Investment Analysis And Performance Reporting
November 21, 2014
New Investment Market & Data:
The UK is witnessing the emergence of a specifically designed and managed ‘institutional grade’ residential asset class, loosely referred to as the new Private Rented Sector (PRS), or as Build-to-Rent. However, for any investor, be this institutional, private equity, sovereign wealth funds or housing associations, there is a need to underpin entry into this sector with good quality data and analysis.
Therefore, this article looks to acknowledge some of the existing sources of data and provide commentary around these. Secondly, it highlights areas where improvement can be gained.
Investment Asset Performance:
In the medium to long-term, the aspiration from an investment performance perspective is that this market resembles the US ‘multi-family housing’ market (MFH), where detailed accounts of the performance of the investments are standard in any investment particulars. Investors need certainty around the investment performance of this asset class. This will comprise both the annual net returns (i.e. income less annual maintenance and management costs) and total long term returns (driven by either yield compression and/or House Price Inflation).
For UK Pension Funds:
The growth of the sector has, in part, been hindered (in particular in respect of the active involvement of the large UK pension funds) by the limited data that is available for investors to analyse. This creates uncertainty around how this asset class should perform. In simple terms, this can be broken down into two broad components, with a strong focus on the first;
- Investment Data
The gap in data broadly relates to the maintenance and management costs but also long term rental trends as well.
- Demographic & Economic Data:
There is also an interest in gaining a better understanding of the wider demographic and economic trends across the country, which will help support geographic investment decisions.
Fortunately, as set out below, some data for both components does exist and the aspiration is that the collective industry continues to work together to further enhance this.
Global Investors Already Moving:
The slight caveat to this is that there has been significant activity in recent times, including both the funding of new build/development and acquisition of existing stock, which has been led primarily by international capital.
- The Dutch fund, APG, which announced a joint venture with Delancey and their land holdings at Elephant & Castle, and who also invested into Grainger’s GRES/GRIP fund in 2013
- M3 Capital Partners and their US investor have backed Essential Living, who have purchased a number of sites across London for development
- Swedish property company Akelius have been acquiring existing investments in London and the South East since 2011
Clearly they have become convinced of the merits of investing into the sector here in the UK, which is probably no doubt buoyed by their own positive experiences of investing in residential assets in their home markets.
Investment Market Performance – Aspiration:
The ‘First Half 2013 CBRE Cap Rate Survey’, focuses on the US real estate investment markets, and provides a useful insight into the depth of investment analysis/performance that hopefully will evolve here in the UK. Page 17 of that report, focusing on the ‘multi-housing’ market, provides links to various charts, including investment returns/cap rates for the various US city markets.
In the US, with the market long established, there is a cap rate range based on the age and quality of stock, from ‘Class A’ through to a ‘Class C’. The UK already has an established, albeit small investment market. If this activity becomes more regularly tracked by the likes of Focus and EGi, the UK should see a similar style rating system become established once the newly built stock starts to be traded.
Maintenance & Management Costs:
The limited quantum of data in respect of the deductions made for annual running and management costs, against the gross income received from tenants, remains a sticking point for some investors.
IPD, who have tracked residential returns for the last 13 years, do report average total operating expense deductions in their UK residential index along with a regional breakdown (see Figure 1). The two charts show void and operating costs for ‘all stock’ and ‘stock which excludes central London’, with the range of costs between 28.3% and 39.1% of gross rental income. However, with the index only totalling c.£2.8bn, some large scale investors have raised concern that this data is not of a sufficient scale or of a sufficient geographic variety (it’s heavily London orientated).
Yet those investors already committed are clearly comfortable with the expectations of these costs, either via direct experience or an awareness of these costs in other established markets. The perceived wisdom is that anything between a 25% to 30% allowance is reasonable. Established gross to net deductions include a combination of void and bad debt, management and lettings costs and annual running costs (insurance, utilities, general refresh, etc). However, there seems to be less certainty around allowances for a sinking fund.
In reality, gross to net deductions will be influenced by the scale of the buildings and/or the quantum of units within any wider operation. Furthermore, the scale of the property and/or the operation will influence whether management (estate and/or property) and lettings functions are internalised or externalised. Given these range of influences, some new entrants to the industry are hoping to achieve even greater efficiencies than 25%.
Rental Data & Rental Premiums:
A shortfall in the market is the lack of of a sizeable and reliable set of rental statistics, tracking long term rental growth. In addition, there is also interest in better understanding the rental premiums that may be able to be generated, both from new build rental apartments and from wholly owned and professional managed apartments. The following data is available:
Rental Data – ONS:
Since June 2013, The Government’s ‘Office for National Statistics’ has published the Index of Private Housing Rental Prices (IPHRP), which measures the change in price of renting residential property from private landlords (Great Britain, its constituent countries and the English regions).
