During times when inflation is running hot – like now – many investors turn to real estate, an asset class they expect to offer some amount of protection. But which areas are attractive now, yet have the potential to perform during more “normal” conditions as well?
The UK single-family rental (SFR) housing market, with its combination of “cycle-agnostic” growth and rising, needs-driven demand, is an example of an area we believe has the potential to yield attractive opportunities while defending against many inflation concerns – and even the specter of stagflation, that devilish combination of low growth and high inflation.
Strong fundamental and demographic trends, including an overall structural shortage of homes and a generation of renters seeking family homes, appear to be contributing to the SFR sector’s compelling potential. It’s also good news for the sector that European investors are viewing real estate as an essential portfolio component in an environment where bonds – even junk bonds, in real terms – continue to resoundingly underwhelm. European investors have generally been more fixed income-oriented than investors in the US, which has a more dominant equities culture, and for a typical European institution, real estate has historically provided much-needed yield and a potential inflation hedge.
As global property consultancy Knight Frank recently reported, the UK’s build-to-rent (BTR) market received record levels of investment in the first two quarters of 2021, amounting to £2.35 billion of capital.1 This represents a 79.8% increase in investment volumes from the same point in 2020, when the country underwent its first national lockdown. We believe the growth potential in residential rentals, particularly for single-family homes in the BTR segment, paired with the desire among investors to guard against increasing inflation, has yielded many strong opportunities across the real estate marketplace.
We see several tailwinds behind the SFR market, particularly in the UK.
The first is an overall structural shortage of homes in the UK, resulting from decades of low new-home deliveries. In recent years, average deliveries have been around 200,000 units annually,2 versus the government’s target of 300,000 units every year – and in reality, even this is likely to be too few. This undersupply is fueling growth in house prices, far above the pace of wage inflation. Soaring home prices are preventing many individuals from stepping up the housing ladder as the deposits required move out of reach, pushing many toward renting instead of buying. Based on current trends, tenants privately renting are expected to make up 50.7% of the housing market by 2039, in stark contrast to today, when homeowners make up 65% of the housing market.3
While the UK has £1.3 trillion of privately rented residences, only 3% of that is institutionally owned and managed.4 The rest have private owners and mom-and-pop landlords. What’s surprising to many is that the majority of renters – 63% – live in houses rather than flats. Yet houses represent only 12% of units in the BTR category, resulting in a clear demand-supply imbalance.5
Exacerbating the shortage problem, BTR development today mainly focuses on apartment buildings in major cities, rather than single-family homes in the regions suffering from shortages of appropriate rental units. As Savills Research recently noted,6 “Even accounting for BTR’s geographic skew towards London, this mismatch presents an untapped opportunity for early investors looking to capitalize on the nascent suburban or ‘single family’ model.”
In addition, tax changes have made private ownership of rentals less attractive, with 180,000 private rental homes removed from the market since 2017.7 That's nearly a year's worth of housing deliveries.
On the demand side, rentals are in the midst of a long-term upward trend powered largely by demographic forces, some of which the Covid pandemic has accelerated. Facing a decade’s worth of rising home prices, “Generation Rent” has grown accustomed to living in rental properties. But with many starting or growing their families, they need and want to move out of apartments and into larger homes. Unlike earlier generations, however, who could afford to purchase a single-family home at this point in their lives, the current generation still finds itself priced out of buying. So, renting a home is a more economic option, allowing them to live in homes they may not have been able to afford otherwise.
While this shift was already underway before Covid, demand for suburban housing has leaped during the pandemic8 and is widely expected to remain high as remote working becomes ever more established.
The pandemic has raised expectations for higher-quality housing in general – and it's worth bearing in mind the difference in quality of life that may be offered by purpose-built, professionally managed housing compared with the aging rental stock found across much of the UK. This is especially true when BTR properties make it possible for families to upgrade the quality of their accommodation in an affordable manner. This is as much a flight-to-quality trend as it is a supply-demand imbalance.
These same demographic forces are resulting in the short vacancy periods and very high occupancy rates we’re seeing across the sector today. And it’s sparking increasing appetite from institutional investors seeking exposure to the highly resilient and granular income stream that BTR may offer. CBRE forecasts investment in UK multifamily rentals will hit £7 billion by 2025, up from £4 billion in 2021. But to date, investment activity in the UK’s single-family rental home market has been limited due to its fragmented nature.9
The UK’s experience presents something of a contrast to other residential real estate markets – for example, that of the US. Redfin recently reported that investors bought a record 18.2% of single-family homes sold in the US in the third quarter of 2021, surpassing the previous high of 16.6% set in the pre-pandemic first quarter of 2020.10 (In the interim, that share had dropped to a recent low of 11.2% in third-quarter 2020.) The total investment in dollars amounted to $64 billion for third-quarter 2021, and Redfin pointed out that “Investors bought a record 90,215 homes in the third quarter, up 10.1% from the prior quarter and up 80.2% from a year earlier – the second-largest year-over-year gain on record.”
Notably, single-family homes accounted for an all-time high of nearly 75% of US investor purchases – and those purchases are skewing ever higher in price, with “low priced” homes falling to a record low of 36% of the total, according to Redfin. The average purchase price was up 5.3% from a year ago, reflecting the continued rise in home prices. Also notable, nearly 77% of the third quarter’s investor purchases were all cash.
