Home Sweet Rental: Why UK Institutions are Embracing Existing Rental Investments, Bringing Good News forRenters
First published by Cambridge University Land Society (CULS) Magazine 2023
The UK’s Private Rental Sector (PRS) is emerging as an appealing prospect for institutional investors. This could be a boon for investors and crucially, for renters. This article explores the growing enthusiasm amongst institutional investors for existing UK rental properties and the positive implications for renters.
The Allure of UK PRS for Institutional Investors
Scale
One of the driving forces behind institutional investment in the UK PRS is the potential scale and value that the sector presents. The PRS is worth £1.4 trillion, 19% of the UK’s £8 trillion housing market. The FTSE 100, valued at £2 trillion at the start of January 2023, seems modest by contrast.
Build to Rent schemes funded by institutions have been increasingly popular in recent years. Yet still, less than 1% of the UK’s housing market is owned by institutions. This leaves huge potential scale, an attractive prospect for institutions seeking long-term, stable investment opportunities.
Yield
The potential for substantial, growing yields (income as a proportion of value) elevates the appeal of the UK PRS. Rental demand is dependable due to the necessity of the product, a home. This demand is on an upward trajectory due to pressures on the housing market from affordability constraints and population growth.
Demographic trends indicate the continuation of this trajectory, for example, the ONS forecasts that the number of households in England will increase by 1.6 million (7.1%) over the 10 years from 2018, from 23.2 million to 24.8 million in 20281 . Growing housing demand, and within that, growth in the proportion of renters, translates to a source of dependable income linked to wage inflation.
Yields vary by factors like location and property type. 95% of the projected population increase is attributable to shrinking household sizes: one-person and multiple adult households without dependent children2 , making smaller housing options — which typically generate higher yields — attractive.
As a guide to regional variation, today’s PRS offers yields ranging from 3% to 12% for single occupancy flats and houses, depending on the geography. The range of risk/rewards to different geographies and archetypes facilitates investments across the risk spectrum, from ‘core’ returns in the safest locations, to ‘value add’ in riskier geographies.
Stability:
The reliability of residential property values is in contrast with the volatility of the stock market. For example, the FTSE 100, a trusted diverse source of value, can fall by 30% in a day. Other real estate sectors such as offices have fallen by 20% in the last year.
Investment values for PRS assets are driven by the income they generate, which is typically only increasing.
Environmental impact Opportunities:
Beyond financial gains, the Environmental, Social, and Governance (ESG) impact opportunities in the PRS have captured the attention of institutions. Regulations, social and media pressure have boosted investors’ focus on sustainable investments, and the UK Private Rental Sector aligns well with this.
On the topic of regulations, Government intervention in the PRS comes in the form of penalties, focused on improving energy efficiency and quality of homes and their management. For example, Minimum Energy Efficiency Standards are currently EPC E though planned legislation will bring this to EPC C, rendering ⅔ of PRS homes unlettable. The Renters (Reform) Bill, published May 2023, aims to offer renters security, regardless of who their landlord is.
The overarching environmental policy objective underlying a great deal of policy on this is Net Zero 2050. In reaching this, improving the homes we already have is critical as the greenest home is the home that already exists. 98% of homes that will exist in 5 years time have already been built, and 80% of the housing stock in 2050 already exists3.
Using these homes better is vital for reducing the emissions associated with living. Many investors hope to lead the path to Net Zero, and here is a clear opportunity to do so: 14% of greenhouse gas emissions in the UK come from homes, and ⅔ homes are below planned minimum energy efficiency standards.
Until now, institutions have focused their ‘living’ investment on new build homes via Build to Rent apartment blocks and Single Family Rental schemes.
Such schemes have their limits, not least potential scale, which is limited to the plots of suitable land available. Existing residential instead offers potential scale of £1.4 trillion.
Build to Rent schemes average 5 years to positive cash flow, whilst existing PRS homes typically generate income from day 1, or < 1 year to stabilised cash flow even when deep retrofits are required. Once built, new BTR schemes are typically accessible only to the privileged few; and crucially, their carbon footprints are high, whereas existing PRS homes already serve all socio-economic groups, from wealthy international students to short term housing for homeless people.
