Throughout the past year, residential – once the poor relation to the property investment industry – has finally taken on the mantle of a fully-fledged asset class.
With increasing professional management now available, and the wider sector gradually becoming more regulated and professionalised, the ghost of the notorious 1960s landlord Rachman is finally being laid to rest.
Advisers throughout the sector describe it as “highly unusual” that two major portfolio deals occurred in 2006 – Insight’s March acquisition of British Land’s residential properties for £300m, and Terrace Hill’s May purchase of Nationwide’s at.home portfolio of 2,253 houses for £272.62m.
Since then, the property arm of Insight has been floated as Invista, and, in January, chief executive Duncan Owen confirmed that the company was intending to launch the portfolio as a real estate investment trust, the first in the residential sector.
With a consortium of housing associations soon to announce plans to float off non-core properties into a second such REIT – the first in either sector to be started from scratch – and rumours of others in the pipeline, it seems that 2007 could see more portfolios emerging or changing hands.
James Mannix, partner and head of residential investments at Knight Frank, believes that the next 12 months could see an American invasion.
American interest
He says: “Historically, the UK market has really followed what the American market has done. But that is no longer the case. A couple of big players over there are looking for an alternative, given that their home market hasn’t been performing. They’re cash-rich and want to spend it.”
It is thought that Archstone-Smith, one of the US’s largest residential landlords, is biding its time on entering the UK market, having decided against bidding for the at.home portfolio now owned by Terrace Hill.
A quick glance at its scale, though, confirms the difference in the sector on either side of the pond: the real estate investment trust owns 82,491 units in America’s larger cities and has a current market capitalisation of around $19bn.
Mannix adds: “There are also some individuals in the US who want to buy into the rising market. They see the UK as having some way to go despite what some commentators say.”
Private equity and hedge-fund groups, such as Blackstone, Carlyle and Westbrook, which bought the famous Westminster apartment block Dolphin Square for £176.5m in January last year, are surveying the UK market with a keen eye, says Mannix.
“Carlyle has just really started to focus on residential. They are basically a major player in the private-equity profile and if they’re going to do something it will have to be of a reasonable size,” he says.
Allsop partner Alan Collett disagrees. He says: “In America, multi-family housing is a yield-driven investment. They look at our net yields, which are in the high-3% area, and say, how can you buy something that is lower than the cost of money?”
“Archstone-Smith have come over to look at Europe, but they simply can’t make the yields here work. They are buying in Germany and the Netherlands instead – Britain is simply not a priority for them.”
“If you exclude the top of the market, international investors aren’t really interested, except for the Irish, who mostly buy new build off-plan. It’s difficult to know who’s involved and how many units they have because they form specific syndicates for each scheme.”
Nevertheless, Collett thinks that the sector will see more activity this year – but will be driven by domestic, rather than international, trends.
He says that an unidentified “firm of lawyers” is looking at the possibility of a REIT, sourcing the stock from scratch – which eliminates one of the major problems faced by the residential investor, particularly in the UK’s tight housing market: lack of supply.
“There are only a limited number of portfolios, representing a few hundred million pounds worth of transactions a year. Not everyone can do it clearly. So inevitably an awful lot will be new-build, which prompts the question: can people realistically buy from the housebuilders, who are notoriously shrewd?”
“Building up large portfolios of decent income-producing assets is not going to be easy. But it’s not impossible,” he says.
One stimulus to the market could come from one of the key features of REITs: their immunity from capital gains tax. There are several large portfolios owned by families such as the Freshwaters or Pears, which have been built up over several generations.
The capital gains liabilities of these properties are enormous, a result of a decade of dizzying growth. These can be eliminated by floating the properties as a REIT, with the vendors liable only for the conversion charge of 2% of total value. If this occurs, it will provide the market with some much-needed stock.
Simon Scott, director at Savills, agrees. He says: “There’s certainly a lot of interest from institutions, but whether that turns into something concrete is a different matter. I’m not sure that there are that many portfolios out there to actually go for.”
Wide exposure
“There is the option of buying new build – or even ‘building-to-let’ – but again, there’s not much on the market, and where there is, it’s opportunities of £20m and £30m. That might be too much exposure in one particular niche or area.” The most successful portfolios – such as at.home – have holdings in Scotland, or English market towns, as well as London and other big cities.
But nevertheless, he says, there are fund management houses “seriously looking” at new-build properties, a result of the “expectation that there will still be capital appreciation” and the need to invest in new opportunities.
While Scott, like Collett, has not picked up on an influx of American interest, he does say: “We haven’t yet seen the sort of weight of Russian money from an investment perspective that has gone into buying a lot of traditional residential.
“I don’t think it will come as a great surprise if that happens. And certainly I would expect interest from the new ‘world powers’ going forward: China and India.”
Others in the market are more sceptical of defining residential as a single asset class. Stuart Law, managing director of investment adviser Assetz, believes that funds and investors will keenly pursue specific segments of the market.
“Every time I hear about residential REITs, I don’t believe a word,” he says.
“My first question is, which sub-sector of residential would they mean? Institutions like steady, predictable rents and independence from the basic residential market. With residential REITs, we’re really talking about students, affordable housing, and retirement complexes – anything that isn’t straightforward buy-to-let.
“There is not a great appetite for UK residential in funds – we are looking at 3.5% net yields in England compared to 6% in Germany, or even as much as 8% if you buy well,” he says
But in the longer-term, Law believes there could be some structural changes in the market, with developers effectively building for purchase by REITs. He says: “Developers are building in capital gains tax, but they could effectively fund development on behalf of REITs and avoid that charge.”
He also believes that the tax-efficient properties of REITs could drive values – and activity – even higher for portfolios of niche, income-producing properties.
All this conflicting speculation, however, suggests only one thing: that whatever happens, it will be an interesting year for the residential investment market.
