The banks’ falling appetite for lending to households and wider economic uncertainty should contribute to a further increase in rental demand growth.
A decline in sales activity could encourage developers to consider collaborating with build-to-rent investors, expanding the primary opportunity pipeline.
Build-to-rent approvals are increasing and the new government has voiced support for the build-to-rent sector.
The Strategy is moving towards the completion of its first major asset, The Cargo Building, which should help support performance in the first half of 2017.
Strategy management update
Economic uncertainty: good for deal flow?
Having recently reduced the base rate to 0.25%, the Bank of England is not expected to increase borrowing rates in the short term but it is likely that retail banks will experience some asset volatility in their own balance sheets. As a result, their appetite to lend to households may diminish. Although a house price correction is not expected, save for some parts of London and the South East where price inflation has been extremely strong in recent years, volumes of transactions have already declined and the ratio of sales to rental transactions is narrowing. Lower economic growth will almost certainly lead to lower wage growth, and therefore lower residential rental growth.
However, the fundamental societal changes which are driving the growth in occupier demand for this sector are likely to continue, and in uncertain economic times this demand may increase (particularly if mortgage credit becomes less readily available). Furthermore, with private sales rates easing, developers and recognised house builders may increasingly look towards build-to-rent investors as an alternative exit route to help maintain the construction pipeline, increasing the number of investable opportunities.
We still believe that the growing appetite of UK and overseas institutions to invest in the UK residential market is unlikely to be affected in the longer term, but the shorter and medium term uncertainty surrounding the economy after the Brexit vote will no doubt impact this nascent asset class. The fund valuers have not yet sought to apply any material impact on asset valuations and the pricing of opportunities has not yet been significantly affected. However, there may be a reduction in net demand from investors until greater clarity is provided on the timing and, more significantly, nature of the UK’s exit from the European Union (EU).
Although the uncertainty created by the outcome of the referendum will impact residential real estate assets in the UK, as it will all investment assets, occupier demand could actually increase over time. This, coupled with a potential reduction in supply, provides a supportive pricing environment outside of those markets which have seen strong price growth over recent years.
Hermes’ Research and Strategy Management teams are currently updating the Vista top-down target location strategy and methodology for 2017. Discussions are ongoing with external data and analytics companies. The teams plan to combine the key drivers of build-to-rent (BTR) locations with various sources to form a unique and enhanced target location ‘scorecard’. The team are looking to combine this with Countrywide Research’s unique data to continue providing the Strategy with a competitive advantage and to mitigate risk when looking at new opportunities.
During its investment phase, the Strategy level performance remains adversely affected by the costs of investment and disproportionate running costs. However, with The Cargo Building completing in early Q2 next year, and Manchester Waters in Q4, we expect these impacts to reduce over time. At an asset level, excluding strategy-related costs, the portfolio continues to deliver a strong income return, of 4.5% overall. Meanwhile, capital growth has been adversely affected by the Government’s introduction of the 3% Stamp Duty surcharge for second homes in the Budget in April.
Architectural depiction of Manchester Waters. Source: Nicol Thomas
Asset management update
In Q3, 22% of the units in the portfolio were either relet or renewed. In October, Medlock Place in Manchester was fully let and Mica Point in Birmingham demonstrated a strong rental growth rate of about 5% on new agreements. Our programme of redecoration works continues across the assets when units become vacant, which helps maintain low void rates and drive rental growth. We see further opportunities to capture rental growth through asset improvement over the upcoming quarters.
We have not seen any material slowdown in the lettings market following the UK’s vote to leave the EU in June – the outcome of the referendum has actually been positive for letting demand so far. With heightened uncertainty in the sales market we have seen some vendors and purchasers delaying sales decisions and would-be first-time buyers continuing to rent. Although rental prices are closely tied to wages and unemployment, the increased demand is also proving to be a contributing factor to rental growth, particularly in the city centres where supply is limited.
We are seeing the private rented market grow and demonstrate resilience in an uncertain economic environment. The expanding rental population continues to be attracted to the superior service, ease and reliability of professionally managed, institutionally owned assets.
Figure 1: Vista investment performance (sterling, net)
Source: Hermes, IPD as at 30 September 2016
Inception date: 31 December 2014
Past performance is not a reliable indicator of future results
The limited affordability of properties for first-time buyers with finite deposits, and the growing attractiveness of renting for longer periods among millennials from a lifestyle perspective, suggest that the private rented sector is likely to grow considerably in the coming years. On the supply side, we are now seeing the delivery of the first purpose-built rental blocks in both London and the regions as institutional investors and large property companies become more involved in the sector.
The Royal Institution of Chartered Surveyors believes there could be a further 1.8m renters by 2025. A 200% surge in BTR approvals over the last 12 months means that 67,000 purpose-built rental properties will come onto the market over the coming few years and the quality of these properties could contribute to the rise in demand, alongside the demographic pressures that have caused the existing peak in renting.
The BTR sector has been further boosted recently by the new housing minister, Gavin Barwell, signalling that the government is planning to shift its focus from promoting mass home ownership to incorporating other forms of tenure, including rented homes, in order to meet its target of 1m new homes being completed by 2020.
Although the UK economy has broadly maintained its momentum since the Brexit vote, it is widely expected to slow over the months ahead, given the fall in sterling and longer term uncertainties. However, the outlook for the private rented sector remains positive. As a defensive sector, private rented property should continue to offer attractive, stable income streams for institutional investors and is expected to be relatively insulated from the impact of Brexit.
The current economic uncertainties are likely to reduce home buyers’ willingness to commit to purchases, limiting transaction volumes and house-price growth. If mortgage lenders decide to tighten their lending criteria because of this uncertainty, home ownership will become even more challenging for first-time buyers. Both of these factors are positive for the private rented sector as they support demand growth.
Table 1: Current (completed) assets in the Vista portfolio
Table 2: Exchanged assets in the Vista portfolio
Vista is an investment strategy launched in May 2015 by Hermes Investment Management and Countrywide PLC, the UK’s largest property services group. Within the private rented sector, Vista invests in build-to-rent (BTR) properties across the UK through forward-funding or forward purchasing new developments, or acquiring existing assets. It provides investors with exposure to real estate opportunities that offer compelling net yields combined with long-term capital growth, which have low correlations to other existing real estate or credit assets.
Vista aims to acquire and manage a portfolio of high-quality, modern BTR housing, without taking material development risk. It invests across the UK, utilising insights and data drawn from Countrywide’s national operating platform.
As strategy manager, Hermes assesses each opportunity: its price, ability to attract tenants and generate strong net income yields, and its contribution to a balanced portfolio. Countrywide provides unique underwriting data and acts as asset manager and ensures that tenants are provided with the best service possible, helping to safeguard the value of the assets and their rental yields.
Diversification of assets across the UK and the balancing of income-producing and new-build assets are key considerations. Hermes applies responsible property investment principles to increase the investment performance, environmental efficiency and positive social impact of real-estate assets.
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