Institutional investment in residential real estate

Together with Spire Ventures and POD management, Beaumont Bailey hosted an online panel discussing the merits of vertical integration versus scaling up in the Build to Rent (BTR) sector and how this has affected the outlook for institutional investors in the residential real estate market. Host Amanda Floyd (Head of Investment Practice, Beaumont Bailey) was joined by industry leaders from the residential investment sector, including Scott Hammond (CEO, Eutopia Homes), Victoria Quinlan (Head of Investment Management, Lendlease), David Goldberg (CEO, POD Management), Matthew Pullen (COO, Eco World) and Anna Harper (Author of Amazon Best Seller Strategic Property Investing).

Market overview

There has for years been a shortage in the supply of homes in the UK of approximately 175,000 new homes per year (BPF, 2020). This is primarily a product of the heavily constrained Build to Sell (BTS) model which delivers homes at a speed in which the market rapidly absorbs the new supply. In major cities like London, cash intense projects such as apartment blocks, the Buy to Let (BTL) market has helped de-risk the BTS market by often making up over 50% of sales (LSE and Savills, 2020). In the current market environment with high sale prices, unfavourable tax environment and increasing regulations on BTL investors, there is a gap in the market that needs to be filled. This is increasingly filled by forward funding Buy to Rent (BTR) investors who seek to capitalise on the long-term investment nature and stable income source residential real estate offers. As a result, PRS has become one of the fastest-growing, most attractive asset classes (currently worth £1.5tr). The difficulty with large scale BTR schemes is often significant capital requirements and multi-year development periods bring rise to the question of whether scaling up or vertical integration is the key to successfully operating and delivering in the BTR market.

Investment outlook and Investors

Large scale residential investment has historically been dominated by pension funds who have both a long-term investment horizon and sufficient capital to take on large schemes that often take over 6 years to complete and require several hundreds of million pounds of investment.

Following the outbreak of Covid-19 and uncertainty in capital markets, both UK and overseas investors are looking for alternative investment products. Our panellists noted that many institutional investors are still heavily overweight in underperforming commercial and retail assets. Looking to rebalance portfolios, residential has become an attractive asset class to institutional investors due to resilient performance and minimal correlation to other real estate classes. Having spoken to over 80 UK real estate-focused investors, one of our guest speakers too, has seen an increase in demand for BTR schemes, particularly those in buoyant markets like London and Manchester. The main barrier to entry for many is the fact that investors often believe the BTR model does not suit their investment style. Added to that, the lack of data and novelty of the market leads to many investors shying away from the sector.

Vertical Integration vs Strategic Partnerships

Build to rent schemes operate on tight margins especially in city centres such as London, where there exists fierce competition for obtaining development land. For BTR schemes to remain competitive in the residential real estate market, the number of units in development schemes will need to increase. The average UK BTR schemes completed in 2019 was 133 units, whilst the number of units in the development pipeline exceed over 325 units (BPF, 2020). To achieve developments of scale there are two techniques that can be adopted:  vertical integration and scaling up through strategic partnerships. The following section will outline the key risk / rewards of each, their respective viability and the key areas where growth is needed.

Vertical integration is often viewed as the more desirable route to achieving scale and alignment of the brand and culture of the operator, but a major barrier to entry is getting the threshold of assets under management to a level such that it is viable and cost-effective to keep operations in-house. From a risk management perspective, there is a sizeable financial commitment to build the team, systems and support needed to run management in house. There is also less room for maneuver to scale up, or scale back, in uncertain markets and clear benefits of being “asset-light” in the current environment. There was consensus on the panel that a hybrid approach often makes the most sense.

Lendlease for example, with a UK development pipeline of over £16bn has made the switch to deliver an end-to-end BTR scheme of over 500 units in Elephant Park, London. Whilst in the US the company does not have such exposure to the local market and scale, instead of adopting a hybrid approach where they partner together with developers and service platforms to deliver their BTR projects.

In the current rapidly evolving and unpredictable environment, investors are pivoting and adopting new strategies to be in pole position to capitalise during the next stage of the cycle. Matthew Pullen commented that selecting the right strategic partners can be crucial to success in this regard.

Large scale BTR schemes are still in the early stages when it comes to outsourcing and partnership models, long build periods and multiple stakeholders can make it extremely difficult to deliver on time and remain within budget. Bringing strategic partners who have expertise in running the properties can already be optimised in the construction stage. For example, in the use of materials and M&E installed can have a long-term effect on later costs and service requirements, hence partnering with someone who understands the full lifecycle costs can be beneficial, David Goldberg, CEO POD management comments. Strategic partnerships continue to be of significance beyond the construction stage. For property management firms, such as POD, effective building management enhances and protects the long-term value of a development. Investors are seeking income over long periods and as such, the quality of homes, surrounding amenity spaces and services needs to be well-maintained as they are part of the extended home of the tenant. Businesses like POD, which have been built specifically to excel at management, inherently understand the customer journey and, having worked with a variety of clients, can draw on experience, with their workflows being developed from years of best practice.

Pain points and the ways in which technology and skilled labour helps optimise the BTR market

 Property technology businesses have, in recent years, experienced rapid growth; the market as a whole however is still very underdeveloped in comparison to other markets like Fintech. There is significant space in the market for ideas and growth. Beaumont Bailey support this by helping both early-stage and developed businesses attract and onboard the right people from parallel sectors. Bringing in expertise from other sectors will be beneficial to the level of innovation in the property market which has lagged other sectors in the adoption of new technology and practices.

When it comes to building up brand awareness there is often a trade-off between creating a name and strategic partnerships. Expert property management firms have historically lacked the ability to let out space and therefore there has been a need to have a separate lettings company and property manager within one scheme. Strategic partnerships in this sense can be a barrier to creating brand awareness from an end-to-end perspective. Alternatives include exclusive partnerships with a property management business which some BTR investors have opted for, creating an umbrella brand.

Concluding remarks

 As the majority of commercial and retail property markets continue to be adversely impacted by the pandemic, the residential real estate market continues to benefit from the new work from home culture, with the importance of having the right space and set up at home continues to grow. BTR service providers have a unique opportunity to capitalise on this. For asset owners, vertical integration allows the development of a strong brand image, which is important in creating a community and enables the owners to stay in full control of all decisions, the downside being the significant investment required and in turn the financial risk and lack of flexibility. Strategic partnerships on the other hand, allow owners to access best-in-class partners, enabling them to deliver a high-quality asset and service across the BTR process. This enables the developer and associated parties to each focus on their respective areas of expertise.

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