So far this blog has focused on real life examples of my work in the private rented sector, including leasing a development fully funded by a private developer, adopting a commercial mindset to make a profit for social purpose and working with HQN to support PRS colleagues in the sector.
In this post, I want to take a more academic approach; last year I completed a CIH University Certificate in Housing at De Montfort University where I completed an assignment on the development of the national policy of build to rent and the findings of, and reactions to, the Montague Review. The assignment concluded with a number of recommendations on how my organisation could take forward the findings of the Montague Review.
Whilst the assignment was purely academic, its conclusions were less so as I was keen to use the assignment as an opportunity to identify the bones of a strategy that my organisation could implement should it want to increase its activities in the private rented sector with institutional funding.
I have reproduced part of the assignment below as an example of how the sector could achieve my Rising Stars campaign idea of working in partnership to develop affordable housing without government finance.
In summary the assignment recommended that my organisation (FHL) progresses the build to let agenda by securing institutional investment in the PRS through a phased approach beginning with offering property management services in the PRS to build experience and reputation, then establishing a consortium of housing associations that work in partnership with LAs to develop a portfolio of properties for private rental. Finally, once the portfolio reaches a suitable size and value, either sell the portfolio to an investor, attract equity investment or transfer to a REIT and use the returns generated at all stages to develop further properties, either for market, affordable and/or social rent, to meet local housing need.
1. Futures Homescape and built to rent
There are a number of roles for Futures Hmescape in taking forward the build to let agenda; this section shall consider these potential roles and the challenges and opportunities that they present. The next section will make recommendations on which of these roles FHL should take on, to take forward the build to let agenda.
Launch or join a Real Estate Investment Trust (REIT) – this is tax efficient vehicle for residential and commercial property investment by individuals and institutions. A residential REIT is established through the transfer of a portfolio of residential properties by a RP or Local Authority (LA) in return for money or equity shares in the REIT. The REIT is then listed on the stock exchange to attract private investment. Since their introduction in 2007, no purely residential REIT has been established in the UK. This is the first challenge; others include generating a sufficient and competitive income return for investors and creating a portfolio of suitable size and value (it is suggested the required value is around £100 million). However, the opportunities are that although a residential REIT is yet to be launched, there are a number under development and a sufficient mixed portfolio of properties for affordable and market rent can generate the required returns.
Facilitator of institutional investment schemes – there is opportunity to follow examples set by Manchester City Council or Thames Valley Housing Association (TVHA) to facilitate institutional investment in new build PRS stock.
Manchester City Council have demonstrated the opportunities for local authorities, local pension funds, a housebuilder and a managing agent, such as a housing association, to work together to combine land, cash and building and management expertise to develop mixed-tenure properties for sale and rental. This model will generate sufficient returns for both investors (the council and the pension fund) and reduces sales risk and overheads for the housebuilder. The challenges here are to replicate this innovative model from a large city authority in a small semi-rural, semi-urban borough, to secure further institutional investment beyond that of the pension fund and the continued viability of the model without LA land.
TVHA have recognised their strong management expertise and diversified by launching a subsidiary to purchase new build properties to let to young professionals at market rents and thereby create cross-subsidy for affordable homes. The subsidiary is financed initially through a combination of equity from TVHA and debt, but the plan is to attract further equity from institutions such as pension funds, and eventually to sell the subsidiary into a REIT. The challenge here again is to replicate this model, which targets young professionals and operates within London commuter areas, in an East Midlands district authority with lower rents and lower demand for young professional housing.
A similar scheme has been recommended by the Resolution Foundation based on work with the Royal Bank of Canada; a consortium of RPs build an investment-attractive number of properties for market rent on their balance sheet, establish a stabilised income stream from letting these properties before either selling them to an investment fund or to a REIT, the RPs continue to manage the units and recoup their development and land costs through an equity stake in the fund or REIT. This consortium model offers an opportunity for smaller RPs who would otherwise be unable to generate the scale required for institutional investment. The challenge would be to secure the initial investment by each RP to develop properties for market rent rather than social or affordable rent.
