Is the UK private rented sector (PRS) market in danger of overheating? That’s the question some experts are asking.
They argue the rate of development could lead to a glut of empty residential units as supply outpaces demand, in the wake of the flotilla of developers and investors entering the market in the past couple of years.
How real is the threat and which parts of the UK are more in danger of oversupply than others?
Few property sectors have hogged the headlines as much as the PRS has over the last 18 months or so. Barely a week has gone by without news of a new scheme getting planning consent or the launch of a new PRS funding vehicle. While some of these schemes have been brought forward by experienced operators who know the PRS market inside out, a raft of more opportunistic developers and investors have also entered the fray, seemingly regarding the PRS as the panacea to a whole host of development ills.
The most popular tactic employed by these operators has invariably been ‘quick and easy’ office-to-residential conversions, with some regional cities losing vast swathes of city-centre office stock as developers have rushed to mothball well-located but fairly run-down, old office blocks and turn them into housing.
The focus of much of the PRS activity in the UK in recent years has inevitably been on the capital. But despite the huge volume of PRS development in London, Stafford Lancaster, investment director at Delancey, thinks the capital’s PRS market is far from overheating.
“The rising population and housing shortage, alongside the contradiction of unaffordable housing with a persistently strong economy, means there is still a real opportunity for large-scale residential investment in the capital,” he says.
However, the sector isn’t without its challenges, he concedes, one of which is achieving a “viable level of financial return when competing on the same land and planning obligation basis as the for-sale market”.
That’s not the only issue, says Hoong Wey Woon, director and lead on PRS within KPMG UK’s real estate advisory practice, who has a less bullish take on the current state of the market. “Central London has been the hot ticket in town. However, as land prices and construction costs have risen over the last few years, potential returns have declined,” he says.
Some have therefore sought yield and capital growth outside London, where many markets are relatively untapped. However, Wey Woon cautions there are a few markets that “look to have a large amount of supply coming out of the ground in the next two to three years and investors need to be wary of these areas”.
Manchester, which has seen a glut of PRS schemes hitting the market over the last 12-18 months, is a case in point.
“There is a risk of the sector overheating in some cities, particularly in certain areas of Manchester, if all forecasted development comes through,” believes Toby Nicholson, director of national capital markets - PRS at Colliers. “However, investors are increasingly recognising that the key to sector stability and long-term success is using viable assumptions in line with the local market intelligence to underpin any acquisitions.”
Phil Mayall, development director at Muse Developments, agrees. He points out that there is a big difference between the number of planning consents that have been granted in the city and the number of developments starting on site and blames spiralling construction costs for causing a drag on delivery times. The situation is only going to get worse, he suggests, likening the city’s current supply/demand situation to the scenario during the last cycle.
“There was a myth of empty blocks of apartments in Manchester, but there weren’t - we were running at a void of 5%-10%,” says Mayall. “There were some developments that got mothballed at the frame stage and they then got started again, but that’s the sign of a fairly efficient market.”
Even if a number of the proposed schemes for Manchester do hit the market at the same time, local property players are confident that the city can cope with a raft of new PRS units due to the area’s projected population growth.
“Some 55,000 new homes are needed in the next five years in the city centre alone, rising to 100,000 in the next decade,” says Michael Howard, managing director of urbanbubble, which currently has a number of PRS schemes in the pipeline. “This year we’ve seen approximately 22,000 new apartment units announced by developers, and while there is a risk some won’t break ground, we expect they will be few and far between.”
Another reason Manchester property pundits are confident the city is well placed to cope with the growing number of PRS developments is the proactive approach the local authority has taken to the sector.
“PRS in Manchester has been particularly driven by the focus of the local authority, and the way it is approaching it is in a very commercial and linked-up, strategic way, which is inevitably advancing that market over other regional markets,” says James Craven, an associate at GVA.
Even so, there are other regional markets where local authorities have promoted PRS development. They recognise “high-quality, professionally managed, rented housing” helps retain young people in the area and can be the catalyst for the regeneration of some city fringe areas, explains Laura Porter, business development director at Balfour Beatty Investments.
“The support offered by such councils helps to address the viability challenge, particularly when competing against open-market sale developers in prime locations,” she says.
The growth of PRS in these well-managed regional markets is providing a buffer against the risk of the sector overheating as it enables investors to spread their risk.
