Rental Britain as an Asset Class

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1 Rental Britain as an Asset Class Savills Development Services Seminar Series Chair: James Coghill, Head of Residential Capital Markets, Savills Thursday 6 September 2012 savills.co.uk

2 Welcome Savills Residential Capital Markets Team James Coghill Head of Residential Capital Markets & Affordable Housing Investment Andrew Brentnall Head of Funding & Development Peter Allen Head of Residential Investment Marcus Roberts Head of Student Investment & Development

3 Rental Britain as an Asset Class Are the market dynamics now right for institutional investment in the Private Rented Sector? The Speakers: - Sir Adrian Montague 3i Group - Martin Towns PRUPIM - Lucian Cook Savills Research

4 Rental Britain as an Asset Class Government s housing and planning package to: Help deliver up to 70,000 new homes (affordable & FTB) Provide 140,000 jobs and boost to construction industry With 50bn debt guarantees for infrastructure & housing... they provide a comprehensive plan to unleash one of the biggest homebuilding programmes this country has seen in a generation David Cameron, Prime Minister.

5 Rental Britain as an Asset Class The new measures include: Flexibility on s106 affordable housing requirements The Infrastructure (Financial Assistance) Bill (Debt Guarantees) 10bn for housing (HAs and developers) 40bn for infrastructure Extra 300m for affordable developers (to cover shortfall from planning?) 200m for market rent sites 280m extension of FirstBuy for 16,500 FTB New loft conversions and conservatories for all!

6 Rental Britain as an Asset Class Sounds sensible? Viability issues resolved? Is affordability just about deposits? Debt guarantee for developers a significant step. Government guarantees for RPs? Extra funding always welcome for affordable housing - but what about delivering mixed and sustainable communities?...will make it easier to build a new home, easier to buy a first home and easier to extend a home. Nick Clegg, Deputy Prime Minister.

7 Rental Britain as an Asset Class Lucian Cook September 2012 savills.com

8 The rise & rise of private renting The number of private rented households in the UK stands at 4.8 million (est). 5 years ago it was 3.4 million. 10 years ago it was 2.5 million. The average deposit for the first time buyer in the UK in 2011 was 26, years ago it was 12, years ago it was 6,300. 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Private Rented Sector Households in the UK FTB Deposit as a % of Income 120% 100% 80% 60% 40% 20% 0% Source: CLG, CML

9 Buying cheaper Buying more expensive Relative costs of buying v renting 140% Interest Only Repayment Mortgage 120% 100% 80% 60% 40% 20% 21% 0% -20% -40% -60% -11% Source: Savills, Rightmove

10 % of adult population The demographic drivers Generation Rent Boomers & Downsizers Aspiring Upsizers Location of the 20% of LAs with the highest concentration of Generation Rent & 10 year growth 45% 40% In the top 10% of local authorities 40% of the adult population are in generation rent 35% 30% 25% 20% 15% 10% Source: 2011 Census

11 Constrained supply In 2007 the number of outstanding buy-to-let mortgages increased by 189,600. In 2011 that figure had fallen to 63,500. Since the credit crunch, the number of private housing completions have fallen by 46% Increase in O/S buy to let mortgages Increase in UK's private rented stock This underpins rental growth 50 forecasts. 0 Source: CML, CLG, Savills

12 Rental growth forecasts Rental Growth Forecast Disposable Income per capita % 1.8% % 2.9% % 4.1% % 4.6% % 4.5% Total 20.5% 19.2% Source: Savills, Rightmove, Oxford Economics

13 In summary Private-rented households in the UK to rise by a further 1.1m (23%) over the next five years. The amount of rent paid by private tenants to rise from 48 billion to 70 billion. 200 billion needs to be invested in the private rented sector. We only expect 25% of this will come from buy-to-let mortgage finance. Opportunities for funds & institutions, property companies and private equity. Linked to contractors, developers & managers.

14 Build to let - the silver bullet?

15 Housing Completions and Approvals Housing Transactions ( 000s) Development constrained by market capacity 70,000 UK Private Housing Completions Planning Approvals (GB) England Private Housing Completions UK Housing transactions (RHS) , , , , , , Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 11 Q3 11 Q1 0 Source: DCLG

16 Build to let - the silver bullet?

17 Meeting the requirement Income Yield & IRR requirements Scale & Management Development Viability

18 Buy to let gross yields 8.0% 7.0% 6.0% 5.0% 4.0% 7.0% 6.2% 5.3% 5.4% 4.4% 3.9% Lower Quartile Average Upper Quartile 7.7% 7.3% 7.3% 7.2% 6.7% 6.7% 6.8% 6.5% 6.6% 5.5% 5.6% 5.7% 5.7% 5.9% 6.0% 6.1% 6.2% 6.3% 4.9% 4.6% 4.7% 4.8% 4.8% 4.9% 5.0% 5.1% 5.1% 3.0% North West North East West Mids Y and H Wales East Mids South East East of Eng Outer London Inner London South West Source: Savills, Rightmove

