Dutch pension fund PGGM is making residential property investments in the UK – a sector that domestic pensions schemes have shunned. Kit Klarenberg looks at factors that could drive local funds to rethink their stance.
About nine-tenths of residential properties in the UK are let by independent, private landlords with a portfolio of five properties or fewer, according to data published by property consultancy IPD.
A number of other private owners make up the last tenth, although institutional investors barely feature; the community currently corners roughly 1% of the market.
This is not an oversight on their part. Institutional investors in the UK have historically eschewed investing in residential property very consciously.
“There’s a belief among pension schemes that property is a highly cyclical asset, and the prospect of entering the market at the wrong stage of the cycle is a major deterrent,” explains James Lidgate, director of housing at Legal & General Capital (LGC).
“Furthermore, residential property is considered harder to fill than commercial property. To fully let a large residential property, you may need to find hundreds of tenants – you may only need one with a commercial property of the same size.”
Institutions have also struggled to compete with the tax efficiencies enjoyed by private homeowners and buy-to-let landlords. The former pay no capital gains tax on their first property, the latter can offset interest payments against property income for tax purposes.
Moreover, reputational risk is also highly dissuasive. Pension schemes are understandably nervous of being associated with eviction and rent rises – two aspects of property management that sully the standing of landlords in the minds of the public. With hundreds or thousands of tenants capable of falling victim to either, this hazard is magnified significantly.
However, this phenomenon is bizarrely unique to the UK. Conservative institutions on the continent are much more relaxed about investing in residential property, as IPD figures attest. In the Netherlands, institutional investors make up 37% of the market; in Switzerland 23%; in Germany 17%. The same is true in the US, where institutions own around 20% of residential properties.
What accounts for this disparity? Lidgate believes differing attitudes, and legal and regulatory structures, are the answer.
“Property laws on the continent tend to favour tenants over landlords; rent controls are common in most EU countries, and it’s virtually impossible to get rid of tenants in some,” he says.
“Europeans are also highly comfortable with renting – home ownership is a very British obsession. Figures suggest Dutch rental tenants stay in their properties for an average span of ten years, while London’s renters stay for an average of 22 months.”
As a result, the comparative ease of finding long-term occupants, and the reduced scope for reputational risk, makes for a greater residential property appetite among Europe’s pension schemes.
Nevertheless, this paradigm could be in the process of becoming outdated. A number of market factors have contributed to an apparent attitudinal shift among a growing number of institutions.
“There’s evidently a lack of availability in the UK rental markets – not just in London, but most major cities too. Rising house prices forcibly create more and more renters every month, and immigration plays a part too – it’s unsurprising institutional investors are now considering meeting that demand,” says Fyodor Blumin, consultant at real estate advisory Noel & Partners.
“The lack of supply and high demand, coupled with the current low interest rate environment, are combining to create a very attractive opportunity. Rental income is stable, dependable and rising – the same can’t be said of yields offered by the asset classes usually favoured by institutions.”
Another motivator may be a shift away from commercial property, driven by declining returns offered by the sector and falling lease durations. The average length of a commercial lease is now less than five years, compared to 25 years in the past. Commercial property’s unique selling point, and its key attraction for institutional investors, simply no longer applies.
Residential property returns have also consistently outperformed commercial since the turn of the century. IPD data indicates that in the past decade, residential property produced annualised total returns in excess of 10% every year; retail property generated average returns of 7%, industrial 6.4%, and offices 6%.
In February, LGC launched a build-to-rent scheme in partnership with Dutch pension fund manager PGGM. The partnership will initially invest £600 million (€776 million) into constructing purpose-built private rental housing across the UK, providing more than 3,000 homes.
PGGM’s role in the partnership may go beyond monetary; the firm has €4 billion invested in residential properties across Europe. Its success in the field have helped its partner, LGC, overcome customary institutional reservations about investing in the sector.
LGC can be confident that filling the properties won’t be an issue – not only thanks to high levels of demand, but also due to their ability to be reactive to market conditions, flexing rental values to meet pricing and demand as necessary.
LGC will also publish clear guidelines they expect their property managers to abide by, concerning responsible and prudent conduct in key areas such as repairs, enquiry response times and rent transparency.
Moreover, the firm won’t be selling off 25-year leases to housing associations, and is unlikely to serve notice on tenants as a result; Lidgate says if occupants pay their rents, they can stay as long as they like.
While the agreement is notable, it isn’t the first of its kind in the UK. In 2013, residential landlord Grainger created the Grip unit trust in partnership with APG, another Dutch pension fund manager (one of Europe’s largest). Via Grip, the firms acquired a €450 million residential property portfolio. While these deals are relatively minor developments in the overall scheme of things, Blumin says they could be harbingers of a new era, which could see the institutional stake in the UK residential property market rise significantly.
“If these schemes are successful, it’s highly likely others will seek to follow their lead. Residential property has been a rewarding investment for private landlords and buy-to-letters for some time – it’s surprising the institutional side has taken so long to see the benefits,” he says.
“2016 could well be a revolutionary year, in which the relationship between institutional investors and residential property changes forever in the UK.”
Nonetheless, this transformation is not a done deal just yet. The UK government’s contentious ‘Help to Buy’ scheme was extended in the 2015 Budget; the move concerned many economists and housing specialists, who say the scheme artificially inflates housing prices. If their forecasts are correct, yields will doubtless be negatively impacted, and one of the sector’s key attractions tarnished.
Still, yields aren’t the sole reason institutional investors may want to get involved. The UK government has cut housing association budgets, meaning supply has been depressed even further than previously; the UK now meets only 50% of its 250,000 annual housebuilding target.
Renters are desperate for someone to fill that deficit, and whereas once residential property investment had potentially negative reputational implications, there’s now arguably a sizeable reputational boost to be gleaned from increasing the supply of new homes on the market. Time will tell whether institutional investors answer the call – and whether they’ll continue to need a helping hand from the continent to do so.
©2016 funds europe