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PRS: Will this be the private rented sector's year?

Against the backdrop of electioneering, the private rented sector faces competition from expanding foreign investment and unleashed UK pension pots.

2014 was a fascinating year of twists and turns for the UK residential sector and we can expect 2015 to be no different.

Clearly, the importance of housing to all the main political parties has added a particular spice to residential development and investment markets.

Meanwhile commercial property markets have continued to sit in the shadow of the total returns available in the residential sector.

The biggest question is how the private rented sector will fare in the face of new market dynamics.

The past 12 months illustrated that there is a real appetite for institutional-grade residential investment in the UK, including many international players who are familiar with residential investment and management in their home markets.

Funds have struggled to deploy money, however, hampered by developers that are driven by higher returns from their conventional ‘trader’ model, as well as a planning system that has not yet embraced the very different PRS viability model and continues to create challenges over accessing land on equal terms to for-sale developers.

PRS lacking class

It is clear there will be no new PRS planning use class under this government, which leaves us with the concept of the ‘rental covenant’.

The covenant means local authorities can provide dispensation against section 106 liabilities, provided homes are kept in rental tenure for a minimum period.

“Housebuilders could potentially be more amenable for a discussion on PRS forming part of the solution on larger schemes’”

If local authorities start to apply the principle of this consistently and with clarity as part of their local plan, then there could be a real step change in build-to-rent development deals being done.

Housebuilders, who may see slightly more sales risk on certain schemes, could also potentially be more amenable for a discussion on PRS forming part of the solution on larger schemes as a sustainable and diversified exit route that still achieves overall development returns.

Overseas money ripples out

A new threat on the horizon for build to rent is the migration of foreign residential investment into parts of the country that were once the domain purely of the domestic developer or purchaser.

The capital has led this shift, with foreign purchasers increasingly looking to Greater London for investment properties as central London starts to look overpriced and the recent stamp duty changes create greater entry costs.

The typical Asian middle-class investor is now looking at Croydon, Ealing, Stratford and other £500-£1,000 per sq ft sales value areas to purchase property to hold and rent.

This immediately brings that segment of the market into direct conflict with the institutional-backed PRS.

“Foreign investors are doing more and more research as to where they can achieve the best total returns and this is very clearly not just a prime London discussion any more”

The classic buy-to-let play could therefore potentially accelerate, fuelling private sales for housebuilders in secondary areas that were once purely domestic markets and, in many cases, have been the primary target markets for PRS schemes.

Lower land and capital values relative to rent price point and rentability have created interest in the ‘doughnut’ around central London and into key commuter towns further afield.

Interest in these areas will now be shared by the private investor for exactly the same reason. This trend could be replicated across the UK in regional towns and cities with the right fundamentals.

Foreign investors are doing more and more research as to where they can achieve the best total returns and this is very clearly not just a prime London discussion any more.

This, combined with recent stamp duty land tax changes, could ultimately create a more buoyant for-sale market where developers will bid hard for sites, possibly against PRS development players, and will also be less inclined to sell at a discount to a bulk PRS purchaser.

Institutional investor competition

The second area that may start to drive a different competition to institutionally held PRS is that of the UK pensioner.

With the changes announced last year due to come into effect in April 2015, there is now unprecedented freedom for pensions to be fully cashed in and reinvested at the policy-holder’s discretion, rather than a simple annuity purchase.

“There is bound to be significant additional interest in residential property and buy-to-let returns as a good long-term route to income with capital preservation and growth”

There is bound to be significant additional interest in residential property and buy-to-let returns as a good long-term route to income with capital preservation and growth.

Again, this will fuel sales in lower-lot-size markets with lower transaction costs and with the best rental credentials relative to capital value affordability.

This will be in direct competition with institutions looking to self-develop or purchase at scale.

PRS position

So what does this mean for the large-scale PRS?

Without the protection of a separate planning use class to carve out sites that don’t have to compete with for-sale developments, there will be a greater reliance on the rental covenant application to ensure that residual land value can be equalised between private sale and rent, and that a developer will therefore obtain the same like-for-like return relative to their risk profile.

“With the long-awaited PRS government debt guarantee scheme now up and running, one would expect to see a further boost to long-term, bulk-held residential investments”

It is also clear political policies continue to generate risk and opportunity for institutionally backed PRS.

With the long-awaited PRS government debt guarantee scheme now up and running, one would expect to see a further boost to long-term, bulk-held residential investments.

But there is clearly political sensitivity about the falling level of home ownership in the UK and the recently announced Starter Home Initiative signifies ongoing government intent to ensure PRS is more of a transition tenure rather than being a default long-term aspiration for UK households.

Cyclical industry

What all of this really means for PRS is that the first wave of aspirational developer/operator/investor deals we are seeing will need to work especially hard on their business plans to ensure they can differentiate from the mass buy-to-let market.

This ultimately will be driven by things such as brand positioning, management quality, amenities and overall customer offer – all well recognised as key ingredients to a successful large-scale PRS.

The reality is that the real battle for future development product market share might not be between the large, professional, branded landlords but against an even greater buy-to-let residential investment market fuelled by Asian middle-class wealth and domestic pension pots.

Two things could swing the pendulum back in favour of the large-scale landlord. Firstly, a housing market correction would shake out the more speculative smaller investors that appear in every upward cycle.

Or alternatively, some significant demand or supply-side government intervention in the market could artificially sway the playing field in favour of large-scale PRS.

The former is always just a matter of time in our cyclical industry – don’t hold your breath for the latter.

Mark Farmer is head of private residential at EC Harris

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