Critically, it takes 10–80 years for replacement buildings to achieve a lower carbon impact than the rehabilitation of existing buildings.4 Existing PRS homes have none of the demolition/rebuild or new build embodied carbon emissions associated with shiny new rental schemes.
Key Trends Shaping Institutional Interest
Macro-Level Rental Growth Story:
A compelling macroeconomic narrative of rental growth is driving the surge of institutional investments. As the demand for rental properties continues to rise, the potential for capital appreciation and steady rental income becomes increasingly appealing to institutional investors.
Micro-Level Advantage:
The availability of data, advanced analytical tools and AI enable institutions to identify value and forecast income across well-selected, diversified rental property portfolios quickly. Access to data facilitates the efficient growth and management of diversified portfolios.
Swift decisions are critical in the face of a landlord exodus. The combination of costly regulations, taxes and higher interest rates are triggering a widespread exit of smaller landlords, who have come to dominate the sector. 82% of english landlords owned <5 properties in 20215 , and for such investors, higher interest rates have acted as the ‘final straw’ causing such landlords to seek a rapid escape route.
ESG Focus — Retrofit and Community Impact:
There is a huge opportunity in retrofitting existing homes to improve their energy efficiency and quality. Upgrading homes from an EPC D to B rating can lead to a 50% reduction in emissions, equivalent to two tonnes of CO₂ per house annually. Government intervention will be a key driver for retrofit, but until then, professional investors are effectively ‘self-regulating’ in line with planned Minimum Energy Efficiency Standards.
The ESG narrative for pre-existing PRS homes encompasses more than just reduced carbon emissions. The social impact of improving homes in existing communities is clear. Facilitating better rental experiences, taking a long term perspective on rental pricing, and offering higher quality homes within existing communities can alleviate families’ cost of living crises and help strengthen existing communities. The enhancement of homes within existing communities is a social responsibility to be proud of. It is quite distinct from previous approaches including segregated new build schemes, or even new builds designed for resale, but acquired by non-resident foreign buyers.
Fundamentals
The fundamentals are attractive. The PRS is rapidly evolving into one of the most significant tenures, carrying substantial political significance. Demand is growing, while supply dwindles due to a landlord exodus. The result is a strong economic case alongside a strong social case. Without institutional investment, there is a risk that we no longer have a PRS, meaning the next generation have the choice to continue to live with their parents or to live in Social Housing — a tenure already cracking under the pressure of excess demand.
Reasons for Renters to Rejoice
Better quality of homes and management:
As institutional investors pour resources into the UK PRS, renters stand to benefit from a higher quality of rental homes, and better management. Professional investors are keen to ensure well-maintained properties that offer comfortable living experiences, creating a positive impact for tenants.
Positive Impact Narratives:
Investors are keen to showcase positive impact stories, and to be held accountable through mandated and optional ESG reporting. Currently, there are 30 ESG services and tools applicable to institutional investment in residential property in the UK, from benchmarks to risk management calculators. There are plenty of areas for development in the realm of measuring ESG impacts, but the important benefit for renters is that there is a clear desire to do right, and to be able to showcase this, leading to better accountability and governance than has ever been seen in the UK PRS.
Avoidance of Negative Stories due to learning from others:
Some countries already have extensive experience of institutional investment into the local PRS equivalents. For example, the US and German rental markets have strong institutional ownership. In many cases, early adopter investment strategies including institutionally backed iBuying and Single Family Rental (e.g. Invitation Homes) highlight the potential social problems of institutional investment in the PRS.
The benefit for UK renters is clear. UK investors have the opportunity to learn from the mistakes of others, and they are keen to embrace ethical and sustainable practices.
Conclusion
The convergence of financial potential — in particular compared with returns available from other real estate sectors — and ESG opportunities in the UK PRS bodes well for both investors and renters. Institutions who proactively enhance the quality of rental properties and contribute positively to local communities have an opportunity to transform a vital sector, with benefits for all stakeholders involved.
1 Household projections for England — Office for National Statistics
3 Climate-neutral building stock by 2050: A highly ambitious goal, Deutsche Bank, March 2021.
