Do Rising Land Prices And Swollen Pipelines Risk Undermining BTR?
Is unrealistic land pricing choking off a potential build-to-rent boom? We are about to find out what happens when you build a large amount of private rented apartments in a small area in a short time.
As Legal & General swoops on yet another BTR asset in Manchester, and as big BTR names circle Birmingham looking for a place to begin, is the BTR sector on the brink of big change? Or is price and supply pressure about to stall progress?
In the first of a two part analysis of the U.K. BTR market, Bisnow investigates.
The ink is barely dry on the contract agreeing Renaker's sale to LGIM Real Assets of the 350-unit West Tower BTR scheme, Deansgate, Manchester. Confirmed on 20 August, the deal brings Legal & General's Manchester build-to-rent portfolio to 750 units following its Slate Yard development in Salford, which was 50% let before first occupation.
The deal came as the West Tower tops out at an unmissable 45 storeys and as confidence in the U.K. BTR sector soars even higher.
And yet all is not entirely rosy. Despite just 124,000 units in the pipeline, roughly half of them in the regions (according to BPF/Savills data), and despite being a tiny fraction of the U.K. housing market, there are some serious constraints at work in the BTR sector in both Birmingham and Manchester.
Many of them focus on Manchester, which now has around 11,000 BTR and PRS units in the pipeline. The city is turning into the U.K.'s first large scale in-the-wild experiment in BTR, with a relatively large number of units, from a relatively large number of providers, appearing in a relatively small space. Mistakes will be made, and lessons learned, as brands and operating models clash for the first time. What happens in the city will determine how BTR unfolds in Birmingham — and will influence plans in London.
Two themes are already emerging. First, BTR demand has woken up landowners whose optimistic or aspirational land pricing is a brake on development. Second, the surge in planning approvals has given credibility to schemes that may never get built. As a result the supply pipeline may be thinner than it looks.
Land Prices Up 300% To 400%
Moda Acquisitions Director Oscar Brooks was among those negotiating the purchase of the 466-unit Apache Capital-funded Angel Gardens site in Manchester in 2016. He says land prices have rocketed since and in a low-margin sector like BTR, that is not good news.
“Arguably at the time Angel Gardens was the best BTR site outside London, yet today we’re now looking at Manchester sites which are three or four times the price we paid at Angel Gardens,” he said. “We negotiate hard on the strength of our track record of delivery. It helps because we’re getting falsely inflated land prices and the big institutional investors want people who can deliver on the ground.”
Brooks said that rapidly inflating land prices combined with a difficult construction market to make the economics of new development look tough. At schemes like the 42-storey, 483-unit Broad Street tower in Birmingham, and at Angel Meadow in Manchester, small sites mean tall buildings. And that means a strictly limited pool of capable contractors, a pool that shrank when Carillion went bust.
“A lot of the contractors retreated to London after the recession, and by default there’s probably now just three contractors in the regions who have the capacity to do towers. They know there is no competition in the tendering process, so to an extent they can have you over a barrel,” Brooks said.
Behind these concerns are the more technical problems of BTR valuation. In the regions, BTR valuations on the basis of vacant possession can slash 15% off value, Brooks said, compared with a valuation protocol based on rents and yields of the kind the office market enjoys.
Combine high construction prices and the valuation problem, and rocketing land prices suddenly become a huge issue in BTR input costs.
Rick De Blaby, executive vice chairman of national developer and operator Get Living, shares the concern. Delancey — whose Get Living venture is a partnership between Oxford Properties, Qatari Diar and APG Asset Management — is reported to be signed up for the £1B Middlewood Locks development in Manchester, and now short-listed for Birmingham’s 3,000 unit Wholesale Markets site. It thinks land price is a serious and growing constraint.
“The barrier to entry is finding land at a cost that makes it viable,” De Blaby said. “The financial appraisal of BTR is in single figure yields — you can’t get away from that — and we want to pitch our product at the mid-market. In Manchester and Birmingham annual salaries average about £26,000 a year and that determines the rent we can finally charge. So your revenue expectations are defined ahead of the game, which tells you how much you can afford on build costs and land, and it’s a challenge.”
