Opportunity blocks

Don't. That's the advice almost every newspaper and financial adviser is giving to individual investors contemplating buying homes for private renting. Agent FPD Savills reports that, in the overheated prime central London market, rents plummeted 12% in the six months following 11 September and average net yield there is running at 3.1%, half the national average.

But at the same time as the tales of saturation at the top of the market are growing, statistics and researchers continue to promote the need for growth of the private rented sector to meet future demand.

In May, an independent private rented sector commission organised by Shelter and the Joseph Rowntree Foundation called for more and better private rented housing. Its report said housing associations had an important part to play in increasing market-rented housing stock and called for the regulatory constraints on registered social landlords to be loosened.

For housing associations the big attraction of letting privately is to earn money for their other operations – but some appear to underestimate the business skills required to be successful.

Research carried out by FPD Savills for the Housing Corporation concluded that many housing associations that had gone into the sector had not thought through their business objectives. Associations needed to have systems to monitor and improve the performance of their assets, the research said, and it pointed out that the market was not always booming.

The Places for People Group's Blueroom Properties and London-based Community Housing Association's Citystyle Living are two very different housing association operations making a healthy profit from the private rented sector, and they believe that they are well placed to go on doing so.

Blueroom Properties
The Places for People Group's board decided to enter the private rented sector just over two years ago. To do so, it founded Blueroom, a separate company, with a bold commitment to invest £100m in its first three to five years. Blueroom is well on target, with nearly 900 units either in management or in the pipeline, representing an investment cost of £88m.

"The decision was taken that this would operate on entirely commercial terms," says Damian Southworth, managing director of Blueroom. "We see the company as an investment vehicle – it is not there to extend our development activity. We are not using it directly to grow."

The company has a very clear objective: to develop a portfolio and then trade properties on, capturing capital growth over three to five years. "It is all about making the best investment decisions," says Southworth. "We go out and identify investment opportunities and work with sister companies within the group. We've done quite a number of mixed-tenure schemes with associations within the group – they give us a bit of a buzz."

It has just worked with Edinvar Housing Association to regenerate a 91-unit estate of townhouses in Edinburgh. Originally designed for multiple occupancy, the townhouses had increasing void levels and Edinvar wanted to get rid of them. "We could see the potential value of the site," says Southworth. "We've got the expertise to show how to unlock the latent value."

Blueroom's solution has seen the estate reconfigured, with 21 general needs and 10 special needs units retained by Edinvar while the remaining 51 homes have been remodelled and marketed as a mix of homes for market rent and sale.

When Blueroom opened for business, its plan was to acquire rather than develop stock. "The problem is that private rented stock is trading at close to market values, so you can't get the capital return," says Southworth.

Instead, it has turned developer. With only six staff, the company relies on out-of-house expertise, and has assembled a team of partners that includes construction professionals. "We are now developing a bespoke product. We have partnerships with contractors and suppliers. We are bringing costs down," says Southworth. "Private developers specify their product as a sales product. We've configured our units to make them appealing to the rental market."

Housing management is carried out by Countrywide Property Management, not in-house. "Private rental tenants are more sophisticated and more demanding," says Southworth. "And, as we are turning the stock, we didn't want to have operational issues."

When the business hits its £100m investment target, a disposal strategy will be formulated. "With such a large investment programme there was a fear of what would happen if the market had a downturn, but we've got contingency plans," says Southworth. "The for-sale market is still so strong that we could release one or two units on a scheme if we needed to."

Citystyle Living
With all its private rented schemes in the over-supplied capital, Citystyle Living might appear a prime candidate to feel the chill wind of the cooling market. But by being careful about location and sticking to areas like Hackney and King's Cross, where it already operates in social rented housing, it is continuing to find tenants. "We've been offered land opportunities elsewhere in London and not taken them," says Christopher Natt, development director with Citystyle Living. "We've exploited the local market."

Its first scheme, completed just over two years ago, was the 63-unit Priory Heights, close to King's Cross. The scheme gained the new company a big profile because it involved the refurbishment of a block designed by distinguished modernist architect Berthold Lubetkin and contained some ultra-swish penthouses. It produced immediate returns, allowing Community HA to build 26 social housing units without grant on the same site, and its private rental units let "amazingly well", according to Natt.

Subsequent schemes have generally had a similar mix of private and social rented housing, the private rented housing playing an important role, not only providing finance for social housing but also helping regeneration by rebalancing communities, Citystyle Living believes.

Like Blueroom, Citystyle Living develops its own product, but it is in business for the longer term. Since it developed its first scheme, the company has learned a lot about both the business and its product.

"We originally had a growth rate of 150 units a year but we decided later to be more cautious," says Natt. "We'll develop what the market dictates."

The company also now limits the size of schemes. "The optimum size is 20 units," he adds. "We did 63 units at Priory Heights successfully but that was in a very good market. At bad times you would struggle.

"We've learned a bit more about specification, and improved it slightly in later schemes," he continues.

"We've also learned that properties don't let themselves. Even though we use external letting agents, you have got to make sure that they focus attention on your scheme. That's how you ensure your property lets before anyone else's in a difficult market."

Properties are currently managed out of house, although this will be reviewed under this year's business plan. Main agent is Allsop, supplemented by local letting agents, while Drivers Jonas provides valuation advice.

The private rented company expertise also proves useful in the housing association environment. "When we have a problem site that we can't finance for social housing, we look at how we can make it work. There has been an impact in the development department," says Natt.

Although Community HA was happy to set up the separate company, the Housing Corporation initially hesitated to give its blessing to the venture. "We had to convince the corporation before we did it – we were doing this quite early on, before the publication of the corporation's Regulating Diversity document," says Paul Coates, finance director with the company.

Now the company is reaping the benefit of its business rigour. It has applied for further funding, receiving half a dozen offers and appointing Britannia Building Society.

"Funders have said that they were impressed by the fact that we've got a good business plan," says Coates. "We apply the same stringent criteria to this business that we do to our social housing activity. This has got to make money. We've got to be comfortable," he says.