Property Funds
Institutional investment. This has been promoted since 2010 by successive Governments but has not taken off so far in any meaningful way with the GLA reporting
While buy-to-let (BTL) investment has boomed over the last decade (since the introduction of BTL mortgages in particular), institutional and corporate landlords’ share of the market has declined substantially since 1994.
The Montague Report cites the following as reasons why its not taking off. Download the Montague Report
- The income yields on residential property are too low and especially compared to commercial property. Montague quotes net yield of 3.5% historically
- High management costs as investment properties are managed by small local agents whereas the tenant is responsible for costs in the commercial investment market
- High risks including voids and damage
There are particular risks inherent to the private rented sector (PRS) that have traditionally proved a barrier to investment and deterred investors. One of the main obstacles is the investor’s ability to acquire a critical amount of stock in one location. Institutions do not want to buy a scattered portfolio of individual assets and prefer large developments, where they can minimise management costs and other overheads. But accessing this type of stock from developers can be difficult.
Also private BtL landlords and owner occupiers often out bid Institutional Investors as they value amenities, such as local schools and parks, higher and often do not fully price in management and opportunity lost costs.
Another disincentive is the short term tenancies typical in the PRS. This might not be the barrier it seems for well-located properties that can be re-let easily; however, the income risk is greater than the commercial market, especially with the lower covenant strength offered. The costs involved in managing a residential portfolio are also disproportionately large relative to a commercial portfolio, as there are generally more, smaller, management-intensive tenancies to deal with.
Finally, while total returns have outstripped the main asset classes, the income portion of the return is much smaller for residential than for commercial assets. Consequently this puts pressure on the owner in terms of the management costs and an over-reliance on capital growth to achieve their desired level of return. This and the other reasons cited mean that institutions have generally preferred not to invest in this asset class.
The GLA Economics unit sees residential property as a ‘political football’. Although the Government has made it clear that it sees a well-run private rented sector as an important part of the housing mix, MPs and councillors are often seen to be ‘anti-landlord’. This deters Institutions and their investors.
The GLA also notes some other problems in PRS for Institutions
- Regulation in the PRS market regulation is heavy-handed and inconsistent. Costs that fall on landlords are not always applied to the owner occupation sector.
- Dealing with peoples’ homes seems to have a higher risk of negative publicity than investing in their workplaces or infrastructure with significant “brand” risk.
- Management of residential property is seen to be labour intensive, or expensive to run (meaning a professional operating and management company is involved).
- Management and maintenance costs affect potential returns whereas with commercial property the tenants are largely responsible for such costs.
- Institutional investors prefer to have larger concentrations of units, which is offered in the commercial sector, unlike the wide dispersion of residential property.
The final nail in the coffin for Private Rented Funds is the ability to price assets based on an income multiples for valuation rather than the traditional UK residential approach of a discount to vacant possession value.
Joint Equity Bonds do not suffer these problems as they are simple, ethical and have a value based on the returns for the Bond not the underlying property.