BTR: from groundwork to growth

Now in its second decade, the UK’s build-to-rent sector has arguably matured, but there could still be growing pains ahead as domestic and international investors alike get to grips with a changing marketplace. In late June, a group of industry leaders gathered for an EG roundtable hosted by Savills at its offices in central London to share their thoughts on lessons learnt and the next steps for the operational BTR sector. The conversation centred on the state of the market in the first half of the year, the market’s evolution as standing assets start to trade, the correlation between BTR and the purpose-built student accommodation sector, and first-generation stock versus the “kind with swimming pools on the roof”, or “generation two BTR”. Held before the general election, there was an air of uncertainty around the table, but also a faint feeling of optimism. The UK’s BTR sector has matured, reaching more than 100,000 homes earlier this year. The sector has proven that it works. “It has taken 10 to 12 years to get to the 100,000-home milestone,” said Jacqui Daly, Savills’ director of investment research and strategy. “But arguably all of the work has been done. The funding mechanisms are out there and more than 100 local authorities have had it delivered in their areas. The management and operational platforms have all been set up. “I would argue that you will reach 200,000 in half the time it’s taken to get to 100,000. And then, if it does follow the PBSA market, you’ll get to 400,000 again at a much quicker pace. The risk around all of that is in the areas of politics and regulation. But that’s how the sector should start to grow given the groundwork is in place.” Yields stabilise as supply dwindles Discussing the state of the BTR market at the midway point of the year, Harry Downes, managing director for UK investment at Greystar, said: “The economy has been in a strange place – with interest rates going up and down there has been lots of uncertainty, and that makes it much harder to get investors onside… It has been difficult. We are all waiting and looking forward to certainty in government, and certainty on planning and all the other open questions. Then we will get cracking again.” Chiming in, Freddie Wonnacott, director of fund management at M&G, agreed with Downes’ sentiment, acknowledging that the market had been volatile for the past 12-18 months. He added: “In terms of H2, hopefully more certainty around the political environment and maybe a rate cut will combine to tip new potential investors who are on the fence to take the plunge as new entrants into the market.” New names looking at the sector will also be encouraged by BTR yields that have stabilised. Rebecca Taylor, managing director for multi-family at Long Harbour, said: “Last year, we saw yields moving out consistently quite regularly. They have stabilised for the past two quarters, which is helpful in terms of investor sentiment.” The sector’s resilience has boosted optimism further, said Rob Hudson, chief financial officer at Grainger. “Relative to the commercial sector, when you look at what has happened in our sector, we have been incredibly resilient,” he said. “And a big compensating factor for the environment has been the natural hedging we have against inflation – rental growth. When you look at valuations, especially compared with those of commercial, our portfolios have held up incredibly well. It’s down only a couple of percent over that time. “So while we have had some yield shift, rental growth has been a huge compensating factor. That is really what has driven the ongoing demand, and investors like the asset class – they can see the low volatility, but that can still make attractive returns.” International sentiment on the UK At Grainger, noted Hudson, more than half the shareholder base is international. “They understand the BTR sector well, and what they particularly like about the UK is the fundamental supply-and-demand characteristics, with the lack of supply and the strong demand,” he added. “Ultimately, we are a constrained island in the UK, with a lack of space. The fundamental growth potential of the UK and the lack of penetration of BTR into the housing sector – with more than 5.5m rental households in the UK but still with less than 2% of the sector [penetrated] – is a huge opportunity.” Despite the sector’s strengths, Taylor argued that BTR still needs to fight for its place in the spotlight when it comes to rallying international interest. “The challenge the UK has going forward is the wider economy,” she said. “A lot of the capital is looking globally. The UK has one of the worst structural housing supply problems. But GDP growth has been fairly flat. Real wage growth has been fairly flat. That is again why it’s important for rates to come down, and for the market to stabilise, for people to get comfortable. Because the UK market is kind of a no-brainer other than those points, and global capital at the moment is asking: ‘do we go to Australia or do we go to the UK’ or ‘do we go to Germany or do we go to the UK?’ That is a big challenge.” Wonnacott reiterated the sentiment, noting that he and colleagues are having “conversations rather than delivery right now”. “We have had more conversations in the first half of this year than we had in the whole of last year with those international investors,” he said. “And for us, it’s mostly core, core-plus, institutional-type capital that’s wanting to invest. And that is encouraging that UK prospects seem to be slightly more positive… We need these ingredients to come together.” A maturing sector Downes described operational stock trading as “the natural process” in the market’s development. “It’s that time in the cycle,” he said. “The capital that invested early in that operational side was seven- to 10-year money, so it makes sense for that to trade. And lots of people want living sector assets but you don’t get the returns because you don’t have the development returns, so [operational stock trading] is a natural part of the cycle.” Wonnacott added: “It’s a natural progression in the market at this time. We are not seeing a huge quantum of assets coming to the market now because most of it is held by long-term patient capital. But we are still a maturing market. That would probably be the next phase of maturity for BTR: