Chaired by Professor Andrew Baum (’Future of Real Estate Initiative’, Said Business School); Westfort Advisors and Beaumont Bailey hosted senior leaders from across the PRS sector, including Sir Stuart Lipton (Lipton Rogers), Richard Jackson (Apache Capital) and Rachel Miller (Grosvenor), for a candid discussion on ‘The Future of PRS’.
The discussion featured personal insights with respect to key challenges facing the sector and thoughts as to how best to meet the demand for quality rental accommodation across the various submarkets. Currently, despite investment into the UK’s PRS reaching a record total of £3.1bn in 2018, (up 33% from 2017), the sector is still substantially lagging in institutional investment compared to the US and Europe.
Resilience of PRS
Covid-19 continues to have a significant impact on the real estate industry and particularly retail and office sectors. Cushman and Wakefield reported leasing volumes were 20% below average for office space in London at the end of Q1 2020. Similarly, ‘Re-leased’ reported that across their portfolio of 65,000 retail assets in the UK, 48.0% of rent due had been received 10 days after the March quarter date, which contrasts to an average of 74.9% collection from the last two years. Across UK commercial property as a whole, 67% of rent had been paid 60 days after the deadline. This compared with a figure of 84% for the December 2019 quarter.
Conversely, owners of PRS schemes around the table, acknowledged a continued demand across their portfolios, with take-up only marginally down (year on year) and rent collection above 95%. Recent changes in living and working regimes, coupled with reductions in higher LTV lending may be factors. In the longer term, forthcoming restrictions to the ‘Help-to-Buy’ scheme and the impact of a recession on affordability may see a decline in mortgaged owner occupation and an increase in demand on PRS.
However, it is important to caveat that the true resilience of the sector will be tested over the next few quarters.
Fundamentally, the lack of housing supply and issues surrounding affordability are a regional issue; not a national one. In London, housing prices have risen the most across the UK, by almost 59% since the 2007 to 2008 peak. Furthermore, the ratio of median house prices to median earnings in London, has risen from c. 5.5x in 2002 to 13.09x in 2018, automatically pushing those dreaming of home ownership within London into the rental sector, which has responded by offering a spectrum of product offerings across attractive locations, with on-site amenities and the promise of community.
Impact of COVID-19 on Consumer Behavior
The consensus around the table was that employees want flexibility (as they always have); however recent events have shown that, for many, working from home has not impacted on productivity and flexible working is likely to increase. Landlords across the table therefore acknowledged that a key question for PRS landlords is how they position their assets to cater for the well-being of their tenants, their appetite for on-site leisure and community, the general convenience for working from home and the optionality to walk to work.
Increasing on-line interaction and WFH will arguably contribute to the growing societal issue of loneliness. People are generally social creatures and will ultimately seek physical, social interactions and the spirit of community. PRS schemes can be designed to help foster a sense of community and this is where participants saw the sector playing an important role.
If COVID-19 truly has catalysed significant shifts in work practices, other communal offerings will arise in its place. Many of the participants agreed that now is the time for accelerated growth within PRS schemes to meet a new type of social need.
Impact of COVID-19 on Institutional Investors’
Following the European precedent, there is great potential for the PRS market to grow in the UK. Switzerland, for example, accounts for a PRS ratio of over 50% and Germany over 40% of total dwellings, much higher figures than England’s 17%. Some of the reasons our roundtable put forward for this lack of institutional interest has been around the inability to scale due to political focus on homeownership, tax regulations, finite availability of suitable land plots, a disjointed planning policy and complex planning process. However, PRS resilience throughout the lockdown period (if that turns out to be the case) is likely to spur further interest from institutional investors, as they pivot away from office and retail sectors.
Bottlenecks to Growth
Short-term
Westfort Advisors provided an insight on the state of the real estate finance market for PRS and where potential bottlenecks may arise. Essentially, there is still significant illiquidity in the debt markets; banks and institutional funds are only just beginning to look at completely new originations, albeit very selectively. However, in the short term (and certainly beyond), there will be availability of senior financing for the right opportunities and the right Sponsors, given the strong markets fundamentals.
