Unlike many European countries, residential rental property in the UK has long been an asset class that most institutional real estate investors have shied away from.
However, the recent flurry of fund launches and joint ventures show that this trend is shifting, driven by changes to government policy, a search for income alternatives to bonds and a growing stock of properties specifically designed for the private rented sector.
Just 1% of residential stock in the UK is owned by institutional investors, compared with about 10% to 15% in continental Europe, according to a UK government housing strategy published in November 2011.
Rising allocations However, the Investment Property Forum, a UK trade organisation, shows institutional investors’ allocations to residential property have risen in the three years from £7.6 billion in 2012 to £12.7 billion in 2014. Nevertheless, this is still a fraction of total real estate assets under management, which reached £204 billion at the end of 2013.
Ben Sanderson, director of fund management at Hermes Real Estate, said institutional investors have traditionally been underinvested in the UK residential market relative to the commercial sector, but this was changing.
He said: “Since the start of this year, we have seen the ‘institutionalisation’ of residential real estate. We haven’t really been investing in residential real estate in the UK, but we, like others, are now thinking about the best way to access that.”
Among the companies to have become more active in the market is LaSalle Investment Management, which manages around £11 billion of assets for corporate and local authority pension funds. John Yeend, director of fund management at LaSalle, said it was still “relatively early days in our model to invest in residential” but said the firm was looking into providing forward funding commitments to acquire completed developments.
In May, LaSalle joined forces with Dutch pension fund APG to finance £238 million of debt for residential projects in London and student housing elsewhere in the UK. APG has also been involved in other large residential deals, including last year’s acquisition of the Elephant & Castle shopping centre in a joint venture with developer Delancey to build a large-scale buy-to-let residential scheme.
Other asset managers and insurers are also exploring residential real estate. At the start of September, Aviva and Canada Life said they were considering opening up internal funds managing in-house money to attract third-party investors.
There are a variety of options to gain exposure to the residential property market. According to IPF data, short-hold tenancy, which involves investing in private rented property, is currently the most popular form of institutional investment at £4.39 billion. This is followed by providing the finance for new residential development projects at £3.06 billion, while student accommodation attracted £1.98 billion.
Political push The UK government has been one of the driving forces behind the increased interest from pension funds, asset managers and insurers in residential property. It has long sought to encourage large institutions to develop the private rented sector and help fix the UK’s housing shortage (see panel). Hermes’ Sanderson said: “There has also been a strong amount of political support for the development of rental housing stock and a variety of government schemes have helped at the margins.”
He added that the UK residential sector also offered strong rental prospects with a large and growing demographic.
The increasing interest from institutions comes despite UK residential real estate rental yields hitting decade-long lows, according to figures from data provider IPD. The annualised monthly net yield from all market lets from UK residential property stood at 2.4% in 2013, down from 2.7% in 2012 and 3.8% in 2003.
However, investment returns from residential real estate have been strong. According to the IPD, the 10-year annualised total return of the IPD UK Annual Property Index was 9.7% for residential units to the end of 2013, compared with just 5.6% for retail properties and 6% for industrial units.
Mike Roberts, head of UK property at Canada Life Investments, said UK residential property is currently a small part of the group’s investment portfolio, but that many clients are now pushing for greater access to this market.
He said: “There is a growing sign that institutions are looking for passive, income-type stock by partnering up with either housing associations or residential developers.
“We could just take the core income from a PRS [private rented sector] block of affordable housing to create an annuity product.”
He added: “We are now seeing our investors saying ‘we want to be invested in the residential sector’. There has been commentary from our parent company and investment board to say ‘why aren’t we invested in residential in the UK?’”
Hermes also believes that from a pension scheme perspective, residential property is an attractive place to be “on a total return basis, because it is a different type of income to a commercial return”, added Sanderson.
As the residential market has secured more interest from institutional investors, so it has become more liquid. Market participants have said that, in the past, institutional investors had been put off the residential sector because of a perceived risk that when they needed to offload an asset, there would be few interested buyers.
Long-term liquidity But as Sanderson said: “More entrants to the market are increasing the liquidity of the market in the long term. The risk of being in a large residential portfolio with a lack of exit is starting to diminish slightly.”
However, the UK market also continues to be held back by a lack of supply of large institutional-quality assets to invest in, according to Canada Life’s Roberts. He said: “It’s very early days in the UK. It is a very different kettle of fish in Europe. Institutions have a significant property weighting to residential. Historically, there has been a stronger rented sector in Europe.”
Hayley Adams, who works in the origination and structuring team at Investec Structured Property Finance, said: “For me, the government still has a long way to go in the development and support of the private rented sector in order to meet demand and give more certainty to long-term residential buy-to-let investment.
“Things are moving in the right direction, and the Investment Property Forum and British Property Federation have also recognised more needs to be done to lobby the government in order to promote the growth of the PRS market.”
Government policy The government has long sought to engage institutional investors to help fix the chronic housing shortage in the UK.
As Sir Adrian Montague, in his 2012 government-commissioned review of institutional investment in private rented homes, said: “An increase in housebuilding is needed not just so that more people can meet their housing aspirations, but also to support wider economic growth.
“There is a widening gap between housing supply and household growth. In 2009/10, there were 115,000 new build housing completions in England. Meanwhile, the most recent household projections suggest that the number of households will grow by an average 232,000 per year until 2033.”
Ian Fletcher, director of policy at trade body the British Property Federation, said that the drive to bring institutional investment into residential renting has taken “far longer than any would care to remember”. However, he said government persistence over the past 20 years is bearing fruit and confidence in the sector is returning.
The current UK government published its housing strategy in 2011 when it said it wanted to “encourage greater institutional investment into the sector”. It noted that just 1% of residential property in the UK was owned by institutions, providing “a clear opportunity to grow and diversify the investment base…[that] could help sustain housing supply at a time when mortgage finance is constrained”.
One year later, the Montague Review recognised there were several barriers to institutions entering the sector and has since taken a variety of steps to improve the attractiveness of the market.
The government has also made cash available to support residential property development, established private public partnerships and committed to engaging institutional investors.
The investment made an immediate impact. In April 2013, M&G Real Estate announced it had acquired a £105 million residential portfolio owned by developer The Berkeley Group. The portfolio’s development had been partially funded by the government’s Homes and Communities Agency in what was a precursor to the government’s build-to-rent fund that launched a year later.
Confirming details of its billion-pound build-to-rent fund in April, the government said it would provide “equity finance for purpose-built rented housing”. This was coupled with a £10 billion debt guarantee scheme to act as a safety net for the building of new homes.
Alex Greaves, residential fund manager at M&G Real Estate, said: “The government had [initially] said they had decided to make £200 million available as a debt package for developers to encourage them to build stock for rental. It was oversubscribed four or five times and the government decided to make another £800 million available.”
Long term, however, Fletcher said the most compelling argument for long-term investment in residential property was economic fundamentals as there was “a severe mismatch between supply of housing and access to it”.
He said: “One way of resolving that is by providing quality rental accommodation purpose built for that task and delivered at scale.”
By Joe McGrath