Where is housing’s white knight?

Change is in the air. For the first time in a century, the relative size of the UK owner occupier market is starting to shrink. In its place, the private rented sector is expanding at pace. Between 2005 and 2009, the UK sector increased by 1 million households and accounts for more than half of all house moves annually. According to charitable think tank the Building and Social Housing Foundation, if this trend continues, by 2013 the private rented sector will have overtaken the social rented sector in size.

Right now there is little to suggest the trend will do anything but continue. With house prices still too costly for many, mortgage lending still low, and uncertainty over whether the housing market will perform a ‘double dip’, the owner occupier market is set for continued difficulties. House building levels remain depressed as developers struggle to obtain finance, and the buy-to-let market remains on its knees. All this despite the housing minister’s recent call for an age of home-owning ‘aspiration’.

Furthermore, social landlords are in no position to provide relief. Many more people look set to join the 1.8 million UK households already waiting for social housing - and, as the government axe falls hard on grant funding, there will be little money to build badly needed new social and affordable homes.

So how will this growing demand for private rented sector housing be met? For some time many have been looking to the institutions - life and pension funds - to become the sector’s ‘white knight’ by setting up private rented sector funds to fuel a new ‘build-to-let’ house building market.

The Homes and Communities Agency, acting as broker between investors and the property industry, launched its private rented sector initiative in May last year to a big media fanfare. As excitement mounted, fund managers Aviva Investors and Legal & General Property both stepped up to confirm they were among four big players interested in setting up £1 billion funds to invest in new private rented homes.

Knight time

But more than a year on, no white knight has emerged - only set-backs and eerie silence. L&G has backed away for now, while other potential players such as Schroder Property also appear to have taken a back seat. There is disillusionment and concern that momentum is ebbing away.
Andrew Pratt, managing director of residential at Grainger, the UK’s largest publicly listed residential landlord with 24,000 homes under managment, is one of the doubters. ‘There is not a lot in the way of support for the [private rented] sector from the new government,’ he says. ‘The private rented sector initiative has withered on the vine. The majority of people don’t have confidence that this will emerge any time soon.’

Robin Goodchild international director and head of European strategy at institutional investor LaSalle Investment Management, agrees: ‘The energy that the HCA has been putting into the initiative in the last 12 months, right up until the election [in May] has been impressive,’ he says. ‘What we don’t know now is whether the new coalition government will follow it up.’

Last week, housing minister Grant Shapps gave some ominous clues when he announced the government would abandon many of the recommendations to regulate the sector outlined in the Rugg Review, an independent review of the private rented sector published in 2008 (see box: To regulate or not regulate?). While scrapping proposed regulation is unlikely to impact on institutional decision-making, for many it re-enforces the perception that the new government is lukewarm about supporting any form of investment that could discourage homeownership.

To overcome this, the British Property Federation has been lobbying the government. Ahead of this week’s emergency Budget, it renewed calls to introduce real estate investment trusts - tax efficient investment vehicles - for residential property in order to stimulate the private rented sector and encourage international investment. In the USA, where tenants are used to institutional landlords, these vehicles are common. The BPF has also called for concessions on stamp duty to make bulk investment in property more attractive.

Behind the scenes

Yet despite tax hurdles and growing industry pessimism about the financial viability of the investment model, Inside Housing has unearthed progress on two fronts: towards investment in new build rental homes and also existing rental properties. The HCA maintains there are three advanced players. Aviva Investors has been quietly working to launch a £1 billion fund - and despite the silence, a source close to the company says fundraising is underway and an announcement due within two months.

Aegon is the only other fund manager to have put its head above the parapet. The Edinburgh-based firm has teamed up with AIM-listed property developer Terrace Hill to set up a £300 million tenanted residential fund. To the disappointment of some, this will be seeded with an existing portfolio rather than invested in developing homes - confirming for many people the suspicion that the maths doesn’t work for ‘build-to-let’.

However, it is understood that from this entry point it intends to build the fund up to £500 million and invest in construction schemes later on. Aegon director David Wise calls the fund a ‘work in progress’ with nothing to report until funds are secured.

There are other similar moves towards existing homes; the UK’s second largest publicly listed property company British Land is to manage a £300 million buy-to-let vehicle called the CR Property Fund which is being raised by a new business launched by law firm Charles Russell called CR Property Advisors. The Mill Group has launched a £500 million Investors in Housing Fund, seeking to invest in the sector through a co-ownership model. The Duke of Westminster’s property company, Grosvenor, is also understood to be examining the possibility of expanding its existing £35 million private rented sector fund. Grainger is also still examining workable means of investing in the sector.

