Future of PRS
Spire Ventures together with our portfolio companies Westfort Advisors and Beaumont Bailey recently hosted senior leaders from across the PRS sector, including Sir Stuart Lipton (Lipton Rogers), Richard Jackson (Apache Capital) and Rachel Miller (Grosvenor), for a candid discussion on ‘The Future of PRS’, chaired by Professor Andrew Baum of Oxford University’s ‘Future of Real Estate Initiative’.
The aim was to uncover the key challenges facing the sector and reveal expert insight as to how best meet the demand for quality rental accommodation across various submarkets.
The following summary reveals why the UK is still substantially lagging in institutional PRS investment compared to the US and mainland Europe, despite total UK investment growing 33% since 2017 to reach a record of £3.1bn in 2018. We outline how this total investment can be increased through overcoming identified barriers and fostering a greater understanding of the financial, social and sustainability benefits of future PRS schemes.
Resilience of PRS
Covid-19 continues to have a significant impact on the real estate industry, particularly the retail and office sectors. Cushman and Wakefield reported leasing volumes were 20% below average for office space in London at the end of Q1 2020. Similarly, ‘Re-leased’ reported that across their portfolio of 65,000 retail assets in the UK, only 48.0% of rent had been received 10 days after the March quarter date, which contrasts to an average of 74.9% collection from the last two years.
Conversely, owners of PRS schemes around the table acknowledged a continued demand across their portfolios, with take-up only marginally down (year on year) and rent collection above 95%. Recent changes in living and working regimes, coupled with reductions in higher LTV lending may be contributing factors. In the longer term, forthcoming restrictions to the ‘Help-to-Buy’ scheme and the impact of a recession on affordability may see a decline in mortgaged owner occupation, and an increase in demand on PRS.
However, it is important to caveat that the true resilience of the sector will be tested over the next few quarters.
Fundamentally, the lack of housing supply and issues surrounding affordability are a regional issue; not a national one. House prices in London have risen more than anywhere else in the UK, growing by almost 59% since the 2007-2008 peak. Furthermore, the ratio of median house prices to median earnings in London has risen from c. 5.5x in 2002 to 13.09x in 2018, automatically pushing those dreaming of home ownership within London into the rental sector, whose response has been to offer a spectrum of product offerings across attractive locations, with on-site amenities and the promise of community.
Impact of COVID-19 on Consumer Behavior
The consensus around the table was that employees want flexibility (as they always have). However recent events have shown that for many, working from home has not impacted on productivity and flexible working is likely to increase. The Landlords present acknowledged that a key question they have for PRS landlords is how to position their assets to cater for the well-being of their tenants. Notably, there is a growing appetite for on-site leisure and community, and an emerging trend towards working from home (WFH).
Increasing on-line interaction and WFH of tenants will arguably contribute to increasing loneliness. People are generally social creatures and will ultimately seek physical interaction and a sense of community spirit. The design features of PRS schemes that can help foster a sense of community is where participants saw the greatest opportunity for developers.
If COVID truly has catalyzed significant shifts in remote work practices, it is our belief that other communal offerings will be needed to fill the social void. Many of the participants agreed that now is the time for PRS schemes to address this new type of social need.
Impact of COVID-19 on Institutional Investors’
Following the European precedent, there is great potential for the PRS market to grow in the UK above its current 17% of total dwelling. For example, in Switzerland PRS accounts for over 50% of total dwellings, and Germany holds over 40%. Some of the reasons for this lack of institutional interest we identified are: a political focus on homeownership creating an inability to scale the PRS, current tax regulations making PRS less financially viable, and a disjointed planning policy combined with a complex planning process. However, PRS resilience throughout the lockdown period thus far is likely to spur further interest from institutional investors as they pivot away from the badly hit office and retail sectors.
Bottlenecks to Growth
Westfort Advisors noted that there is still significant illiquidity in the debt markets as banks and institutional funds are beginning to look at completely new originations, albeit very selectively. However, in the short term (and certainly beyond), there will be availability of senior financing for the right opportunities and the right sponsors, given the strong markets fundamentals.
Large or scalable schemes, managed by top tier sponsors certainly remain attractive to insurance backed lenders, German Pfandbriefbank and clearing banks, who can offer senior financing at c.55%-60% LTV. However, given that prime yields broadly range from 3% for Prime Central London to 4.5% for Prime Regional Cities, higher leverage debt or debt from higher risk/return lenders (debt funds) is often unviable. Many debt funds are also unable or unwilling to consider the relative complexity and risk of financing the development of smaller schemes, which will prohibit smaller scale developers.
Given the prevailing uncertainty in the market, and the construction and operating risks associated with developing PRS, lenders are becoming increasingly selective with respect to the caliber and track record of the sponsor, in addition to the viability of the proposed scheme.
Further bottlenecks mentioned by our guests centred around the availability of land and in turn, the feasibility of PRS schemes. Due to regulations and the barriers to entry created by complex planning rules, the risk of locking in capital over prolonged periods has impacted upon the feasibility of affordable PRS schemes. Current processes, lead times and long-return windows create a competitive edge for BTS developers, who can take money off the table quickly, as well as larger players, who have the resource to wait out long lead times.
The misalignment between developers and operators can negatively impact the sustainability of the product that the PRS world is trying to create. For developers, the aim is to recycle capital as soon as possible and move onto the next scheme, ultimately creating an environment where there is less focus on the long-term durability of the schemes or on how the building promotes community and provides amenities. This is of critical importance to operators aiming to reduce tenant turnover, maximise tenant experience and, in turn, justify higher rents.
One suggested is to focus on vertical integration from cradle to grave. Whilst the vertical model allows full capitalization on the spectrum of monetizable activities within the PRS world, it is incredibly difficult to execute, with few players holding the necessary skillset to develop, brand, let and management the scheme. Beaumont Bailey suggested that this is where talent acquisition is key. Beaumont Bailey is a believer in cross sector skills transfer and suggested that PRS developers need to tap into the hospitality sector for talent more geared towards the BTR offering. In addition, the end-to-end product and investment required is not feasible without scale, given the fixed cost associated with each piece of the puzzle.
Broader Socio-Political Elements
It was highlighted within our discussions, that we need to re-evaluate who the target consumer is for BTR schemes. Those planning future projects need to be clear on which segment of the population this would best serve. Given the social constructs and schema within our society, it is highly unlikely that an individual would choose renting over ownership long-term if they have the capabilities to purchase a home. This is largely due to the culture of home ownership as the pinnacle of success within the UK. As highlighted by one of our guests, this is driven by the UK government who have implemented many policies to help facilitate this. However, those nations with a higher percentage of PRS, have an alternative culture to ours, due to stronger rental markets than we experience in the UK. Again, this is a top down situation. Many European regulations offer greater protection for tenants and place less impetus on the marvels of home ownership.
If a new PRS industry is to emerge after COVID-19, one which can provide all that is being promised in regards to amenities, property management, hospitality and community, the UK government has a need to introduce legislation geared towards protecting tenants rather than landlords, and in the process facilitating a shift in culture away from home ownership, towards the rental market.
The PRS industry will adjust to the challenges posed by COVID and the change in our behavioral patterns. Investors will continue to offer a wide suite of amenities in their schemes to meet demand and remain buoyant for the sector. This could be a pivotal moment for the PRS sector to capitalise on the availability of debt and equity which is seeking refuge from other sectors (such as retail and hospitality) that face much more challenging times ahead.