operational stock trading recycles capital.” Such deals will also bring new sources of capital into the space, Daly said. “There are investors out there that can’t develop as they are prohibited. So by bringing in the capital which would probably be at a low-return requirement you recapitalise so people like Greystar can go and invest in another scheme.” Taylor added: “It allows more UK pension funds to come in as well. Obviously, M&G and L&G are well invested, but it also opens the doors for those other pension funds that haven’t been able to take development risk. So it’s not just about inflows of capital but actually domestic capital that can invest into the sector now.” The next generation The demand for operational BTR will follow two very different strands of product. One is first-generation BTR or PRS stock with fewer amenities, such as Greystar’s Fizzy Living platform. The second is highly amenitised second-generation BTR, which is newer product such as Greystar and Henderson Park’s joint venture offerings, including the Ten Degrees tower in Croydon, south London, and the Equipment Works in Walthamstow, E17. “Generation-one BTR is very different to where we are today,” said Downes. “Those first Fizzy buildings were of average size, about 75 flats. Now we’re building sites like the Bermondsey Biscuit Factory (main image) – 1,600 homes, all going up at once. It’s a completely different scale. There is still a great market for that older stock, the big difference being amenity. And there is a huge range in the product that is being delivered now. Our range goes from the Fizzy stuff at the cheaper end to Bloom in Nine Elms with a swimming pool on the roof. It’s all out there, and it’s attractive to different tenant markets. Taylor agreed, saying: “The past 10 years in particular, everyone has focused on amenity, and we’ve almost got ourselves into a bad habit of people saying, ‘There’s that fancy stuff that’s not good for everybody.’ But the gen-one product stock is a great opportunity for us to start saying, ‘Well, we do have an affordable, with a little “a”, product as well as the other pieces.’ “There is a lot more opportunity for that diversity of offer as we go through those kinds of cycles. Pointing to the gen-one stock is a real opportunity to say, ‘We do it all.’ It’s not about the fanciest, shiniest building, but most investors are looking for that reversion value when they come into the market. Typically resi gives you, what, 7% IRR on a good day? And with the changing market now, equity is looking at where the return hurdles need to be. Is it 7% or does it need to be 9-11% now? That is probably what we are going to see change over the next couple of years.” Efficiencies of scale Hudson pointed out another important trend in the BTR sector – the emergence of technology on larger platforms – as “a very important aspect to driving efficiency”. He said: “You can achieve efficiency through large buildings, or you can achieve it through clustering. And the benefit of scaling a platform for us at Grainger is that we have invested very heavily in technology. We can digitise the whole of the customer experience and journey, and we have invested very heavily in customer service and operations. “Customer satisfaction and platform scale and efficiency are ways that we can continue to drive returns in the sector. The sector is only 10 years old, but when we think about it, there are already generations one to three of the product, and we have only made up 2% of the resi sphere. We are still maturing as a sector, and most of our competition is the individual ‘moms and pops’, the private landlords.” Taylor agreed and said the efficiencies of scale of a platform also include a wider range of product. She added: “We are very London-focused still now, so if we want to get to a £3bn to £5bn platform, it can’t all be that high-end product because you’re then just cannibalising. Now there is going to be a bit more room to cluster projects. “There’s a bit more of a platform value coming through that means people can start to be able to deliver different types of products. But the barrier to entry now is construction costs and land values. And we’ve seen a lot of the development pipeline flip to student and co-living just because the developers need to make the land value work. So that has been really challenging for the build-to-rent space.” Controlling rent rises from within EG’s guests also discussed the adverse effects that they believe imposing rent controls in England would have on the sector. Hudson said: “It’s terrible what has happened in Scotland, but what a case study. And we can talk about what has happened in San Francisco and New York due to the introduction of rent controls, which have seen a collapse in supply, with rents going higher than anywhere else because of that restriction in supply.” Taylor added: “As long as the government stays away from rent control, then it’s for us to deal with affordability as responsible landlords… That is something we should talk about as a sector, that we’re focused on [reasonable rent rises] because we’re aligned with the interests of the tenants.” Wonnacott said: “It is important to note that our business plan has not been to sustain this level of rental growth. The expectation is that it will go back down to a more normalised level. If rent rises are in line with earnings growth, it should be sustainable and is acceptable as well for the required returns of our core investors. If they are getting an income return of 4% and a rental growth of 3.5% on an annualised basis on a 10-year return, then that, in the current environment, is acceptable. “The challenge is that required returns have been going up and repricing hasn’t happened, until more recently. So we’re just getting back now to the cusp of it being an attractive prospect from a business case point of view.” The experts Jacqui Daly, director of investment research and strategy, Savills Harry Downes, managing director for UK investment, Greystar Rob Hudson, chief financial officer, Grainger Rebecca Taylor, managing director for multi-family, Long Harbour Freddie Wonnacott, director of fund management, M&G Main photo, Bermondsey Biscuit Factory photo © Greystar/KPF/Plompmozes. Left to right: Freddie Wonnacott, Guy Whittaker, Rebecca Taylor, Akanksha Soni, Robert Hudson, Jacqui Daly and Harry Downes