The document discusses the challenges and opportunities in the private rented sector (PRS) for low to middle-income households, highlighting the shortcomings of current rental offerings and the potential for institutional investment to improve the situation. It proposes a build-to-rent model that accommodates the needs of long-term tenants while ensuring stable returns for investors, backed by rigorous financial modeling and analysis. Recommendations are provided for housing providers and government to facilitate the development and success of this approach, aiming to increase housing supply and improve affordability.

1. BUILDING HOMES FOR GENERATION RENT:
CAN INSTITUTIONAL INVESTMENT MEET THE CHALLENGE?
Resolution Foundation and Social Finance
10 October 2013
Social Finance is authorised and regulated by the Financial Conduct Authority FCA No: 497568
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2. THE PRIVATE RENTED SECTOR IS NOW THE ONLY OPTION
FOR MANY LOW TO MIDDLE INCOME HOUSEHOLDS
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Source: Whitehead et al. (2012) Housing in Transition: Understanding the dynamics of tenure change,
London: Resolution Foundation and Shelter.
Household projections by tenure, low to middle income families with dependent children
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3. BUT THE PRS OFFER HAS NOT KEPT PACE WITH THE
CHANGING NATURE OF TENANTS
• Rents are now more expensive than the on-going costs of ownership in many parts of the country
• Rent increases are ‘lumpy’ and unpredictable
• Properties are not purpose built for rent – most are built for sale and sold to buy to let landlords
• Sector still dominated by small landlords who offer variable quality – only 10% of landlords have
more than 10 properties
• Standard contract is still a 6 to 12 month AST creating a perception of insecurity
• Lack of transparency in the fees charged by lettings agents
• Many landlords do not provide any flexibility for tenants to make their house a home.
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WE NEED A DIFFERENT OFFER IN THE PRIVATE RENTED SECTOR TO MEET THE
NEEDS OF LONG TERM TENANTS, ESPECIALLY FAMILIES WITH CHILDREN
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4. THE POTENTIAL OF BUILD TO RENT TO CHANGE THE PRS
OFFER
• Important source of new investment to support much needed new supply
• Underpin development of purpose-built, professionally managed market rent sector in the UK
similar to US and other European countries
• Potential alignment between interests of long term tenants for greater security of tenure and long
term investors who want fewer voids
• Potential alignment between long term housing providers and income-focused investors in
developing rented portfolios not predicated on quick sales
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MARKET ACTIVITY IS EMERGING AND GOVERNMENT HAS PUT IN PLACE
SIGNIFICANT SUPPORT BUT QUESTIONS REMAIN ABOUT THE VIABILITY OF
RETURNS FOR INVESTORS, ESPECIALLY OUTSIDE HIGHER RENT DEVELOPMENTS
IN LONDON
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5. OUR AIM
To demonstrate that institutional investment in the private rented sector can
deliver a better quality, more secure rental product for low to middle income
tenants at the same time as viable returns for investors using development and
management costs and rents provided by housing providers on actual or advanced
pipeline developments.
More specifically:
• To test the viability of an RP-led model for institutional investment in build to rent that would allow
RPs to recycle their balance sheets
• To identify the sensitivities that affect investor returns in the model
• To identify the most appropriate financing structures for build to rent investment
• To identify who the build to let model can serve – population segment and location
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6. PROJECT BACKGROUND AND PARTNERS
Housing Partners
Other support
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7. HOW WE DEVELOPED THE FINANCIAL MODEL
• Housing partners used a standard template to provide detailed quantitative and qualitative
information on each development
• Site visits conducted with each housing partner to analyse and test the data provided with input
from operational as well as finance specialists
• Tested data rigorously in on-going discussions with housing partners and against industry
benchmarks including ARLA, Hometrack, HouseMark, IPD, social housing data and with input from
industry specialists such as EC Harris
• Developed a financial model with sensitivities to test returns at different assumptions
• Conducted a series of peer review meetings with investment experts to validate the assumptions
underpinning the financial model and seek views on returns.
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8. OUR APPROACH TO BUILD TO RENT
Theoretical model using real development data from 6 housing partners
• Units built using housing partner balance sheets in areas where they have significant
existing operations
• Units let out predominantly at market rent
• Units offered on a three-year tenancy
• Once rental income stream stabilised with over 95% occupancy, housing partners sell
the units to an investment vehicle to create a large scale national portfolio
• Investment vehicle funded by institutional investors
• Housing partners provide long term management services and insulate investors from
day to day issues such as lettings and maintenance but do not provide ongoing rent or
void guarantees
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9. THE NATIONAL PORTFOLIO 9
• Diversified portfolio
• 16 unique developments located
across the country
• Total number of units: 778
• Total development cost including
land value: £140 million
Scotland:
60 units
NW:
270 units
SW:
164 units
London:
256 units
The Midlands:
28 units
– development
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10. THE NATIONAL PORTFOLIO 10
Distribution of Housesby Number of BedroomsDistribution of Flatsby Number of Bedrooms
Total: 482Total: 296
Studio,4,
1% 1 Bed, 62,
21%
2 Bed, 223,
75%
3 Bed, 7,
3%
2 Bed, 118,
24%
3 Bed, 288,
60%
4 bed, 76,
16%
• Of the total, 482 (62%) are houses and 296 are flats (38%)
• 2 and 3 beds are most common, comprising 82% of the portfolio
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11. THE DEAL FOR TENANTS
Affordability assessed from perspective of three different income levels for family
with one child.
