UK residential market: how and why is money being allocated?

Originally published at https://www.propertychronicle.com.

There’s one question above all that, in the real estate industry, we are constantly asked: ‘Is now a good time to put money into property?’

The consensus is, despite the uncertain environment, residential property in particular is still a fantastic asset — tried, tested, tangible and trusted.

People will always need to live somewhere. There’s a consistent, growing need for property, and yet we have constrained supply:

• There is a housing shortage, with 8.4 million people in England facing a ‘housing crisis’.
• The UK is delivering less than half of its target 340,000 new homes annually.

That said, property is not right for all of us, all of the time. And not all approaches to investing are equal.

The ‘who, why and how’ of property have changed, and are expected to change further.

We’re in a recession. Government stimulus, effective quantitative easing, and long-term low interest rates means capital is cheap, readily available and looking for a safe home.

The good news is that residential property has proved resilient through covid:

• Residential property values have proved stable relative to non-property and other property assets, with annual price growth of 5% in the year to September, versus a value reduction of 6.6% in just six months in the wider real estate sector. Even the Queen has lost substantial sums: the Crown Estate has suffered a £500m down-valuation, largely due to reduced retail rental income.
• Residential rental returns have been resilient, with rental income typically 95%+ through covid versus <50% in other real estate sectors.

There’s more change to come though, including:

• the post-covid ‘new normal’, which is likely to mean lower demand for commercial space and prime city centre locations;
• the aftermath of temporary stamp duty change and furlough ending;
• changing living requirements and preferences; and
• the old spectre of Brexit.

I mentioned earlier that residential property is not right for all of us. It is worth thinking about who is putting money into UK residential property, and why.

In simple terms, there’s:

• homeowners — seeking security, stability and tangibility, encouraged by the temporary reduction in SDLT, and, for now, the Help to Buy scheme;
• investors — seeking cash flow, stability, tangibility, growth and an inflation hedge.

The private rental sector (PRS) is made up of residential assets purchased to be rented out, and it’s seen as one of fastest-growing, most attractive assets. The PRS has doubled to over 20% of households, and is currently worth £1.5trn. Its investors are mostly:

• institutions — who make up just a fraction of the highly diverse sector; and
• high net worth individuals and buy-to-let landlords — in 2018 these made up over 94% of the sector, with 83% of landlords owning four or fewer properties. Individual ownership is less profitable now, so appetite is generally lower, in particular from individuals buying in their personal name.

I mentioned that not all approaches to property are equal. So how are the relevant parties allocating capital, and what issues are they facing?

• Homeowners — Unsurprisingly, this group of buyers are focused on homes. Properties worth over £500,000 are in particularly high demand, due to affordability constraints, and encouraged by the temporary SDLT change. Much of the mini-boom in house prices seen in August was driven by appetite from homebuyers — reflected in the kind of stock (for example semi-detached houses rather than flats) increasing the most in value.
• Institutional investors — This type of buyer needs a scalable way to invest. As a result, their focus is generally on large schemes, such as build-to-rent (BTR), purpose-built student accommodation (PBSA), co-living and later living schemes. These subsectors have grown substantially in recent years. At the same time, the institutional market is not that big.
• For example: BTR stock and pipeline represents <1% of PRS; the widely discussed co-living sector’s total stock and pipeline is less than 5,000 beds; and the established PBSA market is a fraction of PRS, at £51bn pre-covid.
• Some important issues will affect demand and supply from institutions, going forward. These include an average seven-year time lag to ‘cash flow positive’, high development risk, unproven income, or income not tested through cycles, over-reliance on wealthy, transient and changing tenant types and capital growth, and limited exits compared with the established secondary residential market.
• HNWIs and individual landlords — These investors face issues too. They tend to stick with the PRS because it’s what they know (it’s ‘closer to home’!). However, what works has changed. Notably, policy direction favours a professional approach. A salient example is how ‘section 24’ has affected investors, meaning that that leveraged individual ownership no longer ‘works’. In addition, the burden of new regulations is heavy, including licensing, additional health and safety certifications such as around gas and electricity, and the restriction on fees imposed by the Tenant Fees Act 2019. These regulations mean investors generally need more professional operations, which come at a greater cost, to be efficient and compliant.

What next?

I see two key drivers of future change: the economy and new policy. Both are undeniably unpredictable, making it hard to forecast what will work going forward.

I believe it’s still a great time to invest in UK residential property — in the right ways, with risks minimised:

• In terms of strategy: an uncertain economy means increasing rental demand. My business gives investors access to ready-to-let regional PRS assets, typically worth <£1-£5m, that have a proven income, and cash flow from day one, e.g. blocks of flats and housing portfolios in the North/Ox-Cam Arc. To me, these markets seem well-priced relative to risk. Returns are compelling, values have proved stable through recent uncertainties, value and rental growth forecasts are strong, and by investing in built assets, we avoid time lags and development risks.
• In terms of operations: it’s all about efficiency, compliance and customer service. For us this includes leveraging the best practices that have enabled tech businesses to scale, and leveraging partners, expertise and relationships in the sector, as well as operating at a scale that is efficient.

Across the residential market, the biggest priority in the current environment is to strategically identify, manage and minimise risks. To do so efficiently in this complex market inevitably requires the right strategy, the right approach to operations, and the right strategic partnerships.

If you are interested in investing and are not doing so through a professional provider, now is the time to consider working with others, and it is the time to consider who you want to work with. The potential returns to residential property make a compelling case — in absolute terms and relative to the alternatives — but the difference between getting it right and making expensive mistakes just got greater.