Back to Ambition to Deliver

Risk and reward: assessing the private rented sector from a housing association perspective

by Nigel Bosworth, Director, Prime Estates, Savills and Andrew Smith, Associate, Savills Residential Research

The Chancellor used his Autumn Statement to give housing associations increased funding on more flexible terms to build more homes for affordable rent and shared ownership. So what place will the private rented sector (PRS) have in housing provider plans? 

For some housing associations, a development programme which mixes market sale, shared ownership and affordable rented tenures will work very well. But this will not be the case in all locations.

As Savills highlighted in its recent annual residential forecast, we expect house price growth to be relatively low over the next five years. This is because lower household incomes will mean there will be fewer transactions. As a consequence, Lucian Cook has predicted PRS rents will grow 19% from 2016 to 2021. This compares with house price growth of 13% over the same period.

When assessing whether the PRS should form a part of their portfolio, housing associations will want to look at its performance over recent years. Three graphs below help illustrate this.

How can housing associations analyse this market further?

If a housing association is appraising an opportunity and feels PRS properties could potentially add value to its tenure mix, it will want to conduct a more thorough analysis. So what should it consider?

Assessing scheme viability

A gross yield of much below 5% (4% net) generally means it makes more sense to look at market sale, as capital values are likely to be high.

There is a rather large caveat to this, however. At present in the UK there is no common measure for assessing a project’s yield. Some schemes will show a relatively high yield, but this will have been arrived at by excluding several cost items from the calculations.

For instance, if a developer excludes losses from void properties or property management fees, this will give a greater net operating income (NOI). This lack of an agreed approach makes it tricky to compare like with like.

If nothing else, this unsatisfactory situation reinforces the need for housing associations to have a clear handle on their likely operational costs for PRS. At the risk of stating the obvious, although they share some common elements, these costs are different to general needs social housing.

Some of the most common operational costs are:

  • Lettings and ‘lease up’: void periods between tenancies when the property is generating no rental income. Social landlords will be familiar with this concept, but voids are likely to happen more frequently in PRS.
  • On-site staffing: many PRS tenants expect a 24/7 concierge service.
  • Branding: although it is entirely possible for a housing association to utilise its existing branding, it could consider creating a separate brand (e.g. Fizzy/Thames Valley or Folio London/Notting Hill Housing Group) to assist marketing.
  • Operational delivery – housing providers will need to assess the extent to which they have the skills to deliver PRS housing management to the standards expected by customers and cost-effectively
  • Health and safety – insurance, etc
  • Place making: to maximise the rents of purpose-built PRS homes or ‘build-to-rent’ there will need to be investment in the neighbourhood. This can be in retail and food concessions as well as the surrounding environment.
  • Community-building: as with the preceding point, people can be tempted to pay a premium PRS rent, but they need to feel they are part of something. This can mean organising community events and shouldering the associated costs
  • Day-to-day management – this will need to respond to potentially demanding customers
  • Planned maintenance: the costs of unusual items such as security systems, lifts, car parking and white goods.
  • Financial measurement, monitoring and reporting: often this will be undertaken separately from that for the affordable housing portfolio.
  • Governance: if the PRS portfolio is held in a separate entity

Other benefits of PRS worth considering by housing associations include:

  • It can often unlock forward funding from investors looking for long-term yields that other tenures will not achieve.
  • PRS components of large, multi-phase schemes can be brought forward without competing with or undermining sales values.
  • It delivers stable, long-term, asset-backed yield income that is linked to inflation, and is at an attractive level compared to similar long-term yield investments such as gilts (government debt), for example.
  • An area of low financial risk is the granular nature of the income stream. If you have one office building with one tenant then the cashflow risk is binary. With a 200-unit PRS block, one or two voids or arrears cases are not going to move the needle much.

Assessing scheme risks

On the flip side there are also several risks of which housing providers should be aware.

The biggest risk is the lease-up and stabilisation period. Going from the launch of a new PRS scheme to a stabilised asset requires careful planning and skilled execution. Understanding the so-called ‘absorption rate’ of a local market is important here, as this is the rate at which homes will be let.

The next biggest risk is finding a good-quality operator and manager. Many claim to be experienced but not all of them bear scrutiny. A housing association may feel it is well-placed to provide the required property management service, but it should be mindful of the different service requirements and operational cost factors outlined above when making this decision. On reflection it may feel it can deliver the requirements, or it may need to bring in additional skills or even outsource the service.

In addition, it is likely that PRS yields will become compressed in the next few years. This is due to the build-to-rent market maturing and a secondary investment market emerging in stabilised assets with established track records.

The other long-term risks are political and regulatory. For example, in the Autumn Statement the Chancellor announced that the government would legislate to ban lettings agents from charging tenants for their services. This is the latest in a series of taxation and administrative changes that the government has imposed with little impact on the market, suggesting that there will be further changes in future. 

PRS versus alternative tenures

Ultimately in assessing the value of PRS versus the alternative tenures available, there is no single performance metric. A housing association will need to base its decision entirely on its assessment of local market factors and the investment required to provide a product that will appeal to this market.

One point that is worth bearing in mind, however, is the opportunity with which housing associations are currently presented. Recent Savills research has identified £7.4bn in untapped financial capacity that housing associations could use to build up to 44,000 extra homes each year by 2029. This would be in addition to those currently planned and would be a mix of tenures, including around 11,000 PRS homes.

Some subsidy – perhaps in the form of land – would be necessary to achieve these figures, but the potential to substantially boost development across a range of tenures clearly exists.

When the recent government spending plans on housing and the associated aim to build one million homes by 2021 are taken into account, housing associations are well placed to deliver a business model encompassing all housing tenures.

This should allow housing providers to better weather housing market downturns and provide the homes the UK needs – including PRS.

The performance of PRS over recent years

Figure 1. IPD data shows that the UK PRS has performed strongly over the past 15 years. It is less risky than commercial property and offers greater returns on investment.

Figure 2. IPD data demonstrates that PRS investments in the past 15 years have tended to deliver average annual returns of between 3% and 4%. This is perhaps unspectacular, but it is higher than affordable housing and is steady.

Figure 3. Savills data shows the average performance of PRS investments at the regional level across 2015 and 2016. It is immediately clear that the best yields are currently to be found outside the traditional housing hotspots of London and the South. This is caused by the relatively high capital values in southern England (especially in London) when compared to incomes. A gross yield calculation (annual rental income divided by capital value) will always come out quite low as a result.