The UK Build-To-Rent Boom: A Maturing Market

This is the second instalment of a two-part series on residential build-to-rent (BTR) developments in the United Kingdom. In part one, LoopNet looked at the recent history of the UK’s private rented sector, and learned from two industry experts how the emergence of BTR established a new type of asset class. Part two tackles the demographics of BTR tenants, the three branches of BTR growth, and what the future has in store.

Boasting professional management, hotel-style amenities, and longer-than-average tenancies, build-to-rent (BTR) has emerged over the past 10 years as a new type of rental housing asset in the UK’s private rented sector. But as BTR gains traction in the housing market and attracts increasing interest from major investors, it’s crucial to understand the various factors that contribute to its performance as an asset class.

First up: demographics.

Quarterly statistics on the BTR pipeline compiled by Savills and the British Property Federation (BPF) show that the sector comprised 205,525 completed and planned dwellings at the end of the third quarter of 2021, a 14% year-over-year increase. Of those, 63,950 were completed, 42,032 were under construction, and 99,543 were in planning.

And while such significant supply-side growth implies an analogous growth in demand, determining where that demand comes from isn’t as straightforward as it might seem.

“Often when people say demographics, they hear population growth,” said Nigel Allsopp, senior director of investment strategy and research at Greystar, a vertically integrated real estate company that offers investment, development and property management services, and a major player in the British BTR market. “But that's one of three factors. You've [also] got urbanisation, which is still a trend in the UK; there was no sign of that abating during COVID. The third is the rise of single-person households, which is often overlooked.”

A joint study conducted by the BPF, London First, Dataloft and the UK Apartment Association confirms Allsopp’s claims: less than 10% of BTR tenants are families, while over 30% are single.

“What you're seeing across the developed world,” Allsopp said, “is people getting married later, getting divorced more often and often being widowed for longer. So, you've just got more and more single-person households.”

Meanwhile, the study also showed that tenants in BTR developments represent similar incomes, employment sectors and ages as the broader private rented sector (PRS).

In both samples, over 40% of residents are between 25 and 34 years old, although BTR houses significantly more people between the ages of 16 and 24 (31%) than the PRS (24%). Likewise, 32% of BTR residents earn between 19,000 and 32,000 pounds (approximately US$23,000 and US$39,000) per year, compared with 37% in the PRS. The study also found that BTR tenants in the UK spend an average of 29%-33% of their income on rent, roughly the same amount as in the private rented sector.

“[It’s] an economically defined middle class that we tend to focus on,” Allsopp said. “They tend to be professionals, but not necessarily. They may be single sharers. They may be young couples. They tend to be more one-bed and two-bed [units].”

In many cases, BTR also draws inspiration — as well as a significant amount of its customer base — from another similar sector: student housing.

“I think in some of the large regional cities, build-to-rent probably has a more aspirational feel to it,” said Ian Fletcher, director of real estate policy at the BPF. “It’s catering to younger graduates who are taking their first steps on the housing ladder and have liked the quality of the accommodation they've had at university and want something of similar quality.”

And as the market grows, BTR is expanding out of London into other cities identified by the UK Government for additional housing growth, like Birmingham, Liverpool, Bristol and Manchester.

“Build-to-rent is now pretty much nationwide,” Fletcher said. “We're seeing developments in places I didn't anticipate that we'd see it in. And that's great.”

Like the hospitality and office sectors, BTR is particularly well-suited to joint ventures between investors, developers and building operators. In some cases – as with Greystar – one company performs all three roles.

“You need three legs of the stool to make it happen,” Allsopp said. “First is capital; there's a lot of that about at the moment. The second bit is development capabilities; there is some of that from the house-building sector … And then the third part is operations. And there's really not very much of that.”

How those three branches of BTR grow over time will ultimately determine how the sector performs compared to other assets.

• Investment. Unlike for-sale housing, BTR tends to attract institutional investors seeking a long-term income stream, like pension funds or even municipalities themselves. And while some investors were initially wary of the novelty of this new asset class, they’re now flooding the market with capital.

  “I think the investment market is pretty much there,” Fletcher said. “We’re seeing some of the largest UK pension funds investing, like Legal & General and M&G.” He also added that “the debt market is far more comfortable, and the lenders understand the product far more than they did even two or three years ago.”

  Nor is investment in BTR limited to investors within the UK.

