World Research UK Residential

Spotlight Rental Britain February 2016

SUMMARY Demand for rental homes will continue to rise despite Government policies

■ The rental market will still expand large-scale investors to step into the forward fund development for rent. by more than one million households gap created by a fall in off-plan sales We outline some of the routes to over the next five years despite to buy-to-let investors. P2/3 market that large-scale investors are measures to turn “generation rent using. P4/5/6 into generation buy”. P2/3 ■ Mismatch between supply and demand will continue to underpin ■ Investors are looking beyond ■ The supply of rental homes is set to rental growth and attract increasing London to cities with concentrations of be constrained by the introduction of numbers of institutional investment at households in the rental market. Our a Stamp Duty surcharge of 3% scale. We recorded investment deals investment matrix highlights the cities on buy-to-let properties and the worth a total of £2.6 billion in 2015 with the best investment potential. restriction on tax relief on mortgage – a third of which was supported by Manchester, Reading, Edinburgh and interest payments. Both measures institutional investment. P2/3 Bristol top the chart. P7 are likely to limit the ability of private investors to expand their portfolios. ■ The lack of available stock is This presents a major opportunity for prompting an increase in deals to

savills.co.uk/research 01 Spotlight | Rental Britain

Market dynamics Policy changes Government housing policy seeks to RENTAL BRITAIN reverse this trend with the target of delivering 400,000 affordable homes for sale aimed at helping people HERE TO STAY access the property ladder over the course of this parliament. Measures include the delivery of 200,000 Starter Homes, the building of 135,000 new Shared Ownership homes and access to larger equity loans through Help to Buy in London. The rental market will still he economic Without policy interventions, expand by more than one million recovery and ongoing we forecast that the rental market low interest rate would grow by an average rate of households over the next five environment have done 260,000 households a year in the UK. years despite the Government’s little to reverse the The Government target of building Texpansion of the rental market. In 400,000 affordable homes for sale drive to boost homeownership fact, house price inflation, which would enable an average of 80,000 has surpassed wage growth, has new households a year to access served to push homeownership homeownership over the further out of reach for many. next five years. The requirement for sizeable Of the 80,000 new households a deposits and stricter lending criteria, year which may be helped onto the as a result of mortgage regulations, property ladder, 40,000 are likely to have continued to act as barriers come out of the rental market with the to the property ladder. As a result, balance shifting out of other sub- demand for rental homes is still rising, market tenures. This would reduce underlining the long-term trend which the growth of the rental market by predates the financial crisis of 2007. 15% from 260,000 households a year According to the Government’s English to 220,000 new households a year. Housing Survey, the rental market has Hence the sector will still grow by 1.1 been growing by a staggering 17,500 million by 2021. households per month on average over However, we would question the 10 years to 2014. whether policies can accelerate house building enough to deliver 400,000 affordable homes for sale FIGURE 1 in the first place. Given the overlap The growth of the rental market Areas where more than 15% of between the schemes, which are households rent privately focused at similar parts of the market, it is possible that one scheme would simply replace the other rather than 1991 2001 2011 providing additional homes. Without the higher house building numbers, it is unlikely that the Government will achieve these targets. Supply constraints Policy changes aimed at residential property investors are likely to put further pressure on the already constrained supply of rental homes. From April 2016 purchases of residential properties over £40,000 for investment will attract an additional surcharge of three percentage points above the current rate of SDLT. Hence a buy-to-let investor acquiring a property worth £500,000 would pay an additional cost of £15,000. This stamp duty increase follows a restriction of tax relief on mortgage interest payments for buy-to-let investors with debt set against their Source: 1991, 2001, 2011 Census property. Both measures are likely

02 February 2016

to limit the ability of some private FIGURE 2 investors to expand their existing National spread of deals 2015 portfolios or buy their first investment property. The withdrawal of tax relief may also prompt some to rationalise their portfolios although we are not expecting a mass exodus from ■ London (60%) buy-to-let. The experience of the last ■ North West (9%) downturn suggests that most are ■ South West (7%) long-term investors. ■ South East (6%) The Government is consulting on ■ UK-wide Portfolios (5%) the policy detail, including whether ■ East Midlands (4%) an exemption for corporates and ■ Yorks & Humber (4%) funds owning more than 15 residential ■ East of England (2%) properties, is appropriate (see Policy ■ West Midlands (2%) Response: Additional Homes Stamp ■ Scotland (1%) Duty Surcharge). ■ North East (0%) We think it highly likely that corporate investors will remain exempt from these tax changes and that the appetite from housebuilders to secure Source: Savills Research deals with large-scale investors will grow strongly in 2016. Housebuilders have relied heavily on FIGURE 3 off-plan sales to buy-to-let investors, Rising levels of investment particularly as their banks and debt funders very often require evidence 3500 of sales to de-risk the development.

