BUILD TO RENTThe move away from buying/selling homes

Date: 29 th August 2018Author: Michael Urie

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In general terms, build-to-rent (BTR) is the sub-market of purpose-built blocks of privately rented residential accommodation designed specifically for renting rather than for sale.

The accommodation is typically:

WHAT IS BUILD TO RENT?

Professionally managed

3.Developed and owned

by investors or residential developers for long-term rental

2.

Bespoke designed

1.

SPOTLIGHT ARTICLE: BUILD TO RENT (BTR)

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The Growth of BTR in the UK

The number of UK residents renting privately has doubled over the past decade, with 4.7 million (20%) of all households now in private rented accommodation. This trend has been fuelled by a variety of factors. A shortage of housing supply and a low interest rate environment have helped push house prices up (both in absolute terms and also relative to average earnings), pricing would-be buyers out of the market. This has opened a gap in the market for BTR developers.

In 2017, the emergent BTR market attracted £2.4bn in investment and its momentum shows no signs of slowing. The Government has also demonstrated its support of build-to-rent as evidenced by research published by the British Property Federation (BPF) in May 2018, indicating that 75% of MPs support build-to-rent and its contribution to the UK housing supply.

The Mayor of London (MoL), Sadiq Khan, has published his London Housing Strategy (the Strategy), following public consultation on a draft version in the autumn of 2017. The Strategy contains an express recognition of the housing crisis in Greater London, and sets out how the MoL will address existing housing conditions and rebalance housing supply.

To diversify the house building industry and thereby increase capacity and delivery, the MoL will provide a package of support for the BTR sector, including through planning guidance in the new London Plan, and lobbying government to exempt BTR from the 3% SDLT surcharge.

10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2009

-10

2011

-12

2013

-14

2015

-16

own outright buying with mortgage private renters all social renters

source: English Housing Survey and Census data - 2016-2017

Thou

sand

s of

Hou

seho

lds

Trends in tenure (thousands of households), 1980 to 2016-17

SPOTLIGHT ARTICLE: BUILD TO RENT (BTR)

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The Numbers (Q1 2017 and Q1 2018 compared)

The BPF’s first published set of annual data on the BTR sector shows significant growth in both London and the regions. The data, which was published in April 2018, shows that the number of BTR homes completed, under construction and in planning across the UK increased by 30% between Q1 2017 and Q1 2018.

Total number of build-to-rent homes recorded at the end of Q1 2018 and Q1 2017

source: BPF with analysis from Savills

Note: ‘In Planning’ includes capacity identified by local authorities and developers on strategic sites yet to have a planning application submitted

Status Q1 2018 Totals Q1 2017 Totals Increase

Completee 20,863 14,371 45%

Under Construction 33,075 22,498 47%

In Planning 63,955 53,892 19%

Total 117,893 90,761 30%

source: BPF with analysis from Savills

BTR development lifecycle (Q1 2017 v Q1 2018)

Q1 2017 Totals Q1 2018 Totals

140,000

120,000

100,000

80,000

60,000

40,000

20,000

0Complete Under Construction In Planning Total

14,3

71 20,8

63

22,4

98 33,0

75

53,8

92 63,9

95

90,7

6111

7,89

3

SPOTLIGHT ARTICLE: BUILD TO RENT (BTR)

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London v Regions compared, Q2 2018

The most recent data from BPF indicates that at the end of Q2 2018, 57.5% of all BTR homes under construction were in the regions. This has largely been driven by cities such as Bristol, Liverpool and Manchester, where rental-focused developments have been welcomed and are more affordable due to lower land values.

Between Q1 2018 and Q2 2018, the regions saw a significant increase in the number of BTR homes categorised as ‘Complete’. At the end of Q2 2018, BPF reported that 10,586 BTR homes had been completed, a 20.3% increase from the previous quarter, where only 8,801 BTR homes had been completed.

The growth in the number of completed BTR units in the regions are a result of a strong development pipeline. The regions saw a massive jump in the number of homes under construction from 11,623 in Q1 2017 to 20,464 in Q1 2018, a 76.1% increase. Compare this to London, which in the same period saw only a 15.9% increase (from 10,875 in Q1 2017 to 12,611 in Q1 2018).