19 Investment evidence Average Lot Size Average Number of Units Gross Initial Yield London 26m % Scotland 8m % Southern 4.4m % Eastern 2.3m % North East 2.6m % North West 11m % Y and H 1.4m % Large Regional & National 48m % UK 31m %

20 Let s build a rocket boys! Dedicated PRS Term (Years) 10 IRR requirement 9% Vacant Possession Value 150,000 Gross Rental 8,700 Net Rental 6,090 Rental Growth First Five Years 21% Annual Rental Growth thereafter 3% Total Capital Growth 32% NPV of rent and reversion 128,500 % of vacant possession value 86% Dedicating stock to the PRS for a fixed term can: accommodate investors IRR requirements; increase net initial yields; and improve the ability to fund gearing; BUT the trade off is a lower GDV which will affect development viability or mix That is affected by the length of the restriction and the investors IRR and requirements Gross Initial Yield 6.8% Net Initial Yield 4.7% N.B. Illustrative figures are subject to regional and local variation

21 Let s build a rocket boys! Dedicated PRS Term (Years) IRR requirement 9% 10% 11% Vacant Possession Value 150, , ,000 Gross Rental 8,700 8,700 8,700 Net Rental 6,090 6,090 6,090 Rental Growth First Five Years 21% 21% 21% Annual Rental Growth thereafter 3% 3% 3% Total Capital Growth 32% 32% 32% NPV of rent and reversion 128, , ,500 % of vacant possession value 86% 79% 74% Gross Initial Yield 6.8% 7.3% 7.9% Net Initial Yield 4.7% 5.1% 5.5%

22 Let s build a rocket boys! Dedicated PRS Term (Years) IRR requirement* 8% 9% 10% * reduced given investment period Vacant Possession Value 150, , ,000 Gross Rental 8,700 8,700 8,700 Net Rental 6,090 6,090 6,090 Rental Growth First Five Years 21% 21% 21% Annual Rental Growth thereafter 3% 3% 3% Total Capital Growth 90% 90% 90% NPV of rent and reversion 138, , ,500 % of vacant possession value 92% 81% 72% Gross Initial Yield 6.3% 7.2% 8.1% Net Initial Yield 4.4% 5.0% 5.7%

23 Let s build a rocket boys! Current Market 350 Affordable 150 Private Rental 0 Units 500 Vacant Possession Value 150,000 Market 100% Where is it most suitable? Stalled sites where the owner occupier demand is limited Sites where development finance is constrained Larger strategic sites where build to let will be a catalyst for private sales Affordable 50% Private Rental 80% Market 52,500,000 Affordable 11,250,000 Private Rental - GDV 63,750,000

24 Let s build a rocket boys! Current All PRS Zero Affordable Market Affordable Private Rental Units Vacant Possession Value 150, , ,000 Market 100% 100% 100% Affordable 50% 50% 50% Private Rental 80% 80% 80% Market 52,500,000-18,750,000 Affordable 11,250, Private Rental - 60,000,000 45,000,000 Delivering dedicated PRS stock can de-risk stalled large scale development and/or improve GDV and associated viability BUT 100% PRS schemes are unlikely to deliver sufficient GDV and may have issues of market absorption 0% affordable is unlikely to be politically acceptable in terms meeting local housing need & distorting development profit unless you further increase the rental period GDV 63,750,000 60,000,000 63,750,000

25 Let s build a rocket boys! Current All PRS Zero Affordable Two thirds less Affordable One third Less Affordable Market Affordable Private Rental Units Vacant Possession Value 150, , , , ,000 Market 100% 100% 100% 100% 100% Affordable 50% 50% 50% 50% 50% Private Rental 80% 80% 80% 80% 80% Market 52,500,000-18,750,000 30,000,000 41,250,000 Affordable 11,250, ,750,000 7,500,000 Private Rental - 60,000,000 45,000,000 30,000,000 15,000,000 GDV 63,750,000 60,000,000 63,750,000 63,750,000 63,750,000

26 Conclusions Increased demand for renting and prospects for rental growth are supported by but not entirely dependent on the current lack of mortgage debt. The current investment market is already differentiating between investment and owner-occupied values. To deliver scale needs new rental stock. The Montague proposals provide a framework for this. Their implementation relies on informed trade offs between investors return requirements, PRS planning restrictions and development viability. A informed and flexible approach to these issues provide a platform to the delivery of significant and long overdue institutional investment in the sector.

27 The Private Rented Sector An Institutional Perspective 6 September 2012

28 Introduction Why might institutions invest? Issues for institutional investors What might make the sector more attractive? Summary

29 Why might institutions invest? Long term rental growth prospects Diversification Lower downside risk than other property sectors? Greater liquidity (more granular asset base)?