As a result, there is a big opportunity 3000 for large-scale investors to fill the gap through forward funding structures. 2500

Large-scale investment 2000 The mismatch between supply and demand for rental homes is likely 1500 to underpin rent rises, particularly in undersupplied markets. It also 1000 represents an opportunity for institutional investment at scale which Rolling Annualised Investment £ mn 500 has been growing steadily. Some big domestic and international players 0 have entered the rental market and the 2011 2012 2013 2014 2015 flow of capital is building up. Source: Savills Research The overall value of deals recorded by Savills own investment database has increased from £2.3bn in 2014 FIGURE 4 to £2.65bn in 2015. The number of Institutions becoming more dominant players deals backed by institutions doubled between 2014 and 2015. Last year ■ Private Company ■ Registered Provider ■ Private Equity ■ Institution ■ Public Company ■ Fund Manager ■ Developer (2015) over 30% of all rental market 100% deals were backed by institutions 90% compared with 22% in 2014. Private companies also represent 80% a significant part of the sector, 70% accounting for 40% of deals. 60% As the market evolves, we are seeing a shift in the corporate-backed 50% rental market from one in which 40% investors purchase ready-made 30% schemes to one in which forward funding development is becoming 20% increasingly prevalent. This document 10% outlines opportunities for investment 0% and development in the rental market 2011 2012 2013 2014 2015 as demand is here to stay. n Source: Savills Research

savills.co.uk/research 03 Spotlight | Rental Britain

Investment ROUTES TO MARKET

There is more than one way to raditionally, larger and Patron Capital’s acquisition of investors in the rental Cala Homes. Further to this, the invest in the residential market market have built up acquisition of Quintain by Loanstar has for large-scale investors portfolios through the potential to see a large amount of the acquisition of rental market stock being delivered Texisting residential stock. Since through the development opportunities the introduction of the buy-to-let in Quintain’s pipeline. mortgage, the market has grown Aggregators of rental stock are also through buy-to-let investors increasing in numbers with the likes acquiring a high proportion of of Essential Living and others, where newly built residential stock that we may find that once developed and was built and designed for the stabilised, these portfolios may be owner-occupier sales markets. sold to the institutional market through Developing new stock for private large portfolio sales or corporate rent is a relatively new feature of the transactions. residential investment market. It is A key challenge for investors is the a response to the reintroduction of identification of an operating partner to institutional capital seeking investment manage the portfolio. The aggregators grade assets and the limited supply are tending to create new branded of good quality stabilised portfolios. management services developed It is also a result of the recognition alongside the asset pipeline whilst the that delivering a customer-focussed institutions are more likely to outsource service to tenants requires a variation the management function. FIGURE 5 in the design and of As the institutions get more Routes to market residential buildings. comfortable with residential as an For larger, institutional investors, asset class we are likely to see a gaining exposure to the UK residential range of markets emerge from prime Acquisition of market in its broadest sense, is likely bespoke stock to secondary and even to see various investment strategies tertiary stock. As these investors are Existing Stock being deployed. In simple terms, this primarily driven by income returns can be achieved through developing – as long as the net income from a bespoke buildings on an asset by portfolio can be proven, assessed Joint venture and asset basis. This does, however, and priced, taking into consideration take time and require appropriate all operation and capital costs – the co-investment vehicles resources and skills to identify, larger fragmented portfolios, which negotiate and transact in a market historically have been the target of that has largely delivered housing for trading investors, may start to appeal Land acquisition development sales. to the income investors. As property Increasingly, the larger equity houses management services to residents and development who have significant access to capital are increasingly delivered through IT are seeking opportunities which solutions, the make-up and location of provide a higher level of control over assets will become less relevant. Forward delivering large volumes of residential. Corporate transactions, either through Purchase acquisition of companies or share capital where a degree of influence can be applied over the direction of the Forward delivery organisation, are likely to be seen going forward. Developing new rental Fund Examples of this are the acquisition of a number of house builders product is a new feature including Oaktree Capital’s acquisition of the market Source: Savills of and L&G

