Continuing our series of events covering residential investment, last month we focussed on Single Family Housing. What is it, why is it attractive for investors and what are the key challenges for this important segment of the market?
Defining Single Family Housing
Single Family Housing (SFH) is pretty much what it says on the tin; standard housing, with one family renting each unit. This is distinct from blocks of apartments, with multiple units housing a family in each unit – known as multi-family housing (MFH). While some SFH stock is sourced from housebuilders that would otherwise be meant for owner-occupation, most SFH stock for institutional investment is purposely built for rental accommodation and comes under the Build-To-Rent (BTR) banner.
What are the attractions?
Getting away from the acronyms, there are several elements of this segment of the market that make it attractive. The constrained supply of new housing stock is well documented. There has also been an exodus of buy-to-let properties, as tax changes and the proposed ban on no fault evictions have made them less attractive to private investors. Higher mortgage costs recently have further increased demand for rental properties. With the main cohort for this genre of rental property being tenants aged twenty five to forty four, the supply/demand dynamics clearly remain favourable.
Compared to multi-family, SFH tends to have lower cost leakage, giving a favourable gross-to-net rental income ratio. This is because there’s not the same maintenance of common areas and fewer ancillary services required. Add to this the resilient nature of the income streams, with a relatively good duration of rental income (compared to shorter lease lengths for apartments, for example) and one can see why more pension funds are apparently taking a closer look at what’s on offer. This segment of the market is now becoming part of a broad living strategy for investors, one that has a range of residential property with different risk profiles.
Let’s not forget the social impact element either. There is a clear and demonstrable need for family homes throughout the country. With new housing stock sourced from housebuilders, institutional investment can accelerate housebuilder delivery, as it helps de-risk those companies’ building projects. With the specification requirements of institutional capital being somewhat higher too, the quality of housing stock is being enhanced also. And Government, naturally, is very supportive of the quality of housing being advanced.
Some challenges
For institutional landlords wishing to develop SFH themselves, it is hard to compete for land acquisition against housebuilders. It is equally hard to build as efficiently as them. So fund managers forward funding developments is a good model, though persuading the housebuilders to effectively sell at wholesale prices is a challenge. That said, at this time, with higher interest rates, the balance of power is shifting favourably for the institutional landlord.
Where a fund manager has a geographically diverse portfolio, this brings its own challenges. Interestingly too, the economics of SFH works slightly differently throughout the UK. Managers may tend to gravitate towards larger homes in the north east, for example, while smaller homes in the south east work better.
The institutional landlord is likely to have a keen focus on ESG and sustainability features, meeting the requirements of their investors. Ensuring housebuilders incorporate these can be challenging as ‘greening’ comes at a cost. These costs are easier to absorb in more expensive markets, less so where housing is relatively cheaper.
Given the rapid and large moves in interest rates, debt players have moved away and equity is dominant now. With less development debt being taken up, there are fewer housing starts. Government needs to find ways of improving that and it would seem the SFH rental sector is a good way of doing that.
Sustainability in housing
Of increasing importance to fund managers is sustainability because, as mentioned before, their investors are increasingly focused on this. But also, incorporating sustainability features in housing heightens the appeal to prospective tenants too. Indeed tenants are increasingly looking for these features in homes, albeit perhaps more driven by the current cost of living crisis. Previously, housebuilders have been resistant but do appear to be more accepting of fund manager requirements on this front now.
Interestingly, there is a word of caution on the sustainability pursuit however. Some products may be very good for boosting EPC ratings of the properties but may not necessarily be good for the prospective tenants, in terms of running costs at least.
Fund managers report that they don’t see sustainability features being reflected in property valuations yet but playing the long game, they expect the rewards to come later on. And there does appear to be evidence emerging of higher rents attainable for greener homes now.
A modular answer to the housing shortage?
Modern methods of construction, such as modular housing, could be an answer to the housing shortage in the UK, given the speed at which they can be built out. It does come with some very practical challenges though. For example, the sophisticated heating systems they employ, local engineers struggle to understand.
Anecdotally, one of the larger modular construction firms report the only people really pushing them on insulation and energy efficiency are the institutional investors. Another great example of how fund management firms are driving up standards of rental stock in the UK.
While modular could well be the future of housebuilding here, currently, the more expensive build cost is not offset by the speed of delivery. Valuers too are grappling with how to value modular properties because they are relatively unknown, and the covenant strength is lacking among manufacturers given their relative youth. Given the vast array of models also available, perhaps some consolidation would advance the modular cause overall.
The risk of rent controls
The risk of rent control legislation is hard to quantify and factor in, across the whole Build-to-Rent sector, as we discussed in the first event of our residential series (watch it here). The social regulated market cap is actually quite generous though. Arguably, the industry should be supportive of Government helping certainty of rent. If devised collaboratively, between Government and industry, then a workable solution could be achieved. That is unlike the Scottish model, which is already hitting housing supply, resulting in higher rents – quite the opposite effect than that desired. Government must recognise that affordability is much better addressed through facilitating greater supply.
To watch the video, view the slides and read about the presenters at our recent event on Single Family Housing, view it here.
Keep an eye on our events calendar for the next in this series, looking at Planning.
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