• Two affordability thresholds assessed – 35% and 50% of net household income
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Working age HH income
distribution
Net income after tax and
benefits
Low income 25th £18,583
Modest income 35th £21,962
Middle income 50th £27,584
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12. THE DEAL FOR TENANTS 12
Modest income
couple with one
child on £22,000
Middle income
couple with one
child on £28,000
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13. THE DEAL FOR TENANTS 13
• Rent rises annually in line with long run CPI of 2.5%, providing predictability and
transparency
• Three year tenancies for those who want to stay for longer
• Professional management from an experienced housing provider
• Purpose-built properties
Build to rent unlikely to meet the needs of low income tenants without
substantial support from government eg. 1/3 off the price of land. But if subsidy is
required, government has choices to make about whether build to rent or
affordable housing is the priority for this group.
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14. THE DEAL FOR HOUSING PROVIDERS
• Opportunity to recycle capital by selling units onto investment fund. Revenue from
sales can be used to build more market rent units or affordable units according to
organisational priorities
• Low development risk due to guaranteed exit to investment vehicle
• Long term income from Operations and Management contract
• Ability to benefit from fund’s performance through 10 per cent equity stake
• Opportunity to extend social mission to modest and middle income working families
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15. THE DEAL FOR INVESTORS – BASE CASE RETURNS 15
TOTAL DEVELOPMENT
COST £140M
GROSS RENT £7.8M
LESS
MANAGEMENT COSTS
£1.9M
(24.9% GROSS RENT)
LESS
VOID AND BAD DEBT
£0.4M
(5.2% GROSS RENT)
NET OPERATING
INCOME £5.4M
5.6% GROSS YIELD
3.9% NOI YIELD
6.5% TOTAL INVESTOR
RETURN
(2.5% INFLATION)
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16. THE DEAL FOR INVESTORS – OPTIMISED PORTFOLIO
Optimised portfolio:
1. Site selection – 7 developments with initial net operating income >4%
2. Land costs – 15% reduction in line with ‘PRS only’ covenant
3. Build costs – 5% reduction
4. Tenancy length – doubled to 38 months from 19 months
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•Portfolio reduces to 405 units
•2 and 3 bed properties still predominant unit size (86%)
•Increased, but not exclusive focus on London and North West
PORTFOLIO BETTER SUITED TO MIDDLE INCOME TENANTS
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17. THE DEAL FOR INVESTORS – OPTIMISED PORTFOLIO
RETURNS
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TOTAL DEVELOPMENT
COST £71M
GROSS RENT £4.5M
LESS
MANAGEMENT COSTS
£1.1M
(23.4% GROSS RENT)
LESS
VOID AND BAD DEBT
£0.2M
(3.4% GROSS RENT)
NET OPERATING
INCOME £3.3M
6.4% GROSS YIELD
4.7% NOI YIELD
7.2% TOTAL INVESTOR
RETURN
(2.5% INFLATION)
INCREASE IN YIELD COULD ALTERNATIVELY FUND 15% REDUCTION IN RENT
TO DELIVER SAME RETURN AS BASE CASE PORTFOLIO
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18. LEVERAGE AND THE ROLE OF A GOVERNMENT
GUARANTEE
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Robust and credible government guarantee:
• Increase the leverage tolerance of investors
• Reduce finance costs on debt
6.5%
7.0%
8.3%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
No leverage 30%leverage at 5%interest
rate
50%leverage at 4.25%
interest rate
TotalEquityInvestorreturn
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19. SUMMARY OF FINDINGS
• National portfolio can be assembled through pooling developments
– Offering a better deal for modest and middle income tenants
– Supporting an increase in housing supply
– Achieves the scale preferred by institutional investors
– But not within reach of low income tenants without subsidy
• National portfolio achieves a steady state yield of 3.9 per cent and a total investor return of 6.5
per cent over a 10 year period based on 2.5 per cent rental and cost inflation
• Optimised portfolio can deliver an attractive income return of 4.7 per cent and a total return of
7.2 per cent on a comparable basis
– Increased weighting towards London
– Higher rents on average
– Better suited to middle rather than modest income tenants
• Returns can also be improved if a robust government guarantee is available and gearing
added. Assuming an interest rate of 4.25 per cent and 50 per cent gearing, the government
guarantee would push up the equity return in the national portfolio from 6.5 per cent to 8.3 per
cent.
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20. MAKING IT HAPPEN – RECOMMENDATIONS
For housing providers
• Develop a stronger understanding of build to rent as a bespoke product, including site selection,
design, build, marketing and management.
• Use existing balance sheet capacity to help fund the development phase of new build to rent
assets, recycling capital where necessary by passing ownership onto institutional investors. This
will help grow the sector and in the case of Registered Providers, reduce overall funding costs.
For investors
• Assess the viability of build to rent principally on the basis of income returns as part of a
commitment to invest in this asset class for the long term rather than on the basis of quickly
realising capital value through sales.
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21. MAKING IT HAPPEN – RECOMMENDATIONS
For government
• Take a broad strategic view of how different tenures, including build to rent, work together in a
local area to meet different needs
• Adopt an approach to planning that recognises the different economics of build to rent and build
for sale in setting affordable housing and other requirements. This will ensure fair competition for
land between the two tenures
• Designate some public land as ‘PRS only’ to kick start build to rent, particularly for low to middle
income tenants
• Adopt a proportionate approach to regulating the market activities of Registered Provider that
does not limit their ability to diversify their funding base, recycle their balance sheets and extend
their social mission
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22. BUILDING HOMES FOR GENERATION RENT:
CAN INSTITUTIONAL INVESTMENT MEET THE CHALLENGE?
Resolution Foundation and Social Finance
10 October 2013
Social Finance is authorised and regulated by the Financial Conduct Authority FCA No: 497568
#betterrenting