The Recession Means It's UK Single-Family Rental's Big Moment
City centre apartment blocks have absorbed most of the wave of capital trying to get into the UK homes-for-rent business. Until now.
That investment could tilt to single-family rental development, because investors believe it is more recession-friendly, and because a big obstacle to expansion will be weakened as the economy gets worse.
There probably aren’t many business sectors where the prospect of inflation in the teens will be cautiously welcomed. But UK single-family rental is one of them.
Not many are saying it out loud, but the subtext is clear: Anything that takes the heat out of the UK’s red-hot homes-for-sale market will be doing SFR a favour. Rising inflation — and hence rising mortgage rates — are a blessing of a kind.
Many in the sector are now calculating that, however great the returns, during recessions multifamily apartment blocks come with risks that SFR avoids.
The result could be a diversion of capital and development energy into SFR, giving the nascent sector exactly the kind of kickstart it needs.
First, some context, because in the potential trade-off between multifamily city centre blocks and SFR, the context really matters.
CBRE data showed that the UK residential sector (including student housing) recorded a total of £2B of investment in Q2 2022, up 20% on the same period in 2021. As much as 80% was outside London, and the full year looks set to break records. Cushman & Wakefield said £890M was exclusively devoted to BTR in Q2.
Investors are piling into rental, and developers are happy to make use of the money. Currently, there are 230,000 build-to-rent homes under construction, in planning or complete in the UK, according to Cushman & Wakefield. The vast majority are multifamily blocks in city centres — as much as 92% according to BPF data.
A Better Bet Than Multifamily BTR?
The recessionary appeal of SFR begins to emerge from the data. Cushman & Wakefield data shows that the rental demographic is changing. In the existing BTR stock the trend is firmly toward older renters. The number of renters aged between 45 and 54 is up 50% since 2012, and up 111% for the 55-64 age group.
Meanwhile. a yet more significant trend is gathering pace: renting as a family. “The market for single-family housing is also a growth area, driven by changing household types and renter preferences, and is huge, at an estimated 2.9 million households,” Cushman & Wakefield Head of Residential Research Millie Todd said.
“This market is only going to grow as the number of households increase, and economic pressures make it harder to become a first-time buyer.”
So far so good: SFR looks like a good bet. But why might it be a better bet than multifamily, given that recession is looming?
“We’ve actually made money from city centre BTR, and I don’t think many others have,” said Ferguson Davie, reflecting on Moorfield’s decision to cash in its completed BTR portfolio in a series of deals including the £53.5M sale of a Manchester BTR scheme to Barings Real Estate.
The logic of Moorfield’s in-out approach, and the new emphasis on SFR, is revealing.
“The reason we went for multifamily first, rather than SFR, is that in the mid-2010s there were concerns, coming out of recession, about the viability of selling city centre apartments quickly at prices that made sense for developers. So we were able to make the maths work by creating 200-300-unit rental schemes in Manchester, Newcastle and Liverpool at a time when everyone else was scared of the residential market,” Ferguson Davie said.
A modest degree of market failure in the for-sale apartment market opened up space for the rental market. For-sale developers could sell blocks to BTR operators — meaning no development risk for operators, and a happy solution for the developers.
Today, a similar modest market failure promises to open space for SFR. “The strength of the for-sale housing market has held back SFR," Ferguson Davie said.
“It has been hard to make SFR work in the UK — to gather the momentum many predicted — because housebuilders have been able to sell fast at prices higher than a bulk investor could go to generate an acceptable yield."
But with Help to Buy, the government’s funding subsidy for new build, about to end, and concerns about the economy, maybe housebuilders will be prepared to forward sell homes to investors, he said. And there are already plenty of areas in the UK where this could work. As it becomes harder to make BTR city centre towers viable, it may be easier to build SFR houses.
A wobble in the for-sale market may be either a useful, or an essential, condition for the growth of a rental market. And all the economic forecasts suggest a substantial wobble is on its way.
Moorfield does not think most investors will actually swap resources out of multifamily and into SFR — but the firm does believe there is a logic in spending more time and money on SFR.
“SFR is an option now in a way it wasn’t five years ago,” Ferguson Davie said. “Now that the build cost of city centre BTR is going up, so relatively SFR looks more viable. Although I don’t think the city centre block development will stop, because there is so much money behind it.
“We hope to do more city centre BTR ourself, we haven’t switched off our intention to do it, but in the last couple of years that city centre market has been very competitive and others have been prepared to pay more than us for projects.”
Moorfield thinks the benefits of SFR go deeper. Houses have lower build costs than tower blocks, which means rents can be more affordable — ideal if a tenant’s finances are under cost-of-living pressure. Whilst he plans to invest “hundreds of millions” in SFR, he also plans to divide it with city centre apartments, when the market feels cool enough.
The simple statement 'what is bad for the for-sale market is good for renting' gets a thumbs down from Avison Young Head of Residential Investment Richard Stonehouse. But the idea that a for-sale wobble could ease the way for SFR does not.
“Look back two or three years, then if you talked to investors they felt it was inevitable there would be a shift to SFR," he said. "And the spark that lit the fuse was last year’s £150M Goldman Sachs buy of the Sigma SFR portfolio."
But that fuse has not burned steadily. The current economic turmoil could fan it back into vigorous life. Not only is it easier to meet your investment ESG criteria and at less cost, but SFR has lower void rates than city centre BTR, and a less transient tenant group, Stonehouse said.
“Operating the asset is easier because it is less volatile. Tenants tend to look after homes more than they look after flats,” he said. This makes the appraisal numbers a little more appealing.
And like Moorfield’s Ferguson Davie, Stonehouse is also hoping the for-sale housebuilders find reason to be cooperative.
Stonehouse is also watching the yield figures. “Say you were comparing a city centre BTR block in a third-tier city with a suburban SFR scheme on the same city’s fringe — you might expect funding for the BTR block at 4.5-4.75% but it will be comfortable 4.75% for SFR, and that is enough of a difference to make it attractive,” he said.
The danger is that viability appraisals make overly generous assumptions about how cheap it is to provide public space and shared facilities on SFR estates, and how high suburban rents can go. But assuming the calculations aren’t too far wrong, SFR looks mathematically appealing.
There’s a final recessionary plus to SFR, which is that it requires less capital and commitment upfront. “It is much easier to turn off the tap of an SFR development,” Stonehouse said. “You simply stop building. But you can’t stop building a 400-unit city centre apartment scheme.”
Here Comes The Future
One way to express the current mood is to say that the barriers to entry to the SFR market are coming down (a little).
High land prices, and the vice-like grip over land and specifications of the volume housebuilders, tended to deter SFR investment at yields investors could tolerate. Weakening land prices and less dominant volume housebuilders equal a chance for SFR.
Lewis Smith is partner in the residential capital markets team at Cushman & Wakefield. “We may be seeing a changing view among the housebuilders that SFR can help with returns on capital on the larger schemes," he said. "They may think it worthwhile offloading part of a housing estate to an SFR operator. So maybe finding sites to operate SFR will get easier.”
Smith has put his finger on the problem: SFR sites are hard to find, and the control of the volume housebuilders is generally unhelpful. Talking to intermediaries and investors this comes up again and again.
“The fundamental issue with accessing SFR is that generally UK housebuilders control most of the development land so it’s difficult to find," said Native Residential Acquisitions and Development Manager Alec Newton. "They also have control of the product that is created — housebuilders will only sell when they need to and it's unlikely to be their best stock.
“You are also restricted by the individual housebuilder’s building specification, and it’s therefore difficult to make design changes, which is important when trying to differentiate the product. The challenge is finding investable stock at scale.”