  “What we're seeing more of is institutional [investment] managers from all over,” Allsopp said, “not just from Europe, but quite a bit from the U.S. and Canada, and some from Asia Pacific. Also, the Netherlands is actually a country that's got quite a lot of experience with multifamily, so they're very comfortable with it as an asset class.”

  “[Investors] can see the size of the opportunity and they all want to get in,” Allsopp added. “But there aren't the standing assets to buy. So, the obvious thing to me then is you have to develop, and that's what we are doing a lot of.”

• Development. There are several potential players in the BTR development market, including house builders, large contractors who have traditionally delivered to the commercial property sector and housing associations that target the affordable housing market.

  But for investors seeking out opportunities in the BTR market, getting a project into development is no walk in the park.

  “The huge challenge in the UK for anybody trying to get into this market is finding the land and the partners to do this with,” Fletcher said, adding that “one or two of the investors have actually gone out and bought housing developer [companies] to ensure that they have that expertise on tap.”

  While many early investors funded development through forward purchases, i.e., agreeing to take ownership of a project upon completion, others are now willing to take on some of the construction risk themselves through forward funding agreements.

  Fletcher explained that part of what motivates investors to adopt forward funding agreements is “just getting scale reasonably quickly. Hence some of the market reactions in terms of taking the construction risk and that sort of thing, just to ensure that people are able to develop and expand their pipelines relatively quickly.”

  “You need to be willing to take development risk,” echoed Allsopp. “A lot of investors come to us and say they want to do core, i.e., stabilised, income-producing assets. But we've got to build those [assets] first. And then once that's done, you need to understand how you can create value through the operations.”

• Operations. This aspect of BTR is perhaps the least familiar for investors and developers in the traditional housing market. But with competition in the market increasing, many successful BTR owners are taking a different approach to calculating costs, shifting their focus from capital expenditure to operational expenses.

  “A lot of people in the UK still think of real estate like it's a fixed-income asset,” Allsopp noted. “It's not – it's an operating business. And like any operating business, you need to be able to manage your profit margins. You need to be able to hire, recruit and retain staff. And you need to keep your customers happy.”

  To that end, many BTR operators now deliver properties with elements from the hospitality and leisure industries to create added value – both in terms of cash flow and brand recognition. That also means performing a detailed cost-benefit analysis to justify sacrificing additional rental units to make room for shared amenities like pools, gyms, workspaces or cinema rooms that contribute to a differentiated customer experience.

Both Allsopp and Fletcher agree that the future of BTR is promising.

“You can continue to see significant customer retention and customer attraction,” Fletcher said. “All of that helps in terms of getting investors to see that this is something that is reasonably stable and robust. The yields are not stratospheric, but if you're a pension fund paying out regular income to your pensioners, this is a great place to put your investment.”

Allsopp added that although the pandemic forced the sector to slow down for the past few years, things are looking up. “When we saw the last lockdown lift in London in the third quarter of last year, it really took off and we've seen pretty incredible absorption,” he said. “Pretty incredible lease, trade out, and rent growth.”

“The sector's been reasonably robust during what's been a challenging period,” Fletcher agreed.

As for the recent spike in inflation, Allsopp holds to the received wisdom, popularized by Nobel-winning economist Eugene Fama, that real estate – particularly residential real estate – acts as one of the best hedges against inflation, on par with gold and index-linked gilts.

“[High inflation] hits us on OPEX [operating expenses]. It hits us on build-cost inflation,” Allsopp said. “[But] what you see with housing and cost inflation is … a two-year lag between construction costs going up [and] rents going up two years later. There’s a really high correlation between the two.”

Therefore, according to Allsopp, BTR should continue to perform well as an income-producing asset despite rising consumer prices.

It’s also a good time for new competitors to enter the market, according to Fletcher. While there are certainly several large players already in the field, the market remains fragmented enough for early investors to develop properties that will serve as platforms for further growth and consolidation through mergers and acquisitions.

“The last [sign] of a mature market,” Fletcher said, “will be when we start to see portfolios changing hands. We've seen one or two small transactions in the UK, but that transactional market where people are swapping buildings and portfolios is really just starting to happen.”

A recent JLL report indicates that the BTR sector could eventually generate a potential £20 billion in annual transactions if market penetration reaches levels like those seen in the United States multifamily market.

“It's a growing market in the UK,” Fletcher said, “and I think it's destined to continue to grow quite strongly.”