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UK build-to-rent property: a constructive 2017 outlook

Vista Viewpoint

Home / Perspectives / UK build-to-rent property: a constructive 2017 outlook

Key points

The case for build-to-rent investment remains strong due to demographic and lifestyle trends, resulting in demand for well managed accommodation in revitalised city centres

Portfolio assets Manchester Waters and The Cargo Building are scheduled to be completed this year, and we are reviewing new funding opportunities in other locations around the UK

Our properties in Manchester and Nottingham achieved strong rental growth rates in November and December as lettings demand continues to grow following the vote for Brexit

The build-to-rent market continues to benefit from political support, with the Conservative Government and Mayor of London viewing the sector as part of the solution to the UK housing crisis

Fund manager commentary

Despite the UK’s vote to leave the European Union (EU), there has been no apparent impact on the pricing of build-to-rent (BTR) assets: although most transactions take some time to execute, the evidence from deals exchanged during H2 suggests that pricing was in line with those from earlier in the year. The vote for Brexit will lead to a degree of uncertainty for all capital assets over the medium term, although real assets are probably better placed than most to weather the storm due to their relatively low volatility and correlation to inflation.

The case for BTR investment continued to strengthen over 2016. We do not anticipate a UK house-price correction and with mortgage credit likely to become less readily available, affordability looks set to remain under pressure. Obviously, any base-rate increase would also affect affordability. If inflation continues to rise, wage growth is expected to slow down and net disposable income to be squeezed. However, with mortgage capital likely to be constrained, the short-term economic outlook being uncertain and demand for well-managed accommodation in revitalised city centres growing, the occupational background for the BTR market remains robust. That said, effective underwriting will be vital to ensure that assets are correctly priced for their target demographic.

The Fund continues to target properties of 100-350 units, either purpose-built for renting or new-build properties on strong urban centres, at a price-point at which there is currently (and is expected to remain) an excess of occupational demand over supply. We use Countrywide’s proprietary market data and market access to ensure the Fund acquires attractive assets offering excellent services at the right price. The future operation of an asset is at the heart of each investment decision, so the combination of Hermes’ macro-analytic investment capabilities with Countrywide’s micro-market knowledge embeds a major competitive advantage in the Fund’s management time, and we are now seeing evidence of capital commitments coming through. This has been helped by the increasing number of flagship BTR schemes that have completed and have become operational across the UK, and this number will grow over the coming year. 2017 promises to be an exciting year for the Fund, with practical completion of The Cargo Building in Liverpool and Manchester Waters.


Asset management update

In Q4, market activity decreased as the winter period approached and only 5% of the units in the portfolio were re-let. Nevertheless, in November, Medlock Place (Manchester) and Heathcoat House (Nottingham) achieved full occupancy, while Engels House (Manchester) reached full occupancy in December. Heathcoat House demonstrated the strongest rental-growth rate of about 8% on new agreements.

Our programme of redecoration works continues across the assets when units become vacant, which helps maintain low void rates and improve rental growth.

The lettings market continues to show resilience following the UK’s vote to leave the EU in June – the outcome of the referendum has actually increased letting demand so far. Challenging tax regulations have also caused a slowdown in sales to buy-to-let investors, which reduces new stock for letting coming to the market and increases the case for BTR. 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 city centres, where supply is limited. The expanding rental population continues to be attracted to the superior service, ease and reliability of professionally managed, institutionally owned assets.

Construction is progressing well at The Cargo Building in Liverpool. The operations team is mobilised and we look forward to welcoming our first residents when the scheme opens in Q2.

Construction is progressing well at our second flagship BTR scheme and the first to be developed on Pomona Island in Manchester. Upon completion in Q4, Manchester Waters will comprise 164 apartments over two highly specified blocks, benefiting from views over the Manchester Ship Canal. The population demographic in this location – young, affluent people who typically live in apartments in urban areas – is well suited to BTR property.


Responsible property investment

Responsible Property Investment has been instrumental to Hermes’ approach to Real Estate investment for almost 30 years. We seek modern, energy-efficient properties that positively impact communities. The Cargo Building and Manchester Waters are exemplary urban regeneration projects, converting unused land into valuable developments that complement local historical and cultural heritage, and contemporary lifestyles.

Market commentary

The increasing demand for BTR accommodation is set to continue in the years ahead. In addition to low levels of rental stock in the short term, young professionals are facing bigger hurdles as they aim to become owner-occupiers. There is also an increasing desire for the flexibility that BTR accommodation offers.

The supply response to this demand has developed real momentum in recent years, with a significant number of BTR funding agreements and developments completing during 2016 as institutional investors commit significant capital to this rapidly growing sector. This supply trend looks set to continue, with the BTR sector backed by strong demographic and lifestyle fundamentals, limited housing affordability, a long-standing supply and demand imbalance and, more recently, broad government support to help increase housing supply across a range of tenures.

The new Conservative Government led by Theresa May has shown early signs of being much more supportive of BTR than its predecessor, confirming that the sector is seen as an integral part of the solution to the current housing crisis. The Autumn Statement provided some good news for housing, with £2.3bn pledged for infrastructure to support 100,000 new homes and an additional £1.4bn to build 40,000 affordable houses as part of a £7bn affordable housing fund. Meanwhile, the Special Planning Guidance released by the Mayor of London in

November included the encouraging news that BTR schemes can provide their affordable housing element in the form of ‘discounted market rent’, as opposed to social housing being operated by registered Housing Associations or shared equity arrangements, which provide management challenges in BTR schemes.

The BTR sector is underpinned by robust fundamentals. Rental growth looks set to be stronger and more stable than house-price growth over the next five years and yields are expected to be resilient in the face of a positive occupational market. The sector should continue to offer significant benefits to investors during a period of economic and political uncertainty: with the uncertainty surrounding Brexit weighing on the commercial property market, investors are more likely to consider defensive sectors such as private rented residential, which can offer attractive returns through secure income and resilient capital values.


Investment strategy

Vista is an investment fund 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.

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