Andrew Moffat

2018 is a crucial year for the place and case for PRS in my opinion. Whilst market factors are supportive of Institutional PRS, threats to the underlying residential market mean Institutions must tread carefully in selecting stock that will deliver yield and capital growth over the medium to long term.

Many will have become aware that Institutional PRS is finally beginning to build critical mass, evidenced by the latest BPF report into the matter. This report calculates that the Institutional PRS market has grown by 30% over the last year. For seasoned observers it does look like the institutional penny has finally dropped and it will be third time lucky.

In the two previous big pushes (to borrow from “Blackadder Goes Forth”), which occurred in the late 90’s when a small number of funds were created and again in 2006 when REIT legislation was introduced, the advance was halted by a number of factors. There was one overarching factor, which was that developers could make more money – and faster – by selling to owner-occupiers or investors than by opting for the PRS route.

House prices are a major obstacle to get a foot on the housing ladder for many households with ratios of house price-to-earnings at all-time highs, reaching above 10 in all but one London boroughs and averaging over 7 throughout England [1] . Earnings of households are being squeezed full-stop at the moment.

The taxation of buy-to-let investors is also restraining demand for residential and a critical look at the provenance of foreign money and higher stamp duty at the top-end have also dampened demand. There are therefore significant barriers to a rapid resurgence in demand for unit sales. Surely this leaves the playing field clear for Institutions to invest at good value for the long term, especially as they may be wishing to reduce their exposure in other property sectors?

I would offer some significant caution:

Firstly (and hopefully obviously), until many large blocks or portfolios have fully stabilised their income profile, the value of assets will continue to reflect the underlying unit values first and foremost. This means investing in assets which have all the correct infrastructure, amenity and local economy is paramount. However, the local markets also have to perform. With house price growth outstripping household earnings growth in Britain it is safe to conclude that at some point there has to be some sort of reversal, with either earnings catching up with house prices or house prices falling. This will therefore affect the value of PRS residential properties too.

Secondly, it is crucial to make a proper assessment of rent and operational cost. We constantly hear the rules of thumb applied to new developments of Build-to-Rent (‘BTR’), saying it is 25% loss of income to operational costs but I would be concerned about three things:

  • Who is assessing the rental level;
  • Have realistic assessments been made for rental premiums as well as for costs?
  • Whilst 25% gross-to-net loss is appropriate in London with relatively high rents, this can still be true in regional locations where rents are much lower but boilers and light bulbs cost the same.

Thirdly , UK BTR buildings are being acquired with a view to NOI and the comparison with risk-free rates. In the US, as 10-year Treasury pricing rose to 3%, multifamily returns came under pressure. The listed sector lost 5% in the 1st quarter of 2018, making it one of the worst performing sectors. This is a warning for what might happen in the UK.

So as the new wave of Institutional PRS units are being created, as identified by the BPF, I believe there will be winners and losers and 2018 will be a seminal year. I think 2018 will begin to show if the appraisals are correct.

Let’s hope there are more Blackadders than Baldrics in the trenches and that the generals in head office have their eyes on the ball. We are all rooting for the successes of all the new PRS schemes as this will lead to an ever wider pool of investors, and we should see the market mature and properly establish itself.

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