Pythian PRS 2016 Ponderings & 2017 Predictions

 

I don't quite know what to make of 2016. It's seems that society played fast and loose with common sense and convention, social media delivered the new truths and the Grim Reaper went about his work with unusual zeal.

From a residential investment perspective it was a mixed bag: buy-to-let investors got crapped on from a great height by Government who imposed a 3% SDLT surcharge on second properties in a naive bid to reduce competition between the B2L and FTB's. But the move had wider implications throughout the residential real estate industry and has been universally unpopular. Notwithstanding that, new tax rules begin to bite from this year, mortgages are going to be harder to obtain and interest rates are likely to rise. Instead of regulation for letting agents, Philip Hammond announced a ban on lettings fees which most 'experts' feel will be passed onto the landlord. I don't necessarily agree, but it all goes to into the mix and created an 'annus horribilis' for small landlords.

Large scale landlords however, are being supported by government. Particularly Build to Rent. In London, we've seen Sadiq Khan's SPG which clearly identifies B2R as an opportunity not only to create more homes, but to integrate the affordable element seemlessly within each of the schemes and all controllable by operator/landlord, not an RSL or local authority. Government sees this sector as one that not only provides additional housing, but one that also addresses the gripes about poor quality, poor management and insecurity of tenure. Since institutions intend to be long term investors. ......Or so they say. But more of that later.

The amount of money apparently pouring into the institutional PRS sector is truly eye-watering. Knight Frank say £50 billion by sometime in the early 2020's. These are significant sums, and the sort of money that enables regeneration in many areas hitherto left behind. So we can expect some exciting mixed use schemes in the North and the Midlands where long term investment strategies ameliorate the initial costs which previously have made development untenable, or at least risky and difficult from a funding perspective.

So, before I get onto what 2017 may bring, let me give you my 2016 top 5 individuals operating in the PRS sphere. I will just say that these are individuals I know and so it is skewed towards those I've seen in action. These are the people who have impressed me most and are leaders in their field:

1: Alex Notay: Who doesn't know Alex? Previously Policy Director at the ULI and now Director of Product and Service Innovation at Places for People. In many ways, the default mouthpiece for the emerging institutional PRS sector. Brilliantly curated the ULI UK Residential Council "Build to Rent: A Best Practice Guide" in which the fundamental principals of B2R were laid down and form basis of every new B2R scheme in the UK. Has worked tirelessly championing and cajoling the industry and is a familiar face at every significant event. A supreme facilitator, she has opened the eyes of many investors to the opportunities in our sector and shown them how to achieve their goals. Now that she's moved on to PFP, we are likely to see less of her in which is a pity, but no doubt her influence will continue to be felt.

2: Charlie Miller: In stark contrast to Alex, very few people outside the business know Charlie. He keeps an extremely low profile and eschews social media but he is one of the slickest operators in the PRS. Previously at London and Stamford with his business partner Tim Holden, what Charlie doesn't know about PRS isn't worth knowing. He operates in what we used to call "residential investment". Has seen it all before and he's possibly one of the shrewdest about. A go-to guru for many institutional and family office investors, Charlie has had one of his busiest years culminating in his company, CapRes, forming a JV with Cording Real Estate. A strict resi' investor and not B2R'r, the current climate is meat and drink to him. No one is privy to more deals than Charlie and I expect the JV to come out firing in 2017.

3: Mark Farmer: It's been a very busy year for Mark and for his consultancy CAST. Formally director at EC Harris, subsequently Arcadis, Mark's understanding of the technical side of B2R is second to none. Passionate and vocal about innovation in the building industry, both systems and working practices, Mark has worked incredibly hard at influencing change in an industry noted for tradition. His work for the Government typifies his determination to articulate with force the serious issues that face the construction industry. Against Government opposition, Mark had to stand firm in entitling his review of the UK labour construction model "Modernise or Die" which he felt was crucial in putting across the message unequivocally. Mark is also playing a leading role in the resurgence of modular construction which will grow exponentially in 2017.

4: Jo Green: If you didn't know Jo at the beginning of 2016, you certainly knew of her by the end of the year. As Head of Commercial Operations for SLC Solicitors, Jo swept into the PRS and Build to Rent sector and took the firm from the prosaic business of block management, collecting ground rent and service charge arrears, into the institutional arena of developing downstream strategies for debt management in the emerging sector. Like Alex Notay, she was regular at all the principal PRS events around the country and Jo quickly established herself as the face of debt management in the sector. A brilliant determined character with tireless networking abilities and the chutzpah to open any door, her professionalism and integrity has seen her sit on the Residential Management Committee of the BPF and at the UKAA. Recently parted company with SLC, it'll be interesting to see which firm has been smart enough to snap her up.

5: Roger Southam: Both a snappy dresser and a canny operator, Roger pulled off two big deals in 2016: the formation of the UK Apartment Association and sale of his company Chainbow to Savills. Roger's foresight in creating the UKAA is a masterstroke and gives a platform to the institutional PRS from which they can, as their vision statement says, "Professionalise and improve the service delivery of the residential rental sector in the UK by utilising and sharing best practices and knowledge gained from other agencies around the world." A big figure in the world of PRS, Roger's sale of Chainbow to Savills demonstrated the importance of asset management skill-sets as crucial to investors. Never far from the limelight, I expect Roger to have something up his sleeve for 2017.

