Contractor Willmott Dixon and property advisor Savills are joining forces in an industry first to transform themselves into a new hybrid which takes on development risk. Chloë Stothart finds out how they plan to make it work.
Putting your money where your mouth is. Practising what you preach. Poacher turning game-keeper. Cutting out the middle man. Call it what you will: for 156 years, property consultancy Savills has advised on the development of homes, and for 35 years construction contractor Willmott Dixon has built homes for developers. Now the two companies are coming together in a unique joint venture which will see both parties effectively become developers in their own right.
The pair are forming a series of special purpose vehicles to build thousands of homes across England and Wales. The companies will invest their own equity alongside managing partners, which could include social landlords, and landowners (both private and public landlords, such as local authorities) which would take an equity stake in return for their land.
In doing so, they are cutting out the traditional role of the developer and straying into the territory of some of their clients. Both companies insist this will not pose any competition to their client base and point out that, in some cases, they will actually be helping them by unlocking mothballed schemes. Certainly for social landlords, this model could present new opportunities to build homes and take on a management role. Either way, both companies are branching out beyond their respective comfort zones and taking on development risk - although neither company appears too concerned by this.
‘We are involved in major schemes on the development side and this investment model is a natural progression,’ explains Andrew Telfer, chief executive of Willmott Dixon Regeneration. ‘We are on a journey from contractor to investor/developer/contractor.’
After months of negotiations, they expect to sign up their first landowner - a local authority - in the coming weeks to launch a new development scheme. They hope the council, which they did not wish to name, will be the first of several private and public sector landowners to join forces and set up special purpose vehicles to develop much-needed housing.
This first scheme is likely to attract special attention because it is the first foray into the private rented sector by a contractor and consultant. There has been lots of talk about developing housing for market rent backed by cash from institutions such as pension funds and insurers but, until recently, progress has been limited. House builder Berkeley launched a 555-home scheme subsidised by the Homes and Communities Agency last year, and several others are in the pipeline from rivals such as Barratt, but no others have launched yet. The scheme, with a city council - known for its appetite for private rented sector development - should produce around 1,000 homes in the midlands.
The council will put in the land in return for an equity stake - which will be matched by Willmott Dixon. Savills will also invest equity into the scheme. Both will hold their stakes for between five and 10 years when they hope to would sell to an institutional investor. This would be similar to the way Willmott Dixon has previously structured private finance initiative deals.
A move into the private rented sector as a first scheme is quite audacious given that developers and institutions have struggled to do this for years now. But it is an area where those involved in setting up the Willmott Dixon-Savills joint venture hope to be able to quickly carve out a niche. With banks demanding big deposits from home buyers and many people not qualifying for social housing, demand for the private rented sector is rising. Research from Savills predicts one in five households will live in the private rented sector by the end of 2016.
‘If we produce a couple of thousand properties, we will probably be the fifth or sixth biggest landlord within the private rented sector,’ says Phillip Callan, director of consulting at Savills.
And this build-to-let scheme is just the start of bigger ambitions. Eventually, the joint venture hopes to set up development funds to build at least 1,000 homes in each of several regions. ‘We are talking to 10 to 12 landowners across the country,’ reveals Mr Callan. ‘But it takes time to develop.’
The Willmott Dixon-Savills joint venture will also target mothballed and unused development sites. This could make them a white knight for some landlords sitting on development sche-mes that are currently unviable. ‘We have had very positive responses [from private landowners] because they are wondering how they are going to take their sites forward,’ says Mr Telfer.
So how will the model actually work? The fundamentals seem logical enough: each party will hold equity in the fund, landowners will contribute sites, Willmott Dixon will carry out the construction, Savills will advise on the transactions and value properties and an unnamed housing association will manage the properties. All parties will take income returns from the fund, and in addition, they will be paid for their services.
There are numerous benefits to this approach. Normally at least one or several of these parties would be paid for their work and then end their involvement. Giving everyone a share creates a ‘community of interest’, explains Savills’ Mr Callan, so everyone is motivated to ensure the development continues to be successful.