04 February 2016

From an asset perspective, the main of this approach in the UK market. the developer, main contractor and deal structures evident in the market Developers have sought joint the investor, thus making it is less are set out below. Each will have a venture partnerships where risk is resource-intensive for the investor. different risk reward profile. shared on the basis of the level of As a result, an investor with a large equity provided. allocation to residential can spread n Land acquisition and investment more easily across development n Forward funding schemes and markets making the Acquiring land and developing rental The structure of forward funding approach more scalable than straight market stock allows for complete transactions varies widely. In development. control of the product and delivery general, an investor will make An important upside is that the of the scheme. This is the approach an initial payment up front which approach allows for more control of now being used by Essential Living. reflects the transfer of the interest the product and of the delivery of the The approach is considered resource- in land. This is followed by stage scheme. We have seen a number of intensive and involves the investor payments that will cover construction build-to-rent schemes using a forward taking planning and development costs, a percentage of profit and a funding approach, including the risk. Competition for land can be development manager’s fee. M&G scheme in North Acton being fierce, particularly against traditional Stage payments covering developed by Hub Residential. housebuilders. construction costs, particularly As the number of players building when funded from an income fund, for the rental market grows, new n Acquisition of existing are likely to attract a coupon akin business models are emerging. At the blocks and/or portfolios to development finance costs. The heart of these models is the trade-off A number of large portfolios have funding structure may also include between risk and return. In a strong traded over the past two or three years an “End Bullet” upon completion, sales market, traditional build-to-sale which have allowed new investors to usually covering the developer’s models deliver higher returns but the acquire significant portfolios of existing outstanding profit. absorption rates can differ. stock. Examples include the Maison The advantage of a forward Given the cyclical nature of the Portfolio, which saw Apollo acquire funding structure is that it de-risks property sales market, the risks are the West Register portfolio, and the the development by effectively greater in a market downturn. Forward GRES portfolio, which was effectively guaranteeing a block sale to an funded build-to-rent deals diminish refinanced through an acquisition by investor at building completion. From sales risks greatly and are especially the European pension fund APG. an investor’s perspective, development suited to large projects with multiple The shortage of good-quality risk is more evenly shared between phases of development. n existing rental portfolios means that competition is high for fully let stabilised rental stock. Risk is low but commensurate with the level of returns “Forward funded build-to-rent deals achieved from investing in the sector. diminish sales risks greatly” n Forward commitment/ purchase of completed  Hub Residential development Victoria Square North Acton, Ealing London stock This is a simple and fast way to aggregate a portfolio, requiring only a down payment when a deal is agreed with a developer and payment of the remainder on practical completion of the scheme. Fizzy Living effectively used this approach to aggregate their portfolio of rental market stock and it allowed them to quickly aggregate stock and a management platform. The downside of investing using this mechanism is that the investor has very little control over the product and delivery of the scheme. n Joint venture Joint ventures and co-investment vehicles have largely replaced traditional funding arrangements in the aftermath of the credit crisis, predominantly because of the high cost of finance. Residential Land, backed by Ivanhoe Cambridge, is an example

savills.co.uk/research 05 Spotlight | Rental Britain

Case studies WHY FORWARD FUND?

ACCELERATE HOUSING DELIVERY CITY CENTRE REGENERATION

Bath Riverside, Bath City Centre Fruit & Veg Market, Southampton M&G Real Estate purchased 97 new private rental homes in Bath Rockspring and its joint venture partner Atlas Residential have Riverside from Crest Nicholson. The transaction forms part of a agreed a deal to purchase a rental market development site from longer term relationship with Crest. The partnership is designed to local developer Hampshire and Regional Property Group (HRPG). accelerate housing delivery by unlocking future phases of land. M&G The site originally owned by Southampton City Council has planning will provide finance to fund the development of 97 apartments while consent to deliver 211 units. The impact of more rapid letting rates Crest Nicholson acts as developer and contractor of the scheme. on delivery times for new developments is a key attraction.

INVEST IN UNBROKEN BLOCK DE-RISK REGENERATION

Victoria Square North Acton, Ealing London Lewisham Gateway M&G and HUB Residential have renegotiated the S.106 agreement Lewisham Gateway is a major urban regeneration project in for this scheme which required 20 of the units to be allocated for Lewisham in London. As part of the funding strategy for the shared ownership housing. M&G sought to purchase the freehold development, Fizzy Living agreed to purchase 136 units in interest of an unbroken block so that the block could be managed Phase 1 on a fully forward funded basis which helps give certainty to and maintained as a single asset. LB Ealing agreed to allow the the developer Muse. It helps to de-risk the significant infrastructure conversion of the original S.106 requirement to 20 discounted market costs associated with this large-scale regeneration project. rental units.

