Rental Britain as an Asset ClassSavills Development Services Seminar SeriesChair: James Coghill, Head of Residential Capital Markets, SavillsThursday 6 September 2012savills.co.uk
WelcomeSavills Residential Capital Markets TeamJames CoghillHead of Residential CapitalMarkets & Affordable HousingInvestmentAndrew BrentnallHead of Funding &DevelopmentPeter AllenHead of Residential InvestmentMarcus RobertsHead of Student Investment &Development
Rental Britain as an Asset Class• Are the market dynamics now right for institutional investment inthe Private Rented Sector?• The Speakers:- Sir Adrian Montague – 3i Group- Martin Towns – PRUPIM- Lucian Cook – Savills Research
Rental Britain as an Asset Class• Government’s housing andplanning package to:• Help deliver up to 70,000 new homes(affordable & FTB)• Provide 140,000 jobs and boost toconstruction industry• With £50bn debt guarantees forinfrastructure & housing• “... they provide a comprehensive planto unleash one of the biggesthomebuilding programmes thiscountry has seen in a generation”David Cameron, Prime Minister.
Rental Britain as an Asset Class• The new measures include:• Flexibility on s106 affordable housingrequirements• The Infrastructure (Financial Assistance) Bill(Debt Guarantees)• £10bn for housing (HAs and developers)• £40bn for infrastructure• Extra £300m for affordable developers (tocover shortfall from planning?)• £200m for market rent sites• £280m extension of “FirstBuy” for 16,500FTB• New loft conversions and conservatories forall!
Rental Britain as an Asset Class• Sounds sensible?• Viability issues resolved?• Is affordability just about deposits?• Debt guarantee for developers a significant step.• Government guarantees for RPs?• Extra funding always welcome for affordable housing -but what about delivering mixed and sustainable communities?• “...will make it easier to build a new home, easier to buy a first home andeasier to extend a home.” Nick Clegg, Deputy Prime Minister.
Rental Britain as an Asset ClassLucian CookSeptember 2012savills.com
19911993199519971999200120032005200720092011The rise & rise of private renting• The number of ‘private rented’households in the UK stands at 4.8million (est).• 5 years ago it was 3.4 million.• 10 years ago it was 2.5 million.• The average deposit for the first timebuyer in the UK in 2011 was £26,000.• 5 years ago it was £12,000.• 10 years ago it was £6,300.5,0004,5004,0003,5003,0002,5002,0001,5001,000500-Private Rented Sector Households in theUKFTB Deposit as a % of Income120%100%80%60%40%20%0%Source: CLG, CML
Buying more expensiveBuying cheaper19881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120122013201420152016Relative costs of buying v renting140%120%Interest OnlyRepayment Mortgage100%80%60%40%20%21%0%-20%-40%-11%-60%Source: Savills, Rightmove
% of adult populationThe demographic driversGeneration RentBoomers & DownsizersAspiring UpsizersLocation of the 20% of LAs with the highestconcentration of Generation Rent & 10 year growth45%40%In the top 10% of local authorities40% of the adult population are ingeneration rent35%30%25%20%15%10%Source: 2011 Census
200020012002200320042005200620072008200920102011Constrained supply• In 2007 the number of outstanding‘buy-to-let’ mortgages increased by189,600.• In 2011 that figure had fallen to63,500.• Since the credit crunch, the numberof private housing completionshave fallen by 46%.400350300250200150100Increase in O/S buy to let mortgagesIncrease in UK's private rented stock• This underpins rental growth50forecasts. 0Source: CML, CLG, Savills
Rental growth forecastsRentalGrowthForecastDisposableIncome percapita2012 3.0% 1.8%2013 3.5% 2.9%2014 3.5% 4.1%2015 4.5% 4.6%2016 4.5% 4.5%Total 20.5% 19.2%Source: Savills, Rightmove, Oxford Economics
In summary• Private-rented households in the UK torise by a further 1.1m (23%) over thenext five years.• The amount of rent paid by privatetenants to rise from £48 billion to £70billion.• £200 billion needs to be invested in theprivate rented sector.• We only expect 25% of this will comefrom ‘buy-to-let’ mortgage finance.• Opportunities for funds & institutions,property companies and private equity.• Linked to contractors, developers &managers.
