Spotlight: Rental Britain

Rental Britain
 
Routes To Market

2 February 2016, by Jacqui Daly

There is more than one way to invest in the residential market for large-scale investors.

 

FIGURE 5

Routes to market

 
Figure 5

Source: Savills Research

Traditionally, larger investors in the rental market have built up portfolios through the acquisition of existing residential stock. Since the introduction of the buy-to-let mortgage, the market has grown through buy-to-let investors acquiring a high proportion of newly built residential stock that was built and designed for the owner-occupier sales markets.

Developing new stock for private rent is a relatively new feature of the residential investment market. It is a response to the reintroduction of institutional capital seeking investment grade assets and the limited supply of good quality stabilised portfolios. It is also a result of the recognition that delivering a customer-focussed service to tenants requires a variation in the design and construction of residential buildings.

For larger, institutional investors, gaining exposure to the UK residential market in its broadest sense, is likely to see various investment strategies being deployed. In simple terms, this can be achieved through developing bespoke buildings on an asset by asset basis. This does, however, take time and require appropriate resources and skills to identify, negotiate and transact in a market that has largely delivered housing for development sales.

Increasingly, the larger equity houses who have significant access to capital are seeking opportunities which provide a higher level of control over delivering large volumes of residential. Corporate transactions, either through acquisition of companies or share capital where a degree of influence can be applied over the direction of the delivery organisation, are likely to be seen going forward.

Examples of this are the acquisition of a number of house builders including Oaktree Capital’s acquisition of Countryside Properties and L&G and Patron Capital’s acquisition of Cala Homes. Further to this, the acquisition of Quintain by Loanstar has the potential to see a large amount of rental market stock being delivered through the development opportunities in Quintain’s pipeline.

Aggregators of rental stock are also increasing in numbers with the likes of Essential Living and others, where we may find that once developed and stabilised, these portfolios may be sold to the institutional market through large portfolio sales or corporate transactions.

A key challenge for investors is the identification of an operating partner to manage the portfolio. The aggregators are tending to create new branded management services developed alongside the asset pipeline whilst the institutions are more likely to outsource the management function.

As the institutions get more comfortable with residential as an asset class we are likely to see a range of markets emerge from prime bespoke stock to secondary and even tertiary stock. As these investors are primarily driven by income returns – as long as the net income from a portfolio can be proven, assessed and priced, taking into consideration all operation and capital costs – the larger fragmented portfolios, which historically have been the target of trading investors, may start to appeal to the income investors. As property management services to residents are increasingly delivered through IT solutions, the make-up and location of assets will become less relevant.

"Forward funded build-to-rent deals diminish sales risks greatly"

Susan Emmett, Savills Research

From an asset perspective, the main deal structures evident in the market are set out below. Each will have a different risk reward profile.

■  Land acquisition and development

Acquiring land and developing rental market stock allows for complete control of the product and delivery of the scheme. This is the approach now being used by Essential Living. The approach is considered resource-intensive and involves the investor taking planning and development risk. Competition for land can be fierce, particularly against traditional housebuilders.

■ Acquisition of existing blocks and/or portfolios

A number of large portfolios have traded over the past two or three years which have allowed new investors to acquire significant portfolios of existing stock. Examples include the Maison Portfolio, which saw Apollo acquire the West Register portfolio, and the GRES portfolio, which was effectively refinanced through an acquisition by the European pension fund APG.

The shortage of good-quality existing rental portfolios means that competition is high for fully let stabilised rental stock. Risk is low but commensurate with the level of returns achieved from investing in the sector.

■ Forward commitment/ purchase of completed stock

This is a simple and fast way to aggregate a portfolio, requiring only a down payment when a deal is agreed with a developer and payment of the remainder on practical completion of the scheme. Fizzy Living effectively used this approach to aggregate their portfolio of rental market stock and it allowed them to quickly aggregate stock and a management platform.

The downside of investing using this mechanism is that the investor has very little control over the product and delivery of the scheme.

■ Joint venture

Joint ventures and co-investment vehicles have largely replaced traditional funding arrangements in the aftermath of the credit crisis, predominantly because of the high cost of finance.

Residential Land, backed by Ivanhoe Cambridge, is an example of this approach in the UK market. Developers have sought joint venture partnerships where risk is shared on the basis of the level of equity provided.

■ Forward funding

The structure of forward funding transactions varies widely. In general, an investor will make an initial payment up front which reflects the transfer of the interest in land. This is followed by stage payments that will cover construction costs, a percentage of profit and a development manager’s fee.

Stage payments covering construction costs, particularly when funded from an income fund, are likely to attract a coupon akin to development finance costs. The funding structure may also include an “End Bullet” upon completion, usually covering the developer’s outstanding profit.

The advantage of a forward funding structure is that it de-risks the development by effectively guaranteeing a block sale to an investor at building completion. From an investor’s perspective, development risk is more evenly shared between the developer, main contractor and the investor, thus making it is less resource-intensive for the investor. As a result, an investor with a large allocation to residential can spread investment more easily across schemes and markets making the approach more scalable than straight development.

An important upside is that the approach allows for more control of the product and of the delivery of the scheme. We have seen a number of build-to-rent schemes using a forward funding approach, including the M&G scheme in North Acton being developed by Hub Residential.

As the number of players building for the rental market grows, new business models are emerging. At the heart of these models is the trade-off between risk and return. In a strong sales market, traditional build-to-sale models deliver higher returns but the absorption rates can differ.

Given the cyclical nature of the property sales market, the risks are greater in a market downturn. Forward funded build-to-rent deals diminish sales risks greatly and are especially suited to large projects with multiple phases of development.

 

 
North Acton

▲ Hub Residential development Victoria Square North Acton, Ealing London

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