Large/scalable schemes, managed by top tier Sponsors certainly remain attractive to insurance backed lenders, German Pfandbriefbank and clearing banks, who can offer senior financing at c.55%-60% LTV.
However, given that prime yields broadly range from 3% for Prime Central London to 4.5% for Prime Regional Cities, higher leverage debt or debt from higher risk/return lenders (debt funds) is often unviable. Many debt funds are also unable or unwilling to consider the relative complexity and risk of financing the development of smaller schemes, which will prohibit smaller scale developers.
Given the prevailing uncertainty in the market and the construction and operating risks associated with developing PRS, lenders are becoming increasingly selective with respect to the caliber and track record of the Sponsor, in addition to the viability of the proposed scheme.
Long term
Further bottlenecks mentioned by our guests centre around the availability of land, and in turn the feasibility of PRS schemes. Due to regulations and the barriers to entry created by complex planning rules, the risk of locking in capital over prolonged periods has impacted upon the feasibility of affordable PRS schemes. Current processes, lead times and long-return windows create a competitive edge for BTS developers who can take money off the table quickly, as well as larger players who have the resource to wait out long lead times.
Vertical Integration
There is also a case that misalignment between developers and operators can negatively impact the type of product that the PRS world is trying to achieve. For developers, the aim is to recycle capital as soon as possible and move onto the next scheme, ultimately creating an environment where there is less focus on the long-term durability of the schemes, or how the building caters to promote community and amenities. This is of critical importance to operators aiming to reduce tenant turnover, maximise the tenant experience and, in turn, to justify higher rents.
One solution to overcome this, as suggested by the table, would be to look at vertical integration from cradle to grave. Whilst the vertical model allows full capitalization on the spectrum of monetizable activities within the PRS world, it is incredibly difficult to execute with many players lacking the necessary skill-set to execute each piece across development, brand, lettings and management with ease. Beaumont Bailey suggested that this is where talent acquisition is key. In order to spot those with the relevant skill sets within hospitality, to move across to the property sector with the revitalized skill set more geared towards to the BTR offering. In addition, the end-to-end product and investment required is not feasible without scale, given the fixed cost associated with each piece of the puzzle.
Broader Socio-Political Elements
It was highlighted within our discussions, that we need to perhaps re-evaluate who the target consumer is for BTR schemes. Those planning future projects need to be clear on which segment of the population this would best serve. Given the social constructs and schema within our society, it is highly unlikely that an individual would choose renting over ownership long-term, if they have the capabilities to purchase a home. As a collective, we view homeownership as the pinnacle to work towards and a marker of affluence. As highlighted by one of our guests, our government places great encouragement of home ownership, and therefore introduces schemes to help facilitate this. Nations with higher percentage PRS, have an alternative culture to this, however this is due to the state of their rental market, being different to that we experience in the UK. Many European countries receive greater protections for tenants and less impetus on the marvels of home ownership. If new PRS schemes can evolve, to provide all they are promising, in regard to amenities and top property management and hospitality; and the government introduces legislation more geared towards protecting tenants, rather than landlords, we too may see a shift in culture. In addition, the cost of living in owned property is cheaper than renting in most locations. It’s often a practical economic decision for those who have the choice. By making land and planning more accessible, the cost of renting can decrease, reducing the economic arbitrage between the two options.
Conclusion
In summary, the sector will adjust to the challenges posed by COVID-19 and the change in our behavioral patterns. As one might suspect, the need for beds and homes, even during the crisis, has not gone away and to date, PRS has shown to be resilient vs other sectors. Investors will continue to offer a wide suite of amenities in their schemes to meet demand, and they remain buoyant for the sector. This could be a pivotal moment in the PRS sector which is well positioned to capitalise on the availability of debt and equity which is seeking a home away from other sectors (such as retail and hospitality) that face much more challenging times ahead.