For example, the landowner will continue to be interested in what is built on the site and on nearby sites they may also own, which could affect the homes’ values. ‘It brings together the landowner, property specialist and property manager and those things are dealt with separately/sequentially at the moment,’ he adds. ‘All who participate in the process will share the risk and reward and it creates a model people want to participate in.’
So far, so good. The development funds will be backed by bank debt at a gearing ratio understood to be between 70 and 80 per cent. At present, no banks have signed up, but the team says it has held talks with several. Mr Callan says the team will ask banks to bid to provide debt to each development. ‘When we get into the specifics of different schemes we will run a funding competition,’ he says. ‘The debt-equity split varies from scheme to scheme and depends on the scale of the development and pace it goes forward at.’
In the case of the build-to-let developments, once the first phases of homes have been let, the partners then hope to attract institutional investment which will enable them to build the next phases.
The model differs from other build-to-rent schemes in that investors are brought in later rather than at the outset. ‘Early on, the number of homes produced will not be enough to tempt the largest institutions but that will change later,’ says Mr Callan. ‘Once we have a £100 million to £200 million portfolio, bringing in participants [institutional investors] is much more realistic.’ The idea is that investors will be more confident to invest in the fund once they see rental streams from the first batches of homes.
So far, other build-to-rent schemes have been slow to get off the ground. One problem is that investors have wanted shorter-term investments and higher returns than private rented portfolios can offer. But Mr Callan says this has not been his experience in dealing with pension funds for this model. ‘Rented housing produces long-term, secure, relatively low-yield returns and that is exactly what the pension funds aspect of institutions need to acquire,’ he says.
Development is notoriously hazardous, though, especially when there is a lot of debt finance involved. The main risks for the first private rented sector scheme are that demand for rented housing will fall or that rents will drop. Savills and Willmott Dix-on argue they can mitigate these risks. ‘It comes down to location, quality and size standards; the right accommodation does let,’ says Willmott Dixon’s Mr Telfer. The team is considering longer-term tenancy agreements and inflation-linked rents which could encourage them to stay in their homes for longer. ‘They know the rent they will pay over the next three to five years. That could be an attractive so-lution. We believe if you get the design right, they become thriving communities and people enjoy living there and will be fundamental to it rather than an incredibly transient population.’
While few funds of this kind have been launched to date, Mr Callan predicts others will follow. Housing association A2Dominion’s deal with Savills (tipped in Inside Housing, 25 June 2010) should not be far behind and works in a similar way, although it also involves the Homes and Communities Agency. Similarly, Manchester Council is working up a model with a pension fund and several other authorities are also rumoured to be mulling build-to-rent.
Lower land prices and cuts to social housing grant have tempted landowners and contractors to look at new funding models to get homes built. The question is whether the early schemes, like Willmott Dixon-Savills, will be successful enough to tempt others to take the plunge. Otherwise, call it what you will, this brave foray into development could be short-lived.
A new business model
Other contractors have begun looking at taking on a hybrid developer/house builder role. David Birkbeck, chief executive of Design for Homes, says cuts to social housing grant mean contractors are getting less work from housing associations so will try to fill the gap. Some were part of the Homes and Communities Agency’s public sector land initiative, where they developed HCA sites under a profit-sharing venture, and this may have got them thinking about applying the model with other landowners.
Contractor Skanska has gone into development by setting up a house building arm, although its homes will be for sale. It has no plans to be a build-to-rent developer.
Manchester Council is in talks to develop its own build-to-let scheme in which it would also inject land in return for equity and have the homes managed by a housing association. However, unlike the Willmott Dixon-Savills model, it wants to get the scheme forward-funded by an institutional investor in the shape of a pension fund. Paul Beardmore, the council’s director of housing, says other models lacked flexibility in picking contractors and advisors, and had had needed too much bank debt. ‘You are servicing debt with your income rather than an investment return and that is usually more expensive.’
There were also concerns that state aid rules around the use of subsidy could be infringed if the contractor and manager were partners in the fund and state funding had been used to remediate the sites or to subsidise sub-market rented housing. Savills says its model will not conflict with state aid rules because it will have paid market price for the sites.