“Investors are looking to deploy their capital to create geographically balanced portfolios, which should alleviate the risks of overdevelopment,” says Simon Scott, lead director of residential investment at JLL.
Some cities are more likely to benefit than others. “Our recent report, UK Residential Property - Accessing the Opportunity, showed that university cities such as Manchester, Leeds, Birmingham and Liverpool have all been enjoying improving economic conditions, improved urban infrastructure, rising and increasingly talented populations, higher employment rates and rising salaries, which combined have signalled a higher growth in rents,” says Philip Neil, fund director at Hermes Investment Management.
Giles Beswick, director at Select Property Group, agrees that investing outside the M25 can pay dividends. “LendInvest’s latest property yield rankings report places London in 18th position behind cities including Cardiff, Liverpool and Manchester, which took the number-one spot delivering annual average returns of 6.02% compared with London at just 4.79%, reflecting the rocketing cost of acquiring real estate in the capital and the impact this has on returns.”
Although there are inevitably risks associated with investors exploring some of the land opportunities outside London and the South East - even for prime sites - Paul Winstanley, partner in the residential valuation team at Allsop, says “we’re starting to see funds consider less well-developed locations”.
Further opportunities in the PRS sector aren’t just tied to geography - there’s also scope for operators to bring forward a wider range of products. “As the market matures, we anticipate investors will finesse their offering to create identifiable brands and target specific demographic groups, further reducing any concerns regarding oversupply,” says Scott.
One such area is mid-market housing, which Steve Sanham, development director at HUB, thinks is currently underserved. “Our focus is on trying to fill that gap in a way that pushes the bar higher for quality in a local area by prioritising high-quality design.”
Another factor that will inevitably fuel the future growth of UK PRS is the government’s pledge to boost supply.
“The biggest opportunity the sector has is that there is a huge source of new and additional finance for new housing at a time when the government has pledged to build more homes than ever before,” says Martin Bellinger, chief operating officer at Essential Living. “The housing minister understands this and having long-term investment in communities that can, in cases such as our Archway Tower refurbishment, turn vacant buildings into newly redesigned homes should be a win-win for ministers.”
While the outlook appears rosy for the PRS, there are clouds on the horizon. The fallout from new government restrictions on mortgage interest relief, for instance, is likely to hit parts of the market hard.
“Anecdotally, we’re getting feedback from private landlords who maybe own 10-20 properties and who say the change in mortgage relief is going to have a massive impact on them,” says Muse’s Mayall. “It’s going to be interesting to see what happens to schemes that are being built speculatively in the hope they will attract build to rent.”
Some institutions are likely to pick up the slack, he says, but they will be particular about the sort of investment characteristics they’re looking for, with many seeking fairly sizeable developments. They then face an even bigger challenge, however, he adds.
“The main issue in all cities is the difficulty of finding sites of suitable scale in the right locations to deliver assets that are large enough to deliver the net yield targets the big institutions and operators have,” says GVA’s Craven.
“This is a supply-side issue rather than a demand-side issue. There is a lot of demand and a lot of money targeting the UK PRS - now it’s just a question of locating the right sites to find a home for that money.”
Another hurdle is the UK’s perception that renting is less appealing than owning. However, thanks largely to spiralling housing prices this mindset appears to be changing, especially in certain demographics.
“Private renting is increasingly popular with young professionals, couples and families due to the flexibility the sector provides and the increased cost of purchasing a home,” says Kim Vernau, chief executive officer at BLP Insurance.
The growing number of people who see renting as an acceptable option is an attitudinal shift that is long overdue, believes Iain Painting, senior planning partner at Barton Willmore.
“Culturally we need to recognise that home ownership is not the be-all and end-all - the PRS can offer a quality and affordable long-term alternative,” he says. “We need to build on the significant potential of PRS housing, which is still only a drop in the ocean in terms of supply.”
The key to turning this drop into something more requires greater levels of collaboration in the PRS sector - from contractors all the way through to developers and investors.
“The most important thing is that everyone working in the sector needs to be more vocal in promoting the benefits that build-to-rent properties can bring to local communities,” says James McStay, director for build to rent in Capita’s property and infrastructure business. “This will help ensure that it is seen as a viable solution to the housing crisis by planning officers, residents and potential customers.”
Given the sheer size and lack of housing in the UK, it seems like the PRS market is a long way away from coming to the boil.