06 February 2016

Market dynamics OPPORTUNITIES FOR INVESTMENT

he search for higher this is not an exhaustive list, we have Next, we considered relative levels yields and fresh also sought to highlight investment of housing supply and demand in each opportunities is prompting prospects in cities set to experience city, looking at objectively assessed investors to look beyond a significant housing shortfall, such need, household projections, population London. There are high as Oxford. The cities are rated on four growth forecasts and dwelling Tconcentrations of households renting groups of criteria. completions. Most of our top cities have privately in a number of regional cities First, we considered the economic experienced a major shortfall in housing following significant growth in the prospects of each city, which included supply over the last few years, and this tenure this century. analysis of historic and future appears likely to continue. We have analysed the fundamental employment growth and major growth Finally, we looked at how the rental factors driving the rental market. The 29 sectors. Cities that performed well in market has evolved and grown in cities listed below represent some of the this category not only had high levels these cities. Growth in the number of most attractive cities for investment in the of forecast job growth, but also saw households renting privately reflects rental market, although opportunities will growth in sectors where advance a nationwide trend that has been vary on a site by site basis. Manchester, levels of education are required and very pronounced in most of our top Reading, Edinburgh and Bristol top our where pay is relatively high, such as cities. This criterion also considers the list because of their strong economic finance or the technology sector. affluence of rental market households, growth prospects and reputation as Second, we considered the prioritising cities where renters are in vibrant, desirable places to live. Whilst investment potential of each city by well-remunerated, highly skilled jobs looking at the net income return, rental that will support future rental growth. growth prospects, and capital value These industries bring well-paid growth. Cities that performed well here employees who can support higher “These cities represent some of have seen comparatively strong rental rental levels and help to reinvigorate the most attractive opportunities” growth but prices remain relatively low, cities and make them more attractive leading to stronger yields. places to live. n

FIGURE 6 Regional Investment Rating Strongest ■ ■ ■ ■

Manchester Brighton Chelmsford Leicester

Reading Leeds Southampton Norwich

Edinburgh Glasgow Sheffield Aberdeen

Bristol Cardiff Northampton Cambridge

XXXXXX York Portsmouth Newcastle upon Tyne

XXXXXX Milton Keynes Liverpool Bradford

XXXXXX Salford Nottingham Bath

XXXXXX Birmingham XXXXXX Bournemouth

XXXXXX Oxford XXXXXX Plymouth

Source: Savills

savills.co.uk/research 07 Spotlight | Rental Britain

OUTLOOK

■ Rental Growth: Rents are now on UK-wide residential portfolios of existing ■ More sharers likely: Despite average higher across the UK than a year assets traded in 2015 were priced off a Government measures to help first-time ago. Data from HomeLet, which records 5% to 5.5% net yield based on a 28% buyers, we expect to see the traditional rents on new buy-to-let tenancies, shows gross to net deduction. New build-to-rent rental demographic of sharers and young that London saw the bigger rent rises of stock in regional cities is being priced off professionals continue to grow, where the 7.5%. At a national level rents grew by a 4.5% to 4.75% net initial yield, based supply of housing is tight, costs are high 3.8% in the year to November 2015. This on a limited number of deals. and options to move into homeownership masks the growth seen in the core regional remain limited. markets such as Manchester city centre, ■ Looking Ahead: We expect that an where we have seen rents rise by 7%. undersupply of rental homes, which ■ Benefit cuts: Our rental forecasts do is likely to be exacerbated by policy not include tenancies that are reliant on ■ Investors’ yields: Competition changes affecting buy-to-let investors, housing benefit. Rental markets that are for investment stock has led to yield will continue to underpin rents in markets heavily dependent on housing benefit compression. The gap between vacant where demand is strong. These include tenants, such as some of the seaside possession values and investment values popular city centres where there is higher towns along the south coast and parts has narrowed, which has increased the value employment and limited options to of the northern urban belt, will come number of sellers looking at block sales get on the housing ladder. The prospect of under renewed pressure as a result of as opposed to piecemeal break-up. While wage growth is likely to support rent rises, Government policy to limit welfare. yields remain higher outside London, the particularly among young professionals sheer weight of capital chasing regional who are most likely to benefit from an opportunities has driven yields down. improved labour market.

FIGURE 7 Mainstream rental growth forecasts

2016 2017 2018 2019 2020 5 years

UK 3.0% 3.0% 3.0% 3.0% 3.5% 16.5%

London 4.0% 4.0% 4.0% 4.5% 4.5% 22.8%

Source: Savills Research NB: These forecasts do not apply to housing benefit dependent tenancies. They also only apply to average rents in the second hand market. New build rental values may not move at the same rate

Savills team Research

Jacqui Daly Susan Emmett Neal Hudson Lawrence Bowles Andrew Smith Director Director Associate Director Investment Analyst Investment Analyst UK Investment UK Residential UK Residential 020 7299 3024 020 7016 3834 020 7016 3779 020 3107 5460 020 7409 8865 [email protected] [email protected] [email protected] [email protected] [email protected] @jacquidaly @saemmett @resi_analyst

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