There were other obvious contenders: Graham Bates of LIV has done a great job, Howard Morgan of Realservice has seen the industry wake up to his service mantra of the past 12 years, Michael Howard of Urban Bubble has the NW tied up and is an absolute guru in that region.

So what of the PRS in 2017?

Well, just around the corner is Sajid Javid's much anticipated housing "White Paper". Expected at the same time as Hammond's Autumn Statement, acknowledged difficulties in the housing sector meant that it needed more time. Will it prove to be a solution to the housing crisis? Probably not, but we can expect it to mirror, to an extent, Sadiq Khan's SPG on Build to Rent. This is going to further divide the two strands on thinking in the institutional PRS: On the one hand, long term B2R investors intent on creating a distinct residential asset class with a specific management and operational signature, and on the other, the traditional large scale residential investors able to hoover up surplus housebuilder stock and existing assets as has been their modus operandi for years. There may also be hybrids. Grainger for instance.

My feeling is that the Government is going to provide B2R with significant planning and tax advantages in order to speed up the delivery of new homes and to encourage a long term, stable investment class. Clearly, long term investors are able to provide security of tenure to renters not currently enjoyed in the BTL sector. What this may mean in practical terms is an exemption from the 3% SDLT surcharge, and the ability to offset or reduce affordable housing requirements along with the ability to both integrate and manage the affordable element with the scheme as a whole. Additionally, the Government's PRS Debt Guarantee scheme could be both extended and relaxed to encourage smaller and/or regional, but nevertheless, important B2R investors to become involved. Similarly, the Build to Rent fund, which helps fund development could be made more elastic and look at further concessions to champion modular conceived schemes.

I'm not sure the 3% SDLT surcharge, unpopular though it is, is going to be ditched altogther, I do feel that there may be some further exemptions, perhaps to reinvigorate the stalled London market, but I can't see Government rowing back on their suppression of the BTL market. It's a pity, since that sector provides a valuable service. But, at the moment, it doesn't enjoy a good reputation, and it has impacted on pricing FTB's out of the market. It's a tricky balancing act and an unenviable task. Where I hope the government do look closely is at the viability of the current BTL stock. There are an awful lot of interest only BTL mortgages out there and they will be severely impacted by the the new tax rules and the likely increase in interest rates. It's one thing to choke off further investment, it's quite another to strangle the existing investors to death. It needs careful thought and some relaxation.

Modular construction is going to grow and grow. Whether it's pods, panallated, timber or any other material, the speed and quality advantages will outweigh the initial additional costs. It's likely that we will see considerable investment in this sector from overseas, particularly China where we will probably see part assembled units shipped to the UK, fully assembled in factories and delivered to site. Government has taken a strong interest in modular construction and it is possible schemes built using this method may enjoy some support. Modular seems to suit B2R particularly well, although it's suitability for tall towers is uncertain. However, the industry is moving at such a pace, we may well see modular become more and more versatile. Expect further innovation from this sector.

Houses tend not to feature as part of the institutional PRS where the focus tends to be on delivering an exceptional living experience to millennials in compact units. However, as schemes become larger and form part of a general regeneration, providing houses in addition to apartments will start to play a part. Especially in the B2R sector where they can be modular constructed with incredible speed and benefit from an estate CHP system making them tremendously efficient to heat and run. Houses also balance the portfolio between mobile millennials and more stable families with the obvious complimentary void profiles. Probably not for Central London, nor even zones 2, 3 or 4. But beyond that, where land is more plentiful and cheaper, we could start to see more houses in the PRS.

Management: I have a notion that some property management/lettings agents are looking at their client base and wondering how they might enable their landlords to compete on level terms with the institutional investor. I've already spoken to one or two agents (they are in the minority) who are looking to offer a virtual brand, accessed via an app where the services and advantages offered by the institutional PRS can be mirrored in the BTL sector with clients signing up to a 'new deal' What that will be, or how it will develop is not entirely clear, but I can see entrepreneurial agents working hard to make it happen this year.

Finally, separation. It's clear that the sector is developing two distinct strands, and those two strands have very different investment profiles. 2017 will see these strands emerge as distinct from each other. Whilst the institutional PRS has been lumped together as a single entity, its clear that there is a significant difference between B2R and housebuilder stock. B2R embraces the new management paradigm and is designed specifically for creating rented communities with management aimed at delivering a living experience beyond that imagined hitherto. These investors are in it for the long term. Life cycle durability of materials has been carefully considered as has management and maintenance of the scheme. House builder stock, schemes purchased in their entirety, are not build specifically to rent, they're build for sale and for each of those units to be independent of each other. Life cycle durability is not of such importance and maintenance will be slightly more difficult and costly. But, for this type of investor, it's all about exit flexibility. Whilst their investment may not be sold off as low a % return as a B2R scheme, they will be able to choose between breaking up the investment in its entirety or in part, or sell on as an investment and they can do this at any time depending upon the current UK residential cycle. Clearly, these two strands will require different management strategies and the renting experience will differ.

I hope 2017 is a good year for all concerned in the sector. We stand at the edge of creating something quite extraordinary. Time will tell if the UK is ready to eschew ownership for renting. I suspect not, as owning is deeply ingrained in our pysche. But, for a long time renters have been seen as second class citizens; now, I think, that time is over.

Happy New Year.

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© Richard Berridge