In Europe, according to a MoveBubble report, Germany leads the BTR sector with the highest industry investment (roughly £15.9 billion), with the UK (at £5.8 billion) and the Netherlands (£4.9 billion) combined making up one-third less.11 However, the UK is picking up steam when it comes to investment in BTR assets, with more than £4 billion invested in 2021. What does differentiate the UK market is the distribution of activity. Since the Covid-19 lockdowns, investors have recognized the opportunities in geographically diverse markets. Build-to-rent has been earmarked for 29 new local authorities since March 2020, meaning 38% of local authorities now have BTR in their pipelines, up from 20% in the first quarter of 2017.12
While BTR developers and most BTR operators are focusing on building new apartments in urban areas, growth potential in suburban areas should not be ignored. In addition to the lack of current new supply mentioned above, as Savills Research noted, “Single family developments also offer easier access for maintenance than flats and require less communal amenity space, helping reduce operational costs further. With lower running costs, rents can be more affordable and so capture a greater share of the local market.”
A BTR operator in the single-family home market can generate exposure (beyond development exposure) to a multitude of housing-related services, whether it’s to finance construction or to act as a property manager. Most notably, BTR operators can gain exposure both to would-be homeowners’ demand for a house and to demand from yield-seeking end investors, all while mitigating typical housing development risks.
For example, in one strategy, a BTR operator might agree to forward purchases of new housing units from the builder at a discount to open market value. Those homes are then built to the operator’s specifications and handed over to the operator upon completion. The operator benefits by bearing no planning risk and no construction risk, with the builder absorbing any cost or time overruns. The builder benefits because uncertainty about retail home sales is removed, and forward-purchase income can act as a form of financing that’s helpful in many ways, including to bolster return on equity.
A BTR operator also has options for exiting a scheme when the time is right. One off-ramp might be the sale of sub-portfolios in order to recycle equity into new deals. Or housing assets could be held with the potential to build a portfolio of scale. Upside is also available from placing stabilized portfolios with long-term holders who then retain the operator as the property manager.
In this age of seeking “green” investments of all types, the housing market is ripe for adopting energy-efficient practices, from how units get built to how much (or little) energy they consume. Government sustainability targets are part of this momentum, as a recent Knight Frank report pointed out, dictating that new developments will need to include low-carbon heating systems, suitable walking and cycling routes, and electric car-charging points, among other targets.13 Moreover, the report noted that the Future Homes Standard will require a 75%-80% reduction in emissions in new-build homes by 2025, with an interim uplift in building regulations taking effect starting in June 2022.
BTR developers can minimize the impact of new development by ensuring the installation of solar panels and the use of energy-efficient lighting and heating systems, and they can even take steps to protect or improve biodiversity at new developments. BTR developers can also be at the forefront of employing modular construction technology (with units built off-site), which can significantly reduce on-site disruptions, vehicular traffic, and waste during construction. The packaging of some modular sections can even be reused as insulation.
We believe it follows that buildings with poor environmental ratings could become less desirable in the eyes of tenants, and that “future-proofed properties” designed or refurbished with sustainability in mind will help retain tenants, boost demand, and result in more resilient income streams.
Single-family rental properties are very much a workforce-oriented housing type, with rents that should be affordable to 80% of the local population by median net income. A typical single-family scheme could have between 50 and 200 units, with a focus on providing family homes. Some schemes may be located on urban fringes and feature a portion of walk-up apartments.
In 2019, Savills Research forecast the BTR sector could account for as much as a third of the UK private rented sector at “full maturity, or 1.5 million homes.”14 As 2021 ends, we’re already seeing that the UK opportunity set is larger than anticipated.
While still maturing, the UK single-family rental sector appears to be moving forward decisively, driven by demographic and secular forces that all point in the same direction. As occupiers grow increasingly discriminating in their choices, we believe the single-family BTR market may open a door to attractive return potential.
For more real estate insights, see “2022 European Real Estate Outlook: Opportunities in the ‘New Prime’ Properties.”
1 Source: “UK's BTR sector sees record levels of investment,” published 11 August 2021 by Property Funds World, referencing Knight Frank data.
2 Source: “English Housing Supply Update Q4 2021,” published 8 February 2022 by Savills.
3 Source: “UK renters are expected to outnumber homeowners by 2039,” published 13 June 2019 by BuyAssociation.
4 Source: “English Private Landlord Survey 2018,” published by UK.Gov.
5 Source: “Real Estate Insights Podcast: UK Suburban Build to Rent 2021,” published 17 November 2021 by Savills.
6 Source: “Primed for growth,” published 2 December 2020 by Savills.
7 Source: “UK Build to Rent Market Update – Q2 2021,” published 15 July 2021 by Savills.
8 Source: “Cities adapting to the new normal,” published 1 October 2021 by Savills.
9 Source: “2022 UK Investor Intentions Survey,” published June 2021 by CBRE
10 Source: “Real-Estate Investors Bought a Record 18% of the U.S. Homes That Sold in the Third Quarter,” published 24 November 2021 by Redfin.
11 Source: “Build-to-Rent Hotspots: What Areas are Growing?” published 20 November 2019 by MoveBubble.
12 Source: “UK Build to Rent Market Update – Q4 2021,” published 12 January 2022 by Savills.
13 Source: “Sustainability credentials front and centre for BTR investors," published 17 March 2021 by Knight Frank/The Intelligence Lab.
13 Source: “Primed for Growth”, published 02 December 2020 by Savills
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