Importantly, the index is not designed to measure the change in price of new rental agreements (or advertised rental prices), but an index to reflect price inflation in the stock of privately rented property. It is currently released as an experimental statistic and is undergoing evaluation. Key findings in the January to March 2014 index included:
- Private rental prices paid by tenants in Great Britain rose by 1.0% in the 12 months to March 2014, unchanged from a 1.0% increase in the 12 months to February 2014
- Rental prices increased in all the English regions over the year to March 2014, with rental prices increasing the most in London (1.4%)
Rental Data – Oxford Economics:
Oxford Economics has analysed various sources of data and has produced a ‘spliced’ set of charts (see Figure 2 & Figure 3). This is based on data from various sources (DCLG, LSL Property Services, Hometrack and VOA) but the coverage of the data remains limited. It does, however, provide a useful benchmark.
Rental Premiums – Hometrack:
An interesting consideration for investors is understanding what rents will be derived from this new investment stock, not only by way of a new build premium but also relating to provision of a better service.
For the former, a chart (see Figure 4) by Hometrack has analysed rents from selected new build schemes in mid-market inner London locations. The evidence suggests that there is a new build rental premium of between 10% to 15%, albeit acknowledging that the specific premium will be driven by a variety of factors including location and provision of amenities and services.
Demographic & Economic Data
The second component relates to the demographic statistics, growth of the PRS market and wider economic considerations.
Firstly, the Government publishes statistical census data, which includes growth of the PRS markets across all local authorities in England, which allows for a specific understanding of the growth of the PRS over ten years. Investors, as well as local authorities and consultants, can refer to these two data sets; the ‘2001 Census table T08 – Theme table on households’ & ‘2011 Census table KS402EW – Tenure’ (see Figure 5). Taking the eight Core Cities Group as an example, the growth of the PRS has been significant across all cities, with each seeing more than 50% growth. For Manchester and Birmingham, there was over a 100% growth in the PRS.
English Housing Survey:
Secondly, the Department for Communities and Local Government publishes its annual ‘English Housing Survey’. The latest ‘headline report’ was published February 2014 and stated that for the first time, the PRS has overtaken the social rented sector;
“There were an estimated 22.0 million households in England. Overall, 65% (14.3 million) were owner occupiers, 18% (4.0 million) were private renters and 17% (3.7 million) were social renters.”
The significance of this change in dominance of the private rented market allowed for a specific focus on the PRS, within the ‘Household Report’ survey, published in July 2014, which includes a chapter specifically on the PRS and provides a useful insight to the growth of the sector.
The final component to the investment story is the economic outlook of a particular region, town or city. For any investor, confidence in the income stream is clearly imperative. For commercial property and analysis of the income, the tenant’s covenant, the availability of company accounts and credit assessment reports underpins this. With this not feasible for residential investments, reference to the strength of the local economy and in particular the job market may give some comfort.
Gross Value Added:
In addition to working with particular local authorities to draw out this data, the ‘Gross Value Added’ data (a similar metric to GDP at a localised level) can provide some guidance. This annual data set of 99 ‘unitary districts’ across England sets out the economic growth of those districts year on year.
By way of example two tables (see Figure 6 & Figure 7) review the GVA data from 1997 through to 2011 and 2008 through to 2011 only (i.e. downturn only), showing the ten best performing districts. Interestingly, seven of the ten top performing districts are non-London South East locations.
Whilst this is clearly a more macro analysis of the economic performance of these districts and should not alone drive an investment strategy, it does nevertheless provide a meaningful insight in to the economic performance of the wider districts beyond the traditional investment focuses of London and the South East.
Centre for Cities:
A more specific set of analysis for investors to consider is the work undertaken by Centre for Cities, which reviews various economic data for 64 cities in the UK. Using their ‘Cities Outlook’ data app, it is possible to rank cities by a number of different indices, including skills, employment rate, weekly earnings. From a PRS demographic investment perspective, statistics relating to ‘private sector employment’ will be of particular interest. The table ranks ‘private sector employment’ growth by percentage change (see Figure 8). For any investor, focus on those locations which are underpinned by generally more robust local economic performance, and those with the greatest growth projections, will be implicit in any strategy.
The future certainly seems bright with the continued growth of development funding and investment activity with investment decisions being made on the above, and other data sets. Yet, as highlighted in the introduction, the focus has to be on more robust data relating to rents and investment performance and the PRS Taskforce is working hard with the industry on this.
This includes working with the above referenced sources, the large commercial and residential management agencies and the Government. We are also delighted to announce that the Society of Property Researchers has also agreed to assist with this matter.
Furthermore, it is clear that new entrants are looking to underpin their investment with strong management and reporting standards. Therefore, the aspirations of a more transparent investment market, like that enjoyed in commercial property sector, will be a reality.
We hope that our work, and this article, provides further impetuous to the sector to continue to work together to help develop the PRS.