A GROWING SECTOR
The popular Victorian saying that “An Englishman’s home is his castle" may not necessarily paint today's picture as many people struggle to get on the property ladder. The private rented sector (PRS), which can be defined as any property that is privately owned and being rented out as housing, is due to expand significantly over the short to medium term due to many different factors, from regulatory and economic to social and technological.
In 2011/12, the PRS accounted for 17.4% of the total housing stock in the UK (over 3.8 million houses), whereas in 1999 this figure stood at 9.9% (2 million houses)1. Although the Government is implementing various measures to boost house building and access to mortgage finance, it is not possible for everyone to own their own home.
The emergence of a new “squeezed middle” class, i.e. those who are not eligible for traditional social housing but who cannot afford to buy, particularly in London and the South East (in London, one quarter of all households are now private renters) 2 has contributed to the growth in this sector. Housing associations are well placed to take advantage of this as they can expand their portfolio to offer new quality middle-market rented accommodation to intermediate income households.
This strategy can be used to generate capital receipts or a surplus of income to support the more traditional areas of a housing association’s business which require subsidy, such as social rented and affordable housing. If the product is right, the operation and maintenance of such schemes can also generate income.
WHAT CAN HOUSING ASSOCIATIONS BRING TO THE PRS AND WHAT CHALLENGES WILL THEY FACE?
Housing associations have a lot to offer in this exciting new market given their proven experience in developing and managing rented housing of scale and creating sustainable communities. By investing in market rent units and delivering mixed tenure developments on larger sites, housing associations can be provided with cross subsidy to acquire more land for affordable housing and shared ownership. However, where external finance is envisaged, this may be dependent on them having sufficient equity to provide security or utilising their current housing stock. Many are choosing market rent over open market sale given the greater certainty over future cash flows, despite the low net rental yields.
Housing associations will, however, face many challenges including the high cost of sourcing tenants in this sector and potential maintenance costs. This means they will need to consider different investment vehicles and models (e.g. special purpose vehicles, partnerships with housebuilders or institutions, issuance of bonds). In doing so, housing associations may have to adopt a more commercial mindset as their selection of tenants for these units will need to be focused on their ability to pay as well as housing need.
AN EXAMPLE OF A RECENT PRS SCHEME BY A HOUSING ASSOCIATION
A well-known example is Genesis’ Stratford Halo development of 704 units in Newham (410 market rent, 138 social rent, 91 shared ownership and 65 extra care). Genesis has sought to differentiate itself from other providers of private rented accommodation by offering tenants longer tenancies of up to five years with predictable rent increases, the freedom to personalise their own homes and the flexibility to move within their portfolio if tenants’ circumstances change.
Housing associations are free to enter the private rented sector but must comply with their charitable aims and the limitations set by the Homes & Communities Agency (HCA) and the Charity Commission. Although the HCA’s current stance has recently moved towards ringfencing social housing assets so that they are not used to underwrite any other activity such as private renting, many large housing associations are adopting strategies to work around this.
For example, in its response to the Government's discussion paper on how to protect social housing assets in a more diverse sector3, the g15 (a group of London's 15 largest housing associations) has suggested a co-regulatory approach with more emphasis being placed upon boards of housing associations having adequate arrangements to protect a Registered Provider from downside risk. One suggestion is to create "Living Wills" which would be a document prepared to a standard set of requirements set by the HCA that would be audited independently and certified as meeting the HCA's expectations to protect public investment and social housing assets from undue risk.
As for the Charity Commission, housing associations must be able to show that their involvement in the PRS is an "investment" and that any income received is used for charitable purposes and to enhance and preserve the capital of the charity. While this may seem to exclude market rent activity, the test for whether the provision of housing is charitable is a broad one and will depend on the specific circumstances; the rent chargeable; the location in which the tenants are looking to rent; and how any capital receipt will be re- invested.
However, it is clear that the market would be more open to housing associations if the Charity Commission clarified the investment restriction and allowed them expressly to engage in market renting.
BACKING FROM THE GOVERNMENT
In comparison with other countries, owner occupation is still seen as the tenure of choice in the UK as UK tenants generally have shorter leases and less security of tenure than the rest of Europe. However, with PRS being a flexible form of tenure which meets a wide range of housing needs and contributes to greater labour market mobility, it is not surprising that the Government has given its backing to the sector by commissioning the Montague Report in September 2012 . This reviewed the main barriers to institutional investment in private rented homes.
With only 1% of private landlords owning more than 10 properties)4, the Government has targeted institutional investment in PRS as the key to increasing housing supply and boosting the construction sector.
The Report announced a £200 million (increased to £1 billion in the 2013 Budget) Build to Rent Fund to provide equity finance to house builders and developers, a £3.5 billion debt guarantee scheme to support the delivery of build-to-rent developments, as well as a taskforce of PRS investment experts to support the expansion of the sector. It is hoped that a large influx of high-quality rented accommodation will raise standards for private renters and increase competition which will, in turn, stabilise rent levels.
Institutional investors, together with housing associations, are also likely to offer a more professional approach to PRS property management as the current sector is often dominated by small-scale buy-to-let private landlords.
INSTITUTIONAL INVESTMENT IN THE PRS
With the lack of supply of housing continuing to increase house prices and rent levels in desirable locations, the potential of the PRS is clear to see as institutional investors look at launching dedicated residential funds to maximise returns on the long term growth of the sector which is now thought to be valued in the region of £840 billion in the UK5.
Obviously, much of this is based in city centre locations but only 1% of residential stock in the UK is currently owned by institutions, compared with around 10-15% in most European countries6. Market reports indicate that a tipping point has been reached for institutions to enter the PRS, with Aberdeen Asset Management reportedly keen to increase its exposure to PRS to 15% over the next 10 years. APG Asset Management, which has a £350 million private rented venture with Grainger plc, is also aiming to allocate 25% of its total business to residential, up from 15% currently.
Any potential investor in the residential sector could be attracted by the possibility of securing long leases with either fixed uplifts or RPI linked rent reviews backed by strong covenants. However, with social rent anticipated to be pegged to CPI increases in 2015, this has deterred several housing associations from taking PRS opportunities forward.
An investor may also choose to offload the management of the stock to another party such as a housing association. Each investor, however, needs to be certain that the potential risk returns are more attractive than simply investing in commercial property. This is where the covenant strength of housing associations is particularly important - and attractive - to investors in this market. One of the main barriers to investment will be to overcome construction and planning risks associated with delivering purpose-built rented accommodation.
Appropriate opportunities can be difficult to find and institutional investors will need to carefully consider the location together with the planning and development viability for each scheme, while housing associations will need to understand the long-term employment, economic and infrastructure prospects.
The requirement to provide affordable housing in Section 106 Agreements in relation to PRS blocks can render PRS developments unviable.
In the Montague Review, the Government recommended that councils employ flexibility in the planning system to boost the number of PRS developments, including considering waiving the affordable housing requirements and reviewing stalled sites. Linked to this, PRS appears to generally be more viable for larger schemes.
Housing associations are encouraged to engage with local authorities early on in the design stages so that they can assist with meeting an authority’s wider goals of providing social housing in large mixed-use developments and providing more public sector land for housing development.
With the UK facing a housing crisis, the opportunities of the PRS are evident. Changing demographics means that people are changing jobs more frequently and forming families later and so renting appears to be a very attractive and viable option, particularly given the lack of affordability in the current housing market.