Build to let - the silver bullet?
Housing Completions and ApprovalsHousing Transactions (‘000s)Development constrained by market capacity70,000UK Private Housing CompletionsPlanning Approvals (GB)England Private Housing CompletionsUK Housing transactions (RHS)70060,00060050,00050040,00040030,00030020,00020010,0001000Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 …Q3 …Q1 11Q3 11Q1 …0Source: DCLG
Build to let - the silver bullet?
Meeting the requirement• Income Yield & IRRrequirements• Scale & Management• Development Viability
Buy to let gross yields8.0%7.0%6.0%5.0%4.0%7.0%6.2%5.3% 5.4%4.4%3.9%Lower Quartile Average Upper Quartile7.7%7.3% 7.3% 7.2%6.7% 6.7% 6.8%6.5% 6.6%5.5% 5.6% 5.7% 5.7%5.9% 6.0% 6.1% 6.2%6.3%4.9%4.6% 4.7% 4.8% 4.8%4.9% 5.0%5.1% 5.1%3.0%North WestNorth EastWest MidsY and HWalesEast MidsSouth EastEast of EngOuter LondonInner LondonSouth WestSource: Savills, Rightmove
Investment evidenceAverage LotSizeAverageNumber ofUnitsGross InitialYieldLondon £26m 75 5.5%Scotland £8m 87 6.8%Southern 4.4m 39 7.2%Eastern 2.3m 26 7.9%North East 2.6m 59 8.8%North West £11m 237 9.2%Y and H £1.4m 24 9.3%Large Regional & National £48m 280 7.6%UK £31m 130 6.6%
Let’s build a rocket boys!Dedicated PRS Term (Years) 10IRR requirement 9%Vacant Possession Value 150,000Gross Rental Income @5.8% 8,700Net Rental Income @70% 6,090Rental Growth First Five Years 21%Annual Rental Growth thereafter 3%Total Capital Growth 32%NPV of rent and reversion 128,500% of vacant possession value 86%Dedicating stock to the PRS for a fixedterm can:accommodate investors IRRrequirements;increase net initial yields; andimprove the ability to fund gearing;BUTthe trade off is a lower GDV whichwill affect development viability or mixThat is affected by the length of therestriction and the investors IRR andrequirementsGross Initial Yield 6.8%Net Initial Yield 4.7%N.B. Illustrative figures are subject to regionaland local variation
Let’s build a rocket boys!Dedicated PRS Term (Years) 10 10 10IRR requirement 9% 10% 11%Vacant Possession Value 150,000 150,000 150,000Gross Rental Income @5.8% 8,700 8,700 8,700Net Rental Income @70% 6,090 6,090 6,090Rental Growth First Five Years 21% 21% 21%Annual Rental Growth thereafter 3% 3% 3%Total Capital Growth 32% 32% 32%NPV of rent and reversion 128,500 119,000 110,500% of vacant possession value 86% 79% 74%Gross Initial Yield 6.8% 7.3% 7.9%Net Initial Yield 4.7% 5.1% 5.5%
Let’s build a rocket boys!Dedicated PRS Term (Years) 20 20 20IRR requirement* 8% 9% 10%* reduced given investment periodVacant Possession Value 150,000 150,000 150,000Gross Rental Income @5.8% 8,700 8,700 8,700Net Rental Income @70% 6,090 6,090 6,090Rental Growth First Five Years 21% 21% 21%Annual Rental Growth thereafter 3% 3% 3%Total Capital Growth 90% 90% 90%NPV of rent and reversion 138,000 121,500 107,500% of vacant possession value 92% 81% 72%Gross Initial Yield 6.3% 7.2% 8.1%Net Initial Yield 4.4% 5.0% 5.7%
Let’s build a rocket boys!CurrentMarket 350Affordable 150Private Rental 0Units 500Vacant Possession Value 150,000Market 100%Where is it most suitable?Stalled sites where the owner occupier demand islimitedSites where development finance is constrainedLarger strategic sites where build to let will be acatalyst for private salesAffordable 50%Private Rental 80%Market 52,500,000Affordable 11,250,000Private Rental -GDV 63,750,000
Let’s build a rocket boys!Current All PRS Zero AffordableMarket 350 0 125Affordable 150 0 0Private Rental 0 500 375Units 500 500 500Vacant Possession Value 150,000 150,000 150,000Market 100% 100% 100%Affordable 50% 50% 50%Private Rental 80% 80% 80%Market 52,500,000 - 18,750,000Affordable 11,250,000 - -Private Rental - 60,000,000 45,000,000Delivering dedicated PRSstock can de-risk stalled largescale development and/orimprove GDV and associatedviabilityBUT100% PRS schemes areunlikely to deliver sufficientGDV and may have issues ofmarket absorption0% affordable is unlikely to bepolitically acceptable in termsmeeting local housing need &distorting development profitunless you further increasethe rental periodGDV 63,750,000 60,000,000 63,750,000