And there are yet more institutional and private equity investors waiting in the wings, watching for the first move. Moorfield, a Mayfair-based commercial property fund manager and developer, is understood to be considering investing in a private rented sector fund. The company has already formed regional joint ventures with asset managers and developers from its Moorfield Real Estate Fund II which has £390 million of private equity to spend.

University challenge

Another institution thought to have expressed interest in private rental investment is the Universities Superannuation Scheme. The universities’ pension fund has been buying commercial property opportunistically at the bottom of the market over the past year but is now also looking at residential property. LaSalle Investment Management is also attempting to set up a vehicle alongside residential property entrepreneur Charles Fairhurst of Fairbridge Estates.

But despite all this interest, no one has managed to actively launch a fund to invest in new build private rented homes. One reason for this is that many of these investors appear to be seeking returns of around 10 per cent a year, rather than the ‘safe as houses’ lower levels institutions typically seek. There is scepticism as to whether or not the higher figure is achievable.

Aside from the obvious profit motive, in many ways chasing higher returns makes sense. Large scale investment in residential property is considered fairly risky compared to its commercial counterpart. Here, investors carry out due diligence on each of their tenants - often blue chip companies signing leases of up to 25 years - to assess their credit worthiness. With the average private residential tenant, this is a worthless exercise as a person can sign a lease as short as six months, lose their job, void on the rent and decide to move in with friends or family. And that is before considering the market risks of building new houses.

Mr Pratt says that institutions have recently become more attracted to higher returns over a shorter three to five-year period rather than lower but safer returns over a period of seven to 10 years. ‘They [institutions] don’t want to hold property for long; they want to take risk, and be in and out. That doesn’t help a sustainable rented product.’

The bigger picture

Steve Carr, head of economics and new business at the HCA, is unperturbed. He argues that the most serious players are thinking longer term. He also says that comparing residential with commercial misses the point since would-be investors see the private rented sector as an opportunity to diversify their investments and balance their risk.

‘All of the larger institutions are looking for returns that are more index-linked [which track inflation and are lower risk]. If you look back over the years, the private rented sector has provided those type of returns. The money waiting in the wings is not pitched against money that might otherwise go to commercial property, but is actually up against other asset classes such as sustainable energy.’

Also, it is not just commercial property investors looking to set up funds. A housing association is in fact the third mystery pioneer, on track to beat established institutional players Aviva Investors and Aegon to become the first organisation to set up a new build private rented sector fund. A2 Dominion, which manages 33,250 homes, is close to launching a series of six regional funds worth a total of around £1 billion to build new rental homes. Each fund will raise around £100 million in equity - from institutions, private equity investors, and even sovereign wealth investors - which it will leverage to raise between £150 to £200 million to invest.

The housing group has been in discussion with the HCA, investors and development land owners for the past 12 months and expects to begin fundraising in the coming months. Development should begin at the end of next year. It hopes to attract equity and land from other housing associations and local authorities, as well as targeting housebuilders’ development land in return for equity stakes. It is hoping to take advantage of mothballed housing schemes that are ready to go. Overall, the feeder funds will finance the building of 6,000 new private rented sector homes. If they are a success, then they will also be rolled out across Scotland and Wales.

Other social landlords trying to invest in the sector include Affinity Sutton. The 54,000-home landlord has been trying to launch a fund to invest in existing private rented portfolios and has been approached by several investment banks seeking to broker deals with institutions. But chief executive Keith Exford says it is like being asked to pull a rabbit from a hat as the yields they seek are simply unattainable.

‘You can’t get the income they want off the properties, so you need to be able to sell them - and I don’t think many people would want to take on that kind of risk right now,’ he says.

New players

Birmingham Council is more optimistic. It aims to launch a fund in which it can take an equity stake in return for injecting development land for new private rented sector housing. It has earmarked several sites and, according to cabinet member for housing John Lines, is in advanced talks with potential investors. One route, he says, is to target private pension funds that are earning very little interest with the banks. Other local authorities including Manchester are looking to do the same, and it is thought that four London councils are also following Birmingham’s lead.

Certainly the HCA is remains quietly confident that the next few months will bring concrete progress. And institutional investors themselves are aware that, ultimately, there are few alternatives to financing new private rented sector homes.

‘There is no doubt that there is a crisis in the housing sector,’ says Mr Goodchild, ‘and the only way we are going to increase supply is by attracting more equity capital to the market.’

Without it, the spluttering age of homeownership could usher in a new age of disaster in the private rented sector.

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