According to the Investment Property Databank (IPD), residential property has been the best-performing major asset class in the UK, offering the highest returns and second-lowest risk after government bonds between 2001 and 2014.
The wave of financial services regulations introduced over the last five years has caused deep changes in the way we invest in various asset classes, from equities and fixed interest securities to cash – yet the property market seems to have escaped the regulation firing line.
According to the Investment Property Databank (IPD), residential property has been the best-performing major asset class in the UK, offering the highest returns and second-lowest risk after government bonds between 2001 and 2014.
The attraction of investing in bricks and mortar is clear and unlikely to change any time soon: demand for property is reaching fever pitch as the population increases, more people live alone and we are simply not building enough homes.
But whereas those investing in almost any other type of asset would be protected to a certain extent by the fact that their advisers would be conforming to certain standards, there is very little regulation in the property sector.
Just as the introduction of regulation in the financial services sector came as a reaction to the financial crisis, lack of regulation in the property market could ultimately be a contributing factor to a broken property market.
Estate agents have always faced criticism for their conduct but if you dig a fraction deeper, it is not hard to see how, without proper regulation, their behaviour could be causing unnecessary house price inflation.
Even commonplace sales tactics such as holding open days to intensify buyer competition keep pushing prices ever higher.
The National Association of Estate Agents launched a manifesto earlier in the year addressing the problems of the industry and how there is a need for greater regulation. While the body has the right intentions, such changes need to be embraced by the entire industry, cultivating a healthy, honest culture where buyers and sellers can trust the professionals in the market.
The lettings industry is where the cowboys are really running wild as the private rented sector is so poorly regulated. It is incomprehensible that letting agents, managing trillions of assets on behalf of landlords, have no fiduciary duty not to profit from their relationship with their landlords.
A lack of awareness and understanding of the terms means many investors and amateur landlords are unaware of the small print contained in most agreements which sees them forking out huge amounts on renewal fees, mark-ups on contractors’ invoices, unexplained ‘admin fees’ and what can only be described as ‘secret commissions’.
To make these costs stack up, landlords are pushing rents higher and higher across the country, which in turn is preventing first-time buyers from being able to save for deposits to make that all-important step onto the property ladder.
And ultimately this is where the natural market movements of demand and supply have been distorted. The instability of the property market is partly the responsibility of the industry itself – and similar to the bonds and equities markets, the property industry is now crying out for regulation.
This will bring more transparency and integrity to the market for buyers, sellers, investors and tenants alike, weeding out the mavericks that property investors unwittingly allow to look after the country’s highest-performing assets.
Ultimately it will bring a sense of equilibrium to this disjointed property market.
Accelerating the delivery of new housing is a key Government priority with up to one million homes needed by 2020. A new paper published by the Investment Property Forum (IPF) – Mind the viability gap: Achieving more large scale built-to-rent housing – highlights the potential for large scale ‘build-to-rent’ schemes to more than double the rate of a traditional ‘build to sell’ developments - supporting a step change in the delivery of new housing.
The paper provides a practical guide to the issues surrounding delivery and some possible solutions through the use of financial and other illustrations, together with supporting case studies.
As the Housing Minister, Brandon Lewis, says, “This paper sets out some interesting ideas around driving up supply through the planning system”.
Build-to-rent can speed up housing delivery dramatically
The IPF compares the financial dynamics of the ‘build-to-sell’ and ‘build-to-rent’ models. On projects built-for-sell the pace of development is determined by the rate at which homes can be sold. Most house builders assume a rate of 1.5-2 sales per week. Thus a 1000-home development will be phased over a 10-year period.
The pace of development for a build-to-rent scheme can be much quicker because the developer is not dependent on cash flow from a single point of sale. Rents can be reset over time as the project lets up. Letting rates of five units per week can be expected, i.e. at least 2.5 times faster than with build-for-sale, so enabling completion of a 1,000 unit project in four years.
There are other benefits
Amongst the other benefits of large scale built-to-rent housing are: access to good-quality mid-market housing for young professionals and others saving for/or unable to afford a mortgage; a wider range of housing tenure options; more rapid ‘place-making’ for larger regeneration sites; and good risk-adjusted long-term returns for institutional investors.
The viability challenge
The paper includes an illustrative financial appraisal comparing the sale and rental-led housing delivery models. It identifies a significant gap in the financial returns (IRR), generated by each. The rental model is at a 1000 bps per annum disadvantage, albeit at lower risk. So, despite the increasingly well-documented appetite from major financial institutions to invest in the residential sector and at lower rates of return than the conventional house builder market, there is still a material viability issue when taking into account risk-adjusted return requirements.
It is, therefore, essential that all stakeholders in the planning and development process fully understand this viability gap and innovate to overcome it.
What are the solutions?
National Planning Policy Guidance acknowledges that viability will vary with housing type and requires local planning authorities to take this into consideration. The paper identifies three areas where financial viability should be assessed differently for build-to-rent:
1. Recognise that build-to-rent provides housing that is more affordable for local average earners than build-to-sell and take this into account in assessing the level of affordable housing required under the Section 106 provisions of any planning consent.
2. Accept the provision of discounted market rent accommodation in lieu of the provision of social housing per se. The former could be at a fixed percentage to market rent or set for a certain level of income.
3. Where land is being offered for sale by a public body that is actively promoting the acceleration of housing delivery and increase in rental tenure, the level of receipt for the land could be adjusted downwards in return for a formal commitment to achieve these objectives.
Examples of innovation
The paper highlights four case studies where flexibility towards financial viability has been exercised in order to achieve new housing delivery in scheme across London and Birmingham.
Comment by Chair of the IPF Residential Special Interest Group
Robin Goodchild, International Director - Global Research & Strategy at LaSalle Investment Management and one of the paper’s co-authors says, “The potential for build to rent to accelerate new housing delivery is clear cut. Developing quality rented homes for average earners in a local market requires a different assessment of financial viability of development compared to build-to-sell.”
“Considerable progress has been made in the policy environment for the expansion of the build to rent market in recent years. This new study provides policy makers, practitioners and investors with further evidence of the benefits of the build-to-rent model. Only by expanding the sources of capital for new home building and focusing on a wider base of tenures can we hope to reach towards the target of 1 million new homes by 2020. This requires local planning authorities to address the viability challenge head on for the overall benefit of their area’s housing offer.”
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