Just when it looked as if an institutionally funded private rented sector was about to take off, a resurgent market in new homes may be about to snuff it out again
There were essentially just two questions being asked at last week’s annual RESI conference at Celtic Manor. The first was whether the government’s support for house sales is in danger of generating an unsustainable house price boom. And the second was whether 2013 will be the year that institutional investment in the private rented sector finally takes off.
It shouldn’t be a surprise that the minister in attendance - housing minister Mark Prisk - and those representing the industry were keen to both play down the risk of a damaging price bubble, and play up the chances of success for the so-called “build to let” sector.
However, what those on the conference stage failed to do was investigate the impact of the two trends on each other. Because out in the real world where housebuilders have to buy land and sell homes, there are many sensing that the resurgent market for new home sales, fuelled by the government’s Help to Buy initiative, is having a conversely chilling effect on the appetite of developers to build homes designed to be rented. This is important - for the government in particular - because it is relying on the growth of an institutionally funded private rented sector to provide a wholly new market for new houses, and thereby boost the still woefully low rates of housing construction. As one high-profile developer - who declined to be named - says: “The boat has been missed. Land prices are now too expensive [for private rent]. Until interest rates rise, the focus will be back on sales.” He is not the only one wondering whether the moment for developing a genuine private rented sector has been missed.
Governments of different political hues have been attempting to stimulate institutional investment in new homes since at least the middle of the last decade. Because while buy-to-let was a big feature of the pre-crunch housing boom, large-scale investors have been largely absent from the residential sector since rent controls were reintroduced in the sixties. The attempt to reignite this institutional interest has been designed to stimulate additional housing construction in a world where most housebuilding is carried out by a diminishing cadre of ever bigger volume housebuilders, the demands of whose shareholders exert a growing influence on whether the UK manages to meet the demand for homes. But all attempts thus far have hit a major hurdle: the investment yield for a house or housing land sold on the open market has not been enough to interest financial institutions, meaning either rents have needed to rise, or the price of houses (and therefore of the land they are built on) have needed to fall before the equation stacks up.
The boat has been missed. Land prices are now too expensive for private rent. until interest rates rise, the focus will be back on sales
From that point of view the last five years have been a godsend for the proponents of the nascent build to let sector. In most parts of the country house prices have fallen or stagnated, while rent levels have rocketed because far fewer first-time buyers have been able to secure the mortgages they need to get on the housing ladder. This has accelerated a slow shift which has now seen the number of private sector renters rise from 12% to 17% of households in the last decade. Hence the past year has finally seen some of the first significant deals since Qatari Diar bought the former athlete’s village for private rent in 2011 (pictured). Aviva Investors is in discussions with housing association A2 Dominion, for example, about a deal to build 750 homes for market rent, and Prupim has bought 534 privately rented homes from the Berkeley Group. There’s talk that even traditional housebuilders, whose business models are predicated on selling as quickly as possible at high profit margins, could make rental housing a big part of their business.
But behind the scenes, it seems, everything has changed in the last six months. Graham Cherry, chief executive at housebuilder Countryside Properties, says: “The housing market has picked up significantly, and Help to Buy has really caught the public imagination. In this market the question is why would we sell homes at a discount [to an investor in private rent] when we can sell at full price in a healthy market?” Likewise, Stephen Stone, chief executive of Crest Nicholson, a housebuilder that thus far has embraced the growth of private rent, says: “The government has stimulated the market, so currently we can sell houses faster than we can build them. In that environment we’re not going to [offer a] discount to [sell to a] PRS [investor]. It’s just not going to happen.”
For housebuilders, a key part of the rationale for investing in private rent has been to mitigate the low volume of private sales since the credit crunch. But since the introduction of Help to Buy earlier in the year, sales volumes have shot up, with the RICS recently reporting the most widespread increase in new buyer enquiries since 1999. Estate agent Savills has tripled its estimate of 2014 house price growth on the basis of the shift - from 1.5% to 4.5%. So rather than struggling to find sales, and having to tempt buyers with incentives to purchase, housebuilders find themselves struggling to expand their production to keep up with demand. Cherry says: “My job has changed from one of going around trying to boost sales, to one of putting out fires in the supply chain.” Stone adds: “PRS is useful if you have a cashflow problem. But I’m not sure that exists for housebuilders right now.”
The equation is also made more difficult in other ways by the resurgent housing market. Private sales dictate house price values, and therefore with construction a fairly fixed cost, they dictate the value of residential land. Anecdotal evidence suggests the recent growth is already driving up land prices. This increase in land value then squeezes the yield for developers of homes for private rent, making it harder for them to compete in the land market. Cherry says the market talk is that yields are now drifting below the critical 5% return that would attract institutions. EC Harris partner Richard Jones says: “The issue now is whether you can get private rent to achieve the land values [that housebuilders will pay].”
Jones’ colleague Mark Farmer, head of private residential at EC Harris, is a supporter of the private rent idea but says Help to Buy is undermining its success: “There’s no two ways about it, the two policies are competing to an extent.” And this is feeding through to land values: “If you look at the investment yield,” he says, “the discount [for privately rented homes] to open market sale value is 10-20%. It means the developer has to compromise on profit to make it stack up.”
There are also signs that the stellar growth in housing rents which has in part driven interest in the sector, is starting to wane. The latest data from housing analytics firm Hometrack shows that after three years of 5-10% annual rent increases, rents fell in London last year, while remaining static across the country. EC Harris’ Jones, says: “If Help to Buy is relaxing the demand for homes for rent, then it will impact on rental rates because people will buy homes instead.”
This doesn’t mean that hopes of building a new sector are dead. But until the housing market abates, it will be much harder for traditional players who are funded by the stock market or bank debt - such as housebuilders - to afford it on a large scale, except as part of a mix on regeneration schemes. Jones says housing associations, which benefit from low-cost funding and tenant management expertise, will be key to unlocking the sector, with Farmer saying specialist players funded by institutions, such as new player Essential Living, are likely still to be interested as they are able to “take a view” - ie reduce - the profit they take.
So, despite all this interest, the sector has yet to achieve critical mass. As Savills’ residential director Luca Cook said at RESI, the sector requires upwards of £150bn to fund the demand for rental housing over the next five years, but so far just £2bn has been found. “We’re dipping our toe in the water,” he said. “We need to get ourselves wet.”