Yield is a major consideration for investors and developers, and partly explains why the regions have seen such growth in the BTR market.

Total number of build-to-rent homes complete, under construction and in planning across London and the regions at the end of Q2 2018

Num

ber o

f BTR

uni

ts

source: BPF with analysis from Savills

Complete Under Construction In Planning Total

London Regions

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0

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London v. Regions

There is currently no separate planning use class or zoning for private rented property, which means that any site suitable for residential development could receive bids from developers for sale and from BTR developers.

As the gross development value of a rental scheme is based on yield (ie the annual return on the capital investment expressed as a percentage of the capital value), without taking account of any potential future capital gains, the yield-based figure is usually less than what a for-sale scheme would achieve. This means that selling units to owner occupiers almost always produces higher values than BTR and so for-sale developers are able to outbid BTR developers for land.

According to BPF, whilst the regions are outpacing London in terms of the number of BTR homes currently under construction, the total number of BTR homes across all stages of the development lifecycle at the end of Q1 2018 showed a fairly even split between London (51%) and the rest of the UK (49%).

Steve Sanham, Managing Director at HUB, a London-based BTR developer, confirms that:

“It’s all about yield – where can the funds get themselves comfortable that they can buy assets which deliver their yield aspirations. In Central London that’s challenging – sales values are high, and rents while strong are often at a level that doesn’t allow a BTR scheme to compete with a sales scheme.”

“Outside of London, where rents and values are generally lower anyway, there is less of a divergence, and funders are more comfortable that schemes will support their yield aspirations.”

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London v Regions

The most recent BPF report for Q2 2018 shows a more even split still between London and the regions. Across all stages of the development lifecycle, there is now a 50:50 split of BTR units in London and the regions. However, the number of BTR units now under construction in London has risen 26.1% from the previous quarter (from 12,611 at the end of Q1 2018, to 15,903 at the end of Q2 2018). In the same period, the number of BTR units under construction in the regions has only risen by 5.3%.

Whilst London outperformed the regions between Q1-Q2 2018 in terms of the number of BTR units that were under construction, it is important to put this into historical context. As noted on page 5 above, between Q1 2017 and Q1 2018, it was the regions that eclipsed London with a 76.1% increase in the number of BTR homes under construction.

Despite strong demand in the form of a high-quality professional rental market, London is viewed as a more challenging market as BTR developers must first complete a project before being able to receive rental income. Conversely, developers of homes for sale can construct and sell units in phases.

Total number of build-to-rent homes, across all stages of the development lifecycle, by region, at the end of Q1 2018

51% London

25% North West

6% South West

6% West Midlands

5% Yorkshire & The Humber

3% Scotland

1% South West

1% East Midlands

1% East

1% North East

0% Northern Ireland

0% Wales

source: BPF with analysis from Savills

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What are the pros and cons of BTR?

Advantages of BTR Challenges of BTR

Provides institutional investors with a stable, long-term income stream Lack of stock

Streamlined experience for tenants - BTR offers high quality management teams that can be more effective than private landlords, with longer tenancies than standard rental accommodation.

Inflexible planning regulations - Lack of flexibility in planning regulations, eg policy requirements to deliver three and four-bedroom units, are not always appropriate for BTR schemes.

Developments are de-risked from a sales perspective - developers prefer to forward fund BTR schemes, selling all units prior to construction commencing. The ‘for sale’ approach carries greater risk insomuch that the developer is exposed to market fluctuations during the construction phase.

Premium paid by tenants - JLL Residential Research recently undertook analysis of 25 private rented community schemes across London. Such schemes, on average, achieve a rental premium of 11% over their respective local markets, potentially reducing the appeal of BTR accommodation to renters.

Accelerated delivery - BTR can accelerate delivery because developers can deliver stock for both open market sale and market rent concurrently.

Returns profile - there are no instant returns on invested capital from BTR. The long term capital commitment might not appeal to all institutional investors. Because BTR is not profitable instantly, builders for sale are able to outbid BTR investors, making BTR developments more difficult to launch.

Supports housing delivery in uncertain economic periods - investors have greater certainty in the long-term prospects of housing demand. Such certainty de-risks and helps forward-fund capital intensive projects.