Manager of large scale institutional funded PRS stock– there is an opportunity for housing associations to diversify and offer their property management expertise in the institutionally funded PRS, e.g. to a REIT or a partnership as in the Manchester example above. This opportunity is a relatively simple one for housing associations due to their existing experience in managing social and affordable housing. The challenges are minimal as responsibility for developing and delivering a successful investment model would lie elsewhere; one challenge would be to apply the property management expertise in one type of rental market to another, which has numerous significant differences, including different customer needs and reduced financing.
The previous section outlined the potential roles for FHL in taking forward the build to let agenda and the challenges and opportunities that each presents; this section will recommended and justify the specific role that FHL should take.
2.1 Leasing & managing PRS properties
FHL is LSVT housing association, providing around 6000 homes across Derbyshire and Nottinghamshire. FHL has an excellent track record in managing tenancies, collecting rents and maintaining properties, which puts it a strong position to offer these services to others. Indeed, FHL has recently started successfully leasing and managing a small number of properties in Derbyshire on behalf of private landlords. This is the FHL’s first step in diversifying into a commercial activity and it has successfully adapted its approach from managing social housing stock to managing private rented stock on behalf of a private individual.
It is recommended that FHL’s first step in taking forward the build to let agenda is to continue offering management services to others, including REITs and partnerships as in the Manchester example, to build experience and reputation in this area; this is important as the Montague Review identified that a barrier to institutional investment was a “perceived shallowness of the pool of management expertise in residential investment”.
Additionally, FHL has been approached by a number of local builders with a small portfolio of rented properties, who are willing to finance and build PRS properties, if FHL will agree to lease and manage these properties long term; their lender can offer more attractive rates if such an agreement is in place, thereby reducing the builders’ development costs and increasing their return. It is recommended that FHL agrees to the long term lease and management of these properties in order to secure this private, albeit not institutional, investment into the local PRS, which will significantly benefit the local housing market and economy and increase FHL’s experience and reputation of managing PRS properties.
2.2 Attracting institutional investment
Next, it is recommended that FHL progresses from managing PRS properties to facilitating institutional investment in the PRS by developing partnerships to bring together money, land, building and management expertise.
Regarding money, as highlighted by the Resolution Foundation investors prefer to invest in residential properties once they have been built, let and are generating an income stream; they are reluctant to invest in the building phase, as at this point the level of return is uncertain. Therefore, unless a deal can be agreed with a local pension fund, it is likely that FHL initially will have to build properties to let in the PRS from its own funds. Once FHL has built and let properties and is generating an income stream from them, FHL can look for institutional investment, just as Fizzy Living is looking to do and as the Resolution Foundation propose in their model, i.e. transfer the properties into a REIT, attract equity investment or sell the properties onto an investment fund. In all cases, FHL will receive a return that can be invested in developing social, affordable or further PRS properties.
It has been discussed above that in order to attract institutional investment, a property portfolio of a suitable value and size, which can offer the desired income return, must be established. Due to the size of FHL, it is unlikely that it will be able to establish this without working in partnership with others. As FHL is a member of the PlaceShapers Group, it is recommended that FHL forms a consortium with other members to develop a combined portfolio of suitable size and value and attract investment into this combined portfolio. It may potentially be quite challenging to persuade a sufficient consortium of members to invest in developing property for market rental rather than affordable or social rental, however there is overwhelming potential to generate much needed long-term returns to cross-subsidise the latter types of development going forward.
FHL and any consortium members must work closely with their LAs to identify land suitable for PRS development. This will not only ensure sufficient land is designated for PRS development rather than residential development in general, but also reduce the cost of the land and thereby increase the viability of the development and the investment. It may be that the LA can offer the land free of charge or on a build now, pay later basis as Manchester City Council has done. Whilst FHL’s LA partner in Derbyshire owns very little suitable land, it has identified suitable plots of land for development in its Preferred Growth Strategy, has details of the land owners and the power through the planning system to ensure PRS development on this land.
Please share your thoughts and experience of attracting insitutional investment for small to medium-size PRS schemes :)