Let’s build a rocket boys!Current All PRS Zero AffordableTwo thirds lessAffordableOne third LessAffordableMarket 350 0 125 200 275Affordable 150 0 0 50 100Private Rental 0 500 375 250 125Units 500 500 500 500 500Vacant Possession Value 150,000 150,000 150,000 150,000 150,000Market 100% 100% 100% 100% 100%Affordable 50% 50% 50% 50% 50%Private Rental 80% 80% 80% 80% 80%Market 52,500,000 - 18,750,000 30,000,000 41,250,000Affordable 11,250,000 - - 3,750,000 7,500,000Private Rental - 60,000,000 45,000,000 30,000,000 15,000,000GDV 63,750,000 60,000,000 63,750,000 63,750,000 63,750,000
Conclusions• Increased demand for renting and prospects for rental growth are supportedby but not entirely dependent on the current lack of mortgage debt.• The current investment market is already differentiating between investmentand owner-occupied values.• To deliver scale needs new rental stock.• The Montague proposals provide a framework for this.• Their implementation relies on informed trade offs between investors returnrequirements, PRS planning restrictions and development viability.• A informed and flexible approach to these issues provide a platform to thedelivery of significant and long overdue institutional investment in the sector.
The Private Rented SectorAn Institutional Perspective6 September 2012
Introduction• Why might institutions invest?• Issues for institutional investors• What might make the sector more attractive?• Summary
Why might institutions invest?• Long term rental growth prospects• Diversification• Lower downside risk than other property sectors?• Greater liquidity (more granular asset base)?
197219751978198119841987199019931996199920022005200820112014201720202023202620292032Prospects for Rental GrowthDemand vs. Supply (Great Britain)350,000300,000250,000200,000150,000100,00050,000Forecast0• Rising demand for housing• Increased population• Reduction in average household size/ risein single-person households• Limited new supply of housing• “Downturn effect”• Planning constraints• Is buying affordable?• Reduced mortgage availability• Finding a depositChange in Number of HouseholdsHousing completionsSource: CLG,N.B. Scotland household numbers 1972-1981 estimated from data points• Solid prospects for rental growth,BUT location specific
Diversification• Residential property is not strongly correlated with commercialproperty• Correlations with other asset classes are also weaker than they arefor commercial property• This suggests that adding residential to a portfolio could reduce riskand potentially enhance returns• International investors seeking diversification; institutionalinvestment in residential is already significant in many countries
Diversification and performance?Total Returns by Asset Class• Consistently outperforms commercialproperty25.020.015.010.0Residential PropertyCommercial PropertyEquitiesGilts• Performs relatively better thancommercial against other asset classes• Lower volatility of returns• Lower downside risk in recent years5.00.01981-1990 1990-2000 2000-2010Source: IPD Annual Digest, IPD Residential DigestN.B. Residential total returns from 1981-2000 taken from IPD Annual Digest, from 2001+ from IPD Residential Digest
Issues for institutional investors• Yield (and total return)• Scale• Management• Tax/Regulatory (risk of change)
Yield (and total return)• Typically institutions seek income ahead of capital growth• A c. 3% net income yield not attractive in itself• Low income yields can be justified if rental growth prospects aresufficiently strong• Other benefits:• Typically relatively low void rates (compared to commercial)• Diversification and lower downside volatility• Historic stability of (total) returns is an attraction
