What does the future hold for the Private Rented Sector?

David Lawrenson, Director, LettingFocus.com

David Lawrenson, Director, LettingFocus.com

The Private Rented Sector (PRS) is in a constant state of flux and it is impossible to tell, with an absolute certainty, what is in store for our sector, especially with a general election looming on the horizon.

No doubt there will be many Think Tanks producing reports to pontificate on the sector! But, on a serious note, I am sure we will see a step towards more regulation and I do not believe all of it will be for the betterment of the sector!

I can see a drive to increase investment in the PRS by changing the tax system – encouraging landlords to invest in improvements to properties and allowing more of the costs to be offset against rental income – I believe there will also be more attention paid to how to make investment in the PRS work for the institutional investor.

One such example is the Private Rental Sector Initiative (PRSI), a scheme that is there to help increase large scale institutional investment in the PRS.

The PRSI was launched by the Homes & Community Agency in order to encourage institutional investors to take a greater interest in the residential housing market, with a specific focus on encouraging investors to commission new-build housing. The aim is to create an attractive financial opportunity to help stimulate housing supply and provide consumers with a greater choice.

It has come a long way since its inception but new players in the PRS need to tread very carefully. Letting and managing PRS properties might look easy, but it is actually harder than some Build to Rent (BTR) investors and managers might think, especially if they haven’t contracted the services of an experienced PRS consultancy firm.

The argument goes that, in order to reap the available economies of scale, the big players in the PRS, and the new BTR entrants, have to either build units in big developments and/or build them high to make the figures add up.

The problem is that smaller units in densely populated developments and with small or no green space tends to appeal mostly to single individuals and young couples. Fortunately, right now, this type of tenant is a key, and growing, market for the PRS. But these types of smaller units will appeal less to those same people when they start a family.

The changes in demographic of an area can be hard to predict and, faced with a changing demographic, what would a competitor for BTR, the individual Buy-to-Let (BTL) landlords, do?

Well, very simply, they would sell up and buy something in another location that is easier to let and has a better capital growth prospect. But a bigger investor may not have this luxury and potentially may be stuck with a number of nonperforming units. A solution to this conundrum would be to have a diversified portfolio, in terms of the types of units and where they’re located.

Large scale investors are very much in favour of offering long term tenancies for tenants, usually at least three years, as they believe that this will attract families, who make up about a third of the 3.8m PRS households in the UK. The argument is that this group prefers longer term tenancies as they want to stay settled for the sake of the children.

Being able to offer longer term tenancies is a key differentiator that sets the large scale PRS players apart from their buy-to-let landlord cousins.

Though, even families seem inclined to say, “OK, we are fine with a long term tenancy, so long as there is a break clause on my side so I can get out early”. But if there is a clause that allows the tenants to easily get out of a long term tenancy contract then it makes the contract length a bit redundant.

Providers could suffer for this, as frequent changes of tenant will lead to extra costs, such as those involved with; conducting check-out and check-in inventories, possible deposit disputes, tenant referencing costs, management costs, drawing up contracts and other general admin costs. And that is before we take into account possibility of a void period.

As any BTL landlord knows, higher costs, due to the higher tenant turnover, go straight from the bottom line and can quickly shift an investment into the red.

The average tenant in the PRS actually stays in a property of a BTL landlord for about 4 years, and this is continuing to rise (according to the English Landlords Survey).

But, from the presentations I have seen by housing associations and institutional investors, the average tenancy length for them is closer to 2 years – and the figure that the Resolution Foundation quotes in their report is about 19 months, far less than many would have hoped to achieve.

This issue of whether it is possible to achieve longer term tenancies in practice is related to another issue – promotion. Simply put, how do investors market in such a way that customers come to them without them having to spend a lot of money on recruitment costs using letting agents?

Quite a few of the new PRS ventures seem to have been unable to recruit new tenants without using letting agents. But I think it should be possible for new large scale PRS players to get the offer right in the online space, in other words to make enough noise, so that they have applicants coming to them direct.

And this is important because using a letting agent to find your tenants could increase your costs. There is also the possibility that the letting agents, once they have forged a connection with the tenants, will be actively trying to entice those tenants away in the future – leading to further voids as the letting agents use their database to churn tenants into new properties 6 months or 12 months down the line.

A report by the Resolution Foundation, “Building Homes for Generation Rent” found that the percentage of gross rent going to costs varied between 18% and 31% across 16 developments in different parts of the UK, while EC Harris thinks the figure would be around 25% of the gross rent, based on the greater efficiency and lower management costs of new build housing.

Of course, there is a comparator with BTL landlords. As large scale investors are competing with BTL landlords – and this is where they should be looking to benchmark against.

It is hard to get accurate information on costs for landlords – not least due to the lack of available data – but from our own conversations with landlords we believe that the costs, as a percentage of the rent, for BTL landlords is between 10% and 15%, (based on a 2 bed house in London).

Back in 2008 the Rugg Review (conducted by Dr. Julie Rugg) looked at the Private Rented Sector and private landlords. The report found that small scale private landlords did a better job of meeting a tenant’s needs, when compared to a large scale landlord.

This could be, she opined, because the typical private landlords (overwhelmingly individuals or couples) don’t charge for the time they spent on their lettings portfolio while a company would do so with administration, and other, fees.

So, as large scale investors have to compete with their BTL cousins, they need to make sure their financing, the cost of the land etc. is at an optimum so that they can overcome this difference in trading margin that the BTL landlords enjoy.

For large scale investors there is a lot to be learnt from the world of the private landlord and, for all the possible issues, if it is handled correctly they can make their offering can work.

David Lawrenson

(David is an expert on the Private Rented Sector and also the author of the UK’s highest selling property book, “Successful Property Letting”)

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