Building London’s private rented sector

3 March 2014

Kathleen ScanlonChristine Whitehead

LSE London Lent term seminar

Some recent headlinesCouncils urged to build homes for private rent Local councils should set targets for building homes for the private rented sector, says new report (Telegraph 24/2)

A better private rented sector can weed out rogue landlords for good It's the fastest growing area of the market, but rented homes are dominated by amateur landlords. It's time for that to change (Guardian 26/2)

We need rent controls to solve London's housing crisis Too many essential workers are being priced out of the capital. Rent controls could address the uncertainty and unaffordability they face (New Statesman 27/2)

Historic PRS provision in London: Du Cane Court

Dolphin Square

What happened?• Post-deregulation (starting in the 1950s)

companies wanted to sell – and did over the next twenty years

• Owner-occupation grew rapidly with well- developed leasehold arrangements and the possibility of buying long leases

• Tax benefits and other incentives meant private sector building was almost always for owner-occupation

• New rented housing provided in the social sector

Decline and revival• PRS declined to 11% of total stock in

England by the mid-1980s • Deregulation of rents in 1988 led to slow

increase in supply • Owner-occupation for young people

badly hit in early 1990s• Buy-to-Let mortgages introduced in late

1990s – PRS started to increase quite quickly

• Affordability crisis in early 2000s added to pressure on PRS

The financial crisis and its aftermath

• Credit and housing markets dried up• Sellers could not sell; purchasers could not buy –

so PRS grew rapidly • New construction fell by more than half; while• Immigration and natural growth increased the

population of London very rapidly• Crisis of supply with all net growth concentrated in

PRS and among individual amateur/part-time landlords

• Policy makers looked for more housing overall and new build in PRS in particular

Figure 1: Housing tenure, London

Compared to USA: the perception

UK USA

Individual landlords Corporate landlords

Most owning 1-5 units (not buildings)

Owning multi-family

developments

Dwellings originally built for sale to occupiers or as social housing

Purpose-built for rental

Funded by buy-to-let mortgages

Funded by commercial loans

Amateurs Professionals

Current UK policy direction• Encourage construction of rental

developments – to provide big investments for institutions, – allow faster construction on large sites, – introduce specific features suited to rentals

• Attract more institutional investors– to bring professionalism and financial stability

• National subsidies specific to PRS – Build to Rent Fund– Investor guarantees for debt finance

What barriers must be overcome?

• Attracting institutions to the sector has long been the holy grail

• Institutions have argued that yield is too low and that owner-occupation will always be more profitable and will therefore determine land prices

• Has the world changed?

Decision-making by developers and investors

The developer: Land price =

gross development value – build cost – required profit

The investor:Yield = Income / asset price

Investor’s net income made up of revenue…

Revenue

Number of units Rent per unitAnnual rent increase

Yield = Income / asset price ( Yield = Income / asset price )

…less costsVoids  

Average tenant length of stayAverage time to find new tenant

Re-lets Average cost of refurb between tenantsCost of marketing

Management

Property supervision, including letting and running the propertyRent collectionArrears and bad debts

Other costsRepairs and maintenanceInsuranceService charge and ground rentsUtilities

( Yield = Income / asset price )

Risks add to required yield. Some fairly easy to price:

Planning risk

Add X% (say 15-20%) for land and planning risk to required returns to developers

Development risk

Add 5% for construction risk

Initial lettingLittle experience with large-scale rental developments on which to base estimates

Operating or management risk

Add x% for operational risk to investor model OR require rent guarantee from AA counterparty

( Yield = Income / asset price )

Others less so

Exit riskWill investor be able to sell—to owner-occupiers or another investor?

Reputational risk

Problem tenants, bad management, more general issues with PRS

Policy or regulatory risk

Will rent control or security of tenure be reimposed?

(Yield = Income / asset price)

Barriers related toland, construction and

product• Value of land driven by owner-

occupation • Supply of land (particularly in

London) in the right location• Local authority policies (Mayoral

policies vs those of boroughs)• Lack of development finance

Barriers related to yield

• Illiquidity of residential property

• Lack of robust market information

• Management

• Scale of potential investment

Barriers related to investor attitudes

• Predictability of demand into the longer term

• Investors not willing to take planning/development risk

• Investors’ mandates (industry benchmarks)

• Reputational risks• Regulatory and policy risks • Lack of expertise within investment

houses

Have the barriers to investment been

overcome?• Few dedicated new PRS developments

to date—but increasing interest• Government programmes starting to

bear fruit• Mayor’s Draft Housing Strategy calls for

5,000 per annum specifically for the PRS • Possible introduction of covenanted PRS

– but benefit of mixed sites?• Experience of the early adopters (QDD,

Genesis etc) will be crucial

East Village (former Olympic athletes’ village)

Stratford Halo

Conclusions• Many of the barriers reflect very

specific features of the UK planning system and property market, and will be slow to change

• Even so, best opportunity in decades for genuine shift in PRS provision – but only at the margin

• Champions or first movers will be key -- many from overseas