Yield (and total return)Composition of Total Returns(1981-2011)16%14%12%10%8%• Relatively low initial yield• Less income security?• Shorter leases• (Incorrect) perception of higher voidsthan commercial6%4%2%0%ResidentialPropertyEquities Gilts CommercialPropertyCapital Growth Income Return Total Return• Greater loss between gross and netyield (than commercial)• Return historically based on capitalrather than incomeSource: IPD Annual Digest, IPD Residential DigestN.B. Residential total returns from 1981-2000 taken from IPD Annual Digest, from 2001+ from IPD Residential Digest
Scale• Time commitment required to get comfortable with any sector – soneeds to be a real prospect of being able to commit funds• Opportunities of scale are limited• Scale is important to drive economies in management and runningcosts
Management• Granular nature = time consuming = expensive• Reputational risk?• Typically institutions can’t or don’t want to manage directly; usuallyseen as a specialist sector• Getting comfortable with a manager and documenting an agreementtakes time, especially if it’s a new sector for the investor• Institutional fund managers can bring relevant experience from thecommercial property fund management arena
Tax/Regulatory (risk of change)• A stable tax and regulatory environment is important• Institutions historically held residential, typically selling out after theimposition of rent controls• Tax is already an issue in the form of irrecoverable VAT (reducingincome yields)• Current consultation on CGT charges for offshore entities holdingresidential property has created uncertainty
What might make the sector moreattractive?• Higher returns(!), through;• Reducing gross entry costs• Reducing running costs• Build to rent (but most investors seek income, rather than a puredevelopment exposure)• Reduced affordable housing requirement• Cheaper (government owned?) land, but needs to be in the rightplace!• Access to opportunities of scale• Continued professionalisation of residential property management
Summary• Prospects for long term rental growth and relatively stablereturns are key attractions• Net income yields are still relatively low, but probably not anabsolute barrier• Diversification benefits• Limited opportunities of scale could temper interestAre the barriers to institutional investment really that high?
Removing thebarriers toinstitutionalinvestment intoprivate rentedhomesAdrian Montague
Background to the Review• Rapid growth in the PR sector (3.6m households now; 2m early 80s)• Much growth driven by smaller, buy to let landlords: only 1% oflandlords own more than 10 properties• Gap between housing demand and supply: 2009/10 115,000completions vs. 232,000 average annual increase to 2033• Profound changes in the mortgage market• Housebuilding is a major contributor to economic growth• Very little “build-to-let”
The potential (1)For communities and planning authorities• Longer term rented homes• Better service to tenants• Purpose-built accommodation to a highstandard of specification andconstruction• Meeting the needs of local communities• Unlocking stalled sites
The potential (2)For investors• Strong fundamentals• Strong match with liabilities andpotential for diversification• Net yields still something of an issue• Stable regulatory frameworkFor developers• Wide range of potential developers• Housing associations have animportant role
The barriers• Lack of stock• Novelty• Doubts about yields• The planning system• The release of public land• No strong Government lead• All contributing to a lack of momentum:just “too hard”
Recommendations1. Planning system• Strong steer from Government regarding PR sector• Land reserved for PR tenure• S.106 obligations2. Release of public land• Continued pressure on realisations• Identify a portfolio of strong pilot projects3. Targeted financial incentives4. Housing Task Force5. Addressing the brand image of PRS6. Reinforcing regulatory stability
Rental Britain as an Asset ClassSavills Development Services Seminar SeriesThursday 6 September 2012savills.co.uk