Pipeline Growing Longer
It is not just the private sector developers who worry about the land prices. The end-purchaser institutions are also concerned.
M&G Real Estate Head of Residential Investment Alex Greaves said land pricing issues are forcing him to sit on his hands. “We bought our Manchester site [the 135-unit Port Street scheme] in 2016 when the pricing was a bit surpressed, and we haven’t been able to buy in the city centre. And we’d love to invest in Birmingham BTR but pricing is the key. We haven’t found the right pricing or partners in either, so we’ve gone to other cities instead.”
Looking at the lively Manchester BTR market, Greaves thinks he’s right not to rush into anything. “It’s a brilliant city to invest into, but this is all about price. We are slow and steady investors and we’ll take our own time. This is a good time for us to pause and if we get surprised by strong rents or returns we might get more aggressive on our pricing for land.”
Notice the might there: this is not something Greaves is expecting or predicting.
But as Greaves points out, land pricing issues are intimately connected to the surge in demand. In both Manchester and Birmingham the development pipeline is growing: in one celebrated case Manchester’s planning committee approved 177 storeys of new residential accommodation in a single short meeting.
“It’s all about the aspirations of existing landowners, and the long list of planning permissions effects pricing," Greaves said. "But we can’t pay those prices — we are constrained by the need to provide affordable housing. Manchester is unusual, there is so much development in one space — and that is 100% a good reason for making sure the pricing is appropriate before going ahead, because how do you underwrite the scheme, how do you make your rental assumptions, when your entry fee to the market is huge relative to other cities?”
Get Living's De Blaby takes the same view, but with some important qualifications. Looking for 7 to 8 acre sites — scarce in any city — exposes Delancey to even great pricing risks. “We looked at Manchester carefully, we did our homework, there is a perception that there is quite a lot of supply and you could be cautious about that," he said. "On the other side of the picture, Manchester is growing fast and not delivering on its housing targets and has a wealth of really strong employers moving into the city of the kind whose staff would rent our homes. But BTR is still experimenting, and making mistakes, and at the moment it is about stealing market share from the existing rental providers. And all of that is an advantage.”
But Focus On The Horizon, Not Your Feet
So, is it time to worry? British Property Federation Director of Policy Ian Fletcher thinks not. He says that the in-the-wild experiment now underway in Manchester, and gathering pace in Birmingham, will produce a range of stock, and the market will quickly sort the long-term wins from the fails.
“There is clearly a balancing act going on, for supply, and the variety of products of difference styles in various locations,” Fletcher said.
“Developers are not just taking a punt, but undoubtedly there will be winners and losers. There are some who are not comfortable being pioneers. For others trying to find opportunities in this market it is still a challenge. And any market can reach the point where it could become saturated.”
Fletcher dismisses gloomy talk that a large proportion of the pipeline will not get built, but speculates that it will be interesting to see how much falls by the wayside. “Today about 10% of projects drop off our database — and it would be good to know why, was it finance, was it planning?”
In the end, market-makers and investors need to keep their eyes fixed on the distant, long-range future, LGIM Real Assets BTR Fund Manager Dan Batterton said. In that context these local, short-term issues fade away.
“We’re working towards a portfolio which by 2022 will be more than 10,000 units. We’ve 6,000 units in the pipeline now, but we’ll still be less than 1% of the rental supply in our markets, and that seems about sensible,” Batterton said. “Just 8-9% of all housing starts in the U.K. are institutionally-backed BTR.”
Tight margins are OK, in fact, they are expected. “We’re not investing for capital growth. We’re interested in long-term certainty,” Batterton said. “If you look at the land issues, planning consents, selecting contractors — from start to finish BTR developments are a three-four year process so with all the will in the world it takes a long time to get momentum going. We started in 2015 and it's only now that we’re getting that momentum.”
Above all Batterton confesses there is still so much more to learn about potential buyers, about amenity levels, about tenant loyalty and about branding. Next week we look at those issues and ask if the war for amenity will determine who wins, and who loses, in U.K. BTR.