In a real estate landscape that has found itself scrabbling for institutional-grade opportunities in recent years, build-to-rent is emerging as the hopeful pretender to many diversification woes. The UK remains in the grip of its perennial housing crisis. With a growing population and an ever-increasing number of people who cannot afford to buy, the rental sector (and BTR as a sub-sector) continues to thrive in the face of short supply and high capital values.
The sub-sector’s emergence and acceleration has been rapid – now exceeding 260,000 homes, with 100,000 completed and the remainder under construction or in the pipeline. In context, this still only forms a small percentage of homes within the wider rental sector, less than 2%. Although with stabilising construction costs, anticipated interest rate cuts and housebuilding headwinds, steadily increasing growth could see this exceed 5% by the end of the decade.
Where do investors see ideal BTR opportunities?
Ideal locations have good transport links and local amenities with proximity to major urban and employment hubs. There is an obvious regeneration angle here – particularly considering the amount of UK shopping centre, high street and even surplus office real estate that will tick these boxes.
London, Bristol, Manchester, Birmingham and Edinburgh are all cities identified by investors as cities with strong BTR opportunities. Practically speaking, we’re seeing geographic focus move increasingly away from London to areas where yields will be higher because of lower land and build costs. The units themselves are split between “single-family homes” (houses), “multi-family homes” (apartment blocks) and “co-living” (housing for individuals with shared living areas and amenities). The split between these classes has diversified greatly since 2020 when multi-family accounted for nearly the entire market share: the most recent analysis suggests this has reduced to just over half for multi-family and around a quarter for single-family, with the remainder in co-living.
The risk dynamic between developers and investors is holding – for now
In current market conditions, the benefits for developers of forward funding parts of their development are clear. Selling a tranche (and sometimes all) of a development before a foundation is dug gives cash flow certainty, even if the ultimate price may be below what might be achieved if the flats were sold on the open market (assuming buyers could be found). There is always an element of commercial risk with fixed-price contracts so the supply chain and availability of labour will be the key considerations; this should be less of an issue now build costs and inflation appear to have stabilised. As the market improves, we might question whether investors will need to partner more actively through development stages.
A higher-quality alternative for tenants
The Royal Institution of Chartered Surveyors reports high tenant demand for BTR. For tenants, the flats may be more enticing than private rental for a number of reasons.
An institutional landlord with appointed managing agents implies a level of professionalism and corporate accountability which may be more inconsistent among private landlords. Plus the newer homes should be better built and more efficient than a conversion.
A marketed benefit of these developments is a wider community, which often include co-working and living areas. This community-focused amenity will differ between developments and the test will be to see how the more sensitively planned perform against more condensed sites in the long term.
General market challenges are still stalling the sub-sector
Despite both strong occupier demand and investor sentiment, BTR still faces its own delivery challenges:
- The private landlords who have been forced out of the market by high interest rates have created a supply surge, leading to pricing uncertainty.
- The much derided and sclerotic planning system. Anecdotally, we have seen even reserved matters applications taking more than a year to be granted; this is supported by figures from the British Property Federation, whose analysis shows 40% of BTR sites take at least a year to achieve planning consent (up from 7% a decade ago). Recently, the BPF reported that completions were outpacing build starts.
- The causes of these delays are multitudinous, even where the application conforms with the local plan. These can range from the initial dearth of qualified planning officers to review applications at the front end to local councillors more interested in demonstrating perceived local opposition than considering the delay to housing supply and cost to the local authority when they are required to pick up the developers’ costs after a successful appeal.
- Linked to planning, mixed-use schemes will often have an element of affordable housing which need to be delivered alongside and in advance of the private flats. Affordable providers can be slow to transact, with unrealistic expectations as to what can be provided. There are also constant question marks over their funding from central government, which prevents them from committing funds too far into the future.
- Despite all the political rhetoric to the contrary, the appetite to address supply shortage remains limited. The 16 different housing ministers since 2010 will not have helped the continuity of planning and the sector lives in constant hope of political leadership which understands the challenges – maybe even someone with a background in the industry and without half an eye on a more tantalising promotion.
- On the construction side, the trifecta of high construction costs, labour shortages and high interest rates are contributing to high delivery costs. In addition, fire safety regulations post-Grenfell have required (quite understandably) both the remediation of dangerous cladding on completed schemes and the inclusion of second staircases on new ones, which can affect viability.
Are the returns sustainable?
With yields relatively stable – if uninspiring – at around 4% (despite high rents) and interest rates still high, loan to value will need to be adjusted accordingly. This also leads to an over-reliance on capital growth to demonstrate (notional) fund profitability and overall value.
Current demand and rental increases will ensure that occupation rates and returns remain high, but high unit numbers and higher costs of living will make the market sensitive to fluctuations. Ultimately, there is a limit to what tenants are able to pay.
Labour has made overtures about abolishing no-fault evictions and the commitment to do so was in its election manifesto (as it was last time for both main parties). No formal legislation has yet been put forward (and it is easy to remain cynical about the motives behind that) but a change in this area could make portfolios less versatile if units cannot be sold with vacant possession.
Leveraging a positive impact on the residential market
For investors, BTR represents a long-term, stable income prospect with strong occupational demand. Appetite remains strong with a reported institutional ambition to invest £17bn over the next five years. This would lead to a significant increase in supply, which would be more than matched by an increase in demand due to the forecast continued fall in home ownership
In some ways this becomes self-perpetuating: if the rental sector corners supply, it will drive up demand (and therefore costs) among homebuyers.
As the sector expands, it is important that the marketing from providers about placemaking is reflected not just in the finished products but as time passes and costs of maintaining the assets increase (the cautionary tale here being the serviced office market).
At their best, BTR developments have the capacity to create communities with secure housing for the long term (latest projections indicate it takes the average household over 10 years to save for a deposit). This should be balanced by ensuring there is a steady supply of social housing for those who cannot afford the private sector and homes for sale so that occupiers have an opportunity to purchase their own homes in the future.
Image © Andreas Rasmussen/Unsplash
Edward Moss is a senior associate in the housebuilder team at Wedlake Bell
