertise and experience in building and managing PRS schemes. However, the tide does appear to be turning with dedicated PRS expertise continuing to be bolstered across the industry. In many ways, this is similar to the position with the growth of purpose built student housing circa 15 years ago. There was a lack of confidence in that sector at the time as there was no data to show that (student) tenants would provide a continued and stable rental income (albeit on short term tenancies) nor that preference for purpose built accommodation would grow.
The growth of PRS (including attracting much needed institutional investment) has been an objective of the current government for some time. The expert PRS taskforce was set up in 2013 bringing together policymakers, developers, housing associations, and institutional investors to accelerate the status and development of the PRS. The government also launched its flagship funding scheme (the £1 billion Build to Rent fund) in December 2012. Despite governments objectives though there has been criticism on progress. Whilst the government has claimed the scheme is on track, figures unveiled last year gave a different picture (the first phase target of 45 building projects worth £700 million spend on new housing came out at 17 developments at £300 million spend). Despite criticism, others feel (for example, the BPF) that the PRS Taskforce and Build to Rent fund have laid the foundations for long term, large scale, PRS in the UK.
Now with an election looming housing has become one of the key battlegrounds in the run-up to 7 May and, whilst most politicians recognise there is an important role to be played by PRS in the continued housing crisis, there will no doubt be uncertainty in the sector at least until the election. In London, the uncertainty will persist with the mayoral elections in 2016. Looking at Labour and Conservative proposals, Labour reaches out to Generation Rent with promises of three-year tenancies to give “security and peace of mind” and a ceiling on rent rises. Whereas the Conservatives favour less regulation and warn that freezing rents would harm the housing market. Rent controls are blamed for damaging the property sector during the 1960s and 1970s. So, in the short term at least, the political landscape will create caution in the sector.
In summary whilst the potential of PRS is clear, with predictions of the opening of the investment floodgates and rapid transformation of the industry, the sector still faces obstacles in progressing to the next step – large scale institutionally funded schemes. At this stage in the sector’s development, government needs to continue to be a driving force in overcoming the challenges to unlock the sector for investors and in encouraging local authorities (both as landowners and planning authorities) to support PRS. Close co-operation between the various stakeholders will also be key. Private and public sector will need to work together to join up investors, landowners, and developers in order to support the development of a pipeline of institutional standard build to rent opportunities.