Planning rules - currently, developments that offer a minimum of 35% “affordable housing” will be able to take a fast track route through the planning process. This threshold currently applies to both BTR and build-for-sale developers, creating a disadvantage for the former type of developer.

Build-for-sale is delivered on a very different financial model, where developers typically benefit from revenue earned from sales throughout the construction phases of the development. Whereas BTR developers must complete construction of the entire development before having tenants move in and pay rent. As a result, BTR cannot compete with build-for-sale on land acquisition and pricing, and so the two sectors should be treated differently.

Communal living is a core feature of BTR – accordingly, some tenants may be willing to pay premium market rents for BTR developments that offer enhanced communal amenities in shared areas (such as gyms and cinema rooms).

The 3% SDLT surcharge - some argue that 3% surcharge should be aimed at second home owners and not BTR institutional investors, removing one of the barriers for BTR delivery.

Faster absorption rates - can be up to 2.5 times faster than those built for sale, with some London schemes achieving an average letting rate of 60 units per month (Boodle Hatfield).

Operational costs – the operating expense budget is key to the viability of a project. Many residential management agents are small and therefore are unable to provide economies of scale. This translates into higher costs for BTR projects.

Government support - financial incentives, such as the ‘Private Rented Sector Housing Guarantee Scheme’, supports new-build rental projects with a minimum value of £10m, a maximum loan to value of 80/20 and a loan period of up to 30 years, although monies will not be released until practical completion.

VAT - BTR developers are not able to recover VAT incurred from ongoing costs (eg management, maintenance and repair) on the basis that the granting of short leases to residential tenants gives rise to ‘exempt supplies’.

A solution to the housing shortage – with demand exceeding supply for homes in the UK, house prices have increased exponentially. BTR provides those who are currently priced out of the market affordable and high-quality places to live.

Knowledge gap - Lack of market information means there is little industry-wide understanding about the tenants’ requirements for bespoke BTR products, compared to development and management costs, tenancy terms and rent levels.

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US v UK Model

The UK’s relatively fledgling BTR market operates a very different model to the more mature and established BTR market in the US (often referred to as ‘multi-family’). The US’ customer service driven approach caters for a wider demographic (families).

In the US, developments are usually only considered viable when providing mid to high-end rental products to tenants with a higher than average disposable income.

Steve Sanham believes that the US is a long way ahead of the UK with respect to purpose built rental accommodation:

“[The US’] dynamic leasing models allow them to push values hard, and their tenants are much more used to the idea of paying for the added extras (gyms, dry cleaning, etc) which can get the financial model working harder.” “One of the most instructive things to

note from the US model is the relative simplicity of the apartments and the relative extravagance of the shared space. [The US] turn[s] around the flats quickly, and get[s] people enjoying the areas that they can generate more money from.”

He goes on to say that:

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In the US, Greystar is the largest US multi-family operator with over 410,000 homes under management across more than 140 cities in the US and globally. Investment in operators such as Greystar has grown strongly over the past 20 years. The US multi-family market has grown by 9 million people in the 10 years between 2005 and mid-2015.

US developers such as Greystar have also made inroads into the UK BTR market. In June 2017, Greystar signed a pre-construction development agreement with

Telford Homes plc, to deliver 894 build-to-rent homes, together with extensive facilities, close to the River Thames at Nine Elms, Battersea.

In the US, multi-family actually began with suburban community developments (referred to as “garden style”) with urban locations coming later. The UK, however, has adopted the model in reverse, as BTR investors and developers initially targeted the young working professional demographic in urban areas. The first purpose-built rental block in London

Case Study: HUB

HUB is a property developer that focuses on delivering aspirational, innovative yet affordable homes in well-connected parts in London.

Founded in 2013, it targets areas where there is a lack of supply of high quality homes, and uses scale and effective design to drive value.

HUB developed one of the first BTR schemes in the UK (the Rehearsal Rooms), which offers 173 homes for long-term rent and is managed onsite under a single, corporate ownership.

The development incorporates communal facilities such as a residents’ function room with direct roof garden access, BBQ areas, outdoor gym equipment and allotments for food growing.