30 Prospects for Rental Growth Demand vs. Supply (Great Britain) 350, , , , , ,000 50,000 Forecast 0 Rising demand for housing Increased population Reduction in average household size/ rise in single-person households Limited new supply of housing Downturn effect Planning constraints Is buying affordable? Reduced mortgage availability Finding a deposit Change in Number of Households Housing completions Source: CLG, N.B. Scotland household numbers estimated from data points Solid prospects for rental growth, BUT location specific

31 Diversification Residential property is not strongly correlated with commercial property Correlations with other asset classes are also weaker than they are for commercial property This suggests that adding residential to a portfolio could reduce risk and potentially enhance returns International investors seeking diversification; institutional investment in residential is already significant in many countries

32 Diversification and performance? Total Returns by Asset Class Consistently outperforms commercial property Residential Property Commercial Property Equities Gilts Performs relatively better than commercial against other asset classes Lower volatility of returns Lower downside risk in recent years Source: IPD Annual Digest, IPD Residential Digest N.B. Residential total returns from taken from IPD Annual Digest, from from IPD Residential Digest

33 Issues for institutional investors Yield (and total return) Scale Management Tax/Regulatory (risk of change)

34 Yield (and total return) Typically institutions seek income ahead of capital growth A c. 3% net income yield not attractive in itself Low income yields can be justified if rental growth prospects are sufficiently strong Other benefits: Typically relatively low void rates (compared to commercial) Diversification and lower downside volatility Historic stability of (total) returns is an attraction

35 Yield (and total return) Composition of Total Returns ( ) 16% 14% 12% 10% 8% Relatively low initial yield Less income security? Shorter leases (Incorrect) perception of higher voids than commercial 6% 4% 2% 0% Residential Property Equities Gilts Commercial Property Capital Growth Income Return Total Return Greater loss between gross and net yield (than commercial) Return historically based on capital rather than income Source: IPD Annual Digest, IPD Residential Digest N.B. Residential total returns from taken from IPD Annual Digest, from from IPD Residential Digest

36 Scale Time commitment required to get comfortable with any sector so needs to be a real prospect of being able to commit funds Opportunities of scale are limited Scale is important to drive economies in management and running costs

37 Management Granular nature = time consuming = expensive Reputational risk? Typically institutions can t or don t want to manage directly; usually seen as a specialist sector Getting comfortable with a manager and documenting an agreement takes time, especially if it s a new sector for the investor Institutional fund managers can bring relevant experience from the commercial property fund management arena

38 Tax/Regulatory (risk of change) A stable tax and regulatory environment is important Institutions historically held residential, typically selling out after the imposition of rent controls Tax is already an issue in the form of irrecoverable VAT (reducing income yields) Current consultation on CGT charges for offshore entities holding residential property has created uncertainty

39 What might make the sector more attractive? Higher returns(!), through; Reducing gross entry costs Reducing running costs Build to rent (but most investors seek income, rather than a pure development exposure) Reduced affordable housing requirement Cheaper (government owned?) land, but needs to be in the right place! Access to opportunities of scale Continued professionalisation of residential property management

40 Summary Prospects for long term rental growth and relatively stable returns are key attractions Net income yields are still relatively low, but probably not an absolute barrier Diversification benefits Limited opportunities of scale could temper interest Are the barriers to institutional investment really that high?

41 Removing the barriers to institutional investment into private rented homes Adrian Montague

42 Background to the Review Rapid growth in the PR sector (3.6m households now; 2m early 80s) Much growth driven by smaller, buy to let landlords: only 1% of landlords own more than 10 properties Gap between housing demand and supply: 2009/10 115,000 completions vs. 232,000 average annual increase to 2033 Profound changes in the mortgage market Housebuilding is a major contributor to economic growth Very little build-to-let

43 The potential (1) For communities and planning authorities Longer term rented homes Better service to tenants Purpose-built accommodation to a high standard of specification and construction Meeting the needs of local communities Unlocking stalled sites

44 The potential (2) For investors Strong fundamentals Strong match with liabilities and potential for diversification Net yields still something of an issue Stable regulatory framework For developers Wide range of potential developers Housing associations have an important role

45 The barriers Lack of stock Novelty Doubts about yields The planning system The release of public land No strong Government lead All contributing to a lack of momentum: just too hard

46 Recommendations 1. Planning system Strong steer from Government regarding PR sector Land reserved for PR tenure S.106 obligations 2. Release of public land Continued pressure on realisations Identify a portfolio of strong pilot projects 3. Targeted financial incentives 4. Housing Task Force 5. Addressing the brand image of PRS 6. Reinforcing regulatory stability

47 Rental Britain as an Asset Class Savills Development Services Seminar Series Thursday 6 September 2012 savills.co.uk

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