Trends Watch: U.K. Residential Real Estate
- Feb 17, 2022
EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.
This week, Elana talks with Simon Hookway, CEO and CIO, MSS Capital.
What is your outlook for investing in U.K. residential real estate?
Our view is that the U.K. residential property market has a problem regarding the affordability of home ownership, and it has been brewing for over 40 years. Essentially, the U.K. has not been building enough residential accommodation for our growing population. This has resulted in a shortage in accommodation in key core city areas which have seen the largest influx of people wanting to live, work and socialize. As a result, housing prices and inflation have far outpaced the rate of growth of real incomes. Young people in particular are priced out of this market and are increasingly needing to rent.
That being said, what’s often overlooked is young people in this generation are more culturally disposed towards renting. The nature of work over the last 40 years has fundamentally changed, and this younger generation expects and needs to be far more economically and geographically mobile than previous generations were.
As space for development is at a premium in the U.K., and planning permissions remain prohibitively stringent, there is a strong emphasis on utilizing technology to identify strong, risk-adjusted investment opportunities to acquire high yielding residential assets. We believe that the application of technology is also key to finding mispriced residential assets throughout the U.K. within gentrifying urban and suburban neighbourhoods to acquire as part of a diversified property portfolio.
Where do you see the greatest opportunities and why?
Knight Frank, a real estate consulting firm, values the U.K.’s total residential housing stock at approximately £7.5 trillion, of which almost £1.5 trillion is currently in the private rental sector. This is predominantly owned by private landlords, most of whom are referred to as ‘non-portfolio’ landlords -- those who own three or fewer properties.
This has produced a marketplace which has not been particularly professional nor subject to rigorous institutional standards and regulation. The U.K. government has been very keen to see that change and introduced a greater regulatory burden on non-portfolio private landlords to own buy-to-let property as their tax liabilities are now considerable. As you start to see these non-portfolio landlords retreat at the margin from the U.K.’s private rental space, this creates a great opportunity for professional, institutional landlords to replace these outgoing private landlords to fill the void and service rapidly growing tenant demand.
These institutional landlords -- typically real estate fund managers -- can then build and scale professionally managed portfolios of rental properties, which provide tenants with an overall improved rental experience by avoiding the highly fragmented privately owned landlord market. We envisage a further strengthening of the regulatory landscape for both tenants and landlords in the U.K. in the coming years, which will professionalize the rental market, lead a drive for improved standards and offer a better rental experience for tenants.
Investors using strategies focusing on residential real estate will be very well positioned to benefit from a vaccine-led recovery as we learn to adapt to life with COVID-19. The U.K. government can now shift their focus to the immense opportunities created by Brexit within the economy of which the real estate sector can profit. In addition, the way in which residential property lettings and investments work also lends a natural inflationary hedge; as investors become increasingly concerned about structural, rather than transitory, inflation in the economy they will naturally want to seek out investments that can hedge their portfolio exposure to inflationary pressure.
The outlook for the U.K. economy is one of strength as we emerge from the latest global setback caused by the Omicron variant. The IMF growth projections for GDP indicates that the U.K. is due to grow 4.7% in 2022, faster than any other developed economies. Additionally, Savills, one of the largest real estate brokerage firms in the world, has recently indicated that U.K. rental growth is forecast to grow by 17% by 2025, with the strongest annual rental growth of 4.5% set to occur in 2022. This is good news for institutional landlords involved in the private rental sector, as these institutional rental portfolios are underpinned by stable cash flows, low volatility and attractive risk return profiles. Indeed, these factors will help ensure rising demand from both income-seeking investors and those aiming to capitalize on the trend towards capital appreciation following the pandemic-induced phase of repricing.
What are the greatest challenges you face and why?
For our property development arm, uncertainty remains about the actual impact that Brexit will have on immigration and its effect on supply chains within the property market. Over the years, the U.K.’s construction industry has benefited from employing migrant labor as HGV drivers and builders, so it remains to be seen what policies the U.K. government will introduce to support this sector of the British economy. Meanwhile, tightening supply chains coupled with rising inflation have seen prices rise for building materials, which is disrupting development projects and squeezing margins. Despite the disruption caused by Brexit and the COVID-19 pandemic, void rates have been relatively low whilst the portfolio’s rent collections have remained high. The past 12 months of trading has demonstrated the need for a resilient business model and a prudent approach to management.
We continue to monitor rising inflation and other economic factors which have an impact on our development business, whilst there remains uncertainty around the Bank of England’s hawkish stance on interest rates to manage the ongoing inflationary pressure. We expect interest rates to rise further in the year ahead and thus have taken measures to mitigate the portfolio’s exposure to rate rises by locking in a new fixed debt facility. This should allow the portfolio to apply further leverage without materially increasing the cost of borrowing.
What keeps you up at night?
Not one thing in particular. Ensuring that we are partnering with investors that take a long-term view and allocate patient capital to us as their operating partner is key to our scalability. Volatility in equity markets and unattractive return profiles within fixed income are increasingly driving investors to diversify their exposures to alternative investments, and real assets provide both necessary income generation and a natural inflationary hedge. Managing liquidity remains a concern for many investors; however, it should be noted that residential property is the most liquid part of the U.K. real estate market and with the growing demographic trends towards renting we envisage the continuing growth of the U.K.’s private rental sector.
Political focus on the undersupply of housing should remain a priority for the government, so we are keen to gain further clarity on the tax treatment for property developers seeking to redevelop brownfield sites into new rental accommodation and deploy capital into such projects should circumstances allow.
The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.
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Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.
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