More recently, HUB was granted planning permission in August 2017 to deliver 513 new homes of mixed tenure at Taberner House in Croydon. The development of this key regeneration site will include housing for sale and rent, as well as 13,000 sq ft of retail and commercial space. Work started on site in May 2018 and will also revitalise one of Croydon’s most popular green spaces, The Queen’s Gardens.

that was designed specifically for families (Essential Living’s Creekside Wharf development) only received approval in July 2015.

BPF estimate that if the BTR market is able to mature and reach a similar scale of investment as the US multi-family market or the UK purpose built student accommodation (PBSA) market, it would create around 15,000 new homes per year in the period to 2030.

The multi-family model has proved resilient in the US by incorporating new

technologies. Whilst the US multi-family model is centered on tech innovation (automated air-conditioning, keyless entry, sensors to flag up maintenance issues, amenitisation of services such as remote fridge re-stocking), the UK lags behind the US in this respect.

However, with keen interest from US BTR investors in the UK market, it’s likely that the UK will see a gradual increase in the number of BTR developments that embrace the US tech-focused BTR model.

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The draft National Planning Policy Framework (NPPF)

The draft revised NPPF, published on 5 March 2018, has given the BTR sector formal recognition by distinguishing it from the C3 Use Class and other forms of residential development.

BTR has been given the following definition:

“Purpose built housing that is typically 100% rented out. It can form part of a wider multi-tenure development scheme comprising either flats or houses, but should be on the same site and/or contiguous with the main development. Schemes will usually offer longer tenancy agreements of three years or more, and will typically be professionally managed stock in single ownership and management control.”

The revised NPPF also recognises that affordable housing should be treated differently to build-to-sell developments. Draft paragraph 65 exempts BTR from the requirement that at least 10% of major housing development homes must be made available for affordable home ownership.

This has been generally welcomed by the industry as it means that BTR applications are able to deviate from existing Local Plan affordable housing policies, which has historically been a time-consuming battle with Local Planning Authorities.

The paper also suggests that in order to satisfy its obligation to provide affordable housing, BTR developers should ensure that at least 20% of its units are let on Affordable Private Rents (defined as rents at least 20% below local market rate) at all times.

“While there is a recognition that BTR schemes will most likely yield lower amounts of affordable [housing] on a viability basis, this does just lead most local authorities to ask for a scheme to be assessed on an open market sale perspective instead!”

However, Steve Sanham points out that:

“This is clearly not OK if you’re a BTR developer.”

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SPOTLIGHT ARTICLE: BUY TO RENT (BTR)

Revisions to the Planning Practice Guidance (A Summary)

Shortly after the draft revised NPPF was published, draft updates to the Planning Practice Guidance (PPG) were released for consultation on 9 March 2018, containing more details on BTR. This is a summary of the key points affecting BTR:

• Local planning authorities (LPAs) encouraged to consider the need for PRS homes as part of their evidence base

• Policy support would aid BTR developers when competing with build-for-sale developers for sites

• Introduced ‘Affordable Housing for Rent’ as a defined tenure, establishing that 20% is a generally suitable benchmark for the level of Affordable Private Rent (APR) homes to be provided and maintained at an average maximum of 80% of open market rents in any BTR scheme

• Viability considered on a case-by-case basis, with flexibility for the requirements to be met by other methods

(eg commuted payments)

• LPA to determine whether national space standards apply to BTR developments

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CONCLUSION:

If you have any questions regarding the content of this report, please contact Michael Urie or Nick Rowe in the first instance.

Additional key contacts and contributors to this report include Chris Benn, Jonathan Eyles, William Galley and Matthew Upton.

The greater levels of attention afforded to BTR in both the NPFF and the PPG show that BTR is firmly on the Government’s radar.

The Government sees BTR as a potential solution to the UK’s housing shortage and is looking to support it in any way it can. LPAs have been decreed to ensure BTR features in its plans with supportive policies designed to encourage investment.

As the US multi-family model has proven, the sector is able to weather global recessions, regulatory changes and supply/demand changes. If we can take the US’ growth trajectory in the sector as a precedent, which grew from a market worth $1bn in 1992 to over $80bn in 2016 (BPF - unlocking the benefits and potential of build to rent - p.79) the future for UK BTR looks promising.