UK residential investment
Why consider investing in the UK residential market?
H1 2016
Whitepaper
This document is for Professional Clients in
the UK, and is not for consumer use. Please
do not redistribute this document.
Institutional investors have traditionally perceived the residential sector as a specialist real
estate asset class, and perhaps have not fully appreciated the potential benefits it may add
to an investment portfolio. This paper looks at why institutions should consider investing in
the UK residential market, where Invesco Real Estate (IRE) believes the opportunities are
currently and whether institutions require specialist knowledge to access the sector.
The UK residential market is made up of a diverse universe of sub-sectors. However, IRE
believes the UK Private Rented Sector (PRS), a sub-sector with an estimated value of
£1.16tn1, is one which currently offers potentially attractive opportunities for institutions.
John German
Senior Director
Residential Investments
UK residential market: The scales of opportunity
Residential markets are typically impacted by two variables: population growth and the
supply of new homes (see Figure 1).
Figure 1
The scales of opportunity:
The supply/demand imbalance in today’s UK residential market
+4% p.a.
100,000
too few new
houses built
each year
There
will be a
1.1m
Population growth
amongst 24-34
year olds
2020
£198k
Supply
Average
house
price
More people
now rent than
own increasing
by 0.2% p.a.
34
Average
age of first
time buyer
Demand
Sources: Moody’s analytics, Department for Communities and Local Government (DCLG), 1981 to 2015.
Nationwide, January 2016 (average house price). Latest available data as at 31 January 2016.
Out of a
£1.16tn
PRS less than
5% is
institutionally
owned
Today, the UK is facing a demand and supply imbalance in its housing market. Demand
for housing is under pressure with an increasing population, which is one of the highest in
the EU, and with house prices rising, (the average house price being £198,0002), owner
occupation has become less affordable, making many people to turn to the rental market.
The greatest pressure on affordability is in Greater London, which potentially provides the
strongest opportunity for institutional investors (see Figure 2).
2016
2013
2010
2007
LondonUK
London Average UK Average
2004
2001
1998
1995
1992
1989
1986
1983
Figure 2
Owner occupation has become less affordable
House price to earnings ratio
95% above the 12.0
long run average
10.0
8.0
6.0
45% above the
long run average
4.0
2.0
Source: Nationwide as of January 2016.
Coupled with the fact that about 100,000 too few houses are being built annually across
the UK, this suggests that the UK is potentially facing a 1.1m housing deficit by 2020, if
supply isn’t increased from current levels (see Figure 3).
IRE believes the current opportunity lies in developing intelligently-designed rental
accommodation, which will be professionally managed and seeks to meet the needs of
this growing population who need to rent. With growing institutional investment funding
developments of scale, in proven letting markets, which will offer high quality buildings,
we believe that this could revitalise the rental market in the UK and significantly help
address the country’s housing crisis.
From an investment perspective, the sector potentially offers the opportunity to match
liabilities, through income streams, which provide a correlation to inflation; potential
diversification within multi-asset portfolios; as well as the potential for total return, all
attributes important to institutions.
2020E
Cumulative Shortfall
2015E
2014
2013
Household Formation
2012
2011
2010
2008
2007
2006
2005
2004
2003
2002
2001
2000
2009
New Homes Built
Figure 3
New homes delivery shortfall in the UK
1,124,949
Cumulative under-supply expected
to be c.1.1 million homes by 2020
666,582
572,517
Household
/units
1,200,000
1,000,000
800,000
600,000
400,000
200,000
Source: Welsh Assembly Government, National Records of Scotland, NISRA and DCLG as at March 2015. E = estimate.
Lessons from the US
An integral part of the opportunity is to provide modern rental accommodation for the
next generation, which is in low supply. Research shows that 48% of the current PRS
housing stock in the UK was built before 1945, with only 18% built in the last 25 years3.
There is therefore an opportunity to kick-start a process that began in the US some 30
years ago and which has grown into that country’s huge multifamily sector of today.
In considering the UK PRS as an asset class, an initial comparison with the multi-family
rental market in the US, which is now a well established institutional investment class,
provides a useful guide.
IRE has analysed the UK IPD Residential Index (“UK Index”) and the US NCREIF Index
(“US Index”), which measure the market value of institutionally owned residential
investments in these respective countries.
Figure 4 shows that in 1982 the UK Index amounted to £15.6m and the US Index was
£88.4m. However, by 2014, the UK market had grown to £5.8bn, whilst the US market
had increased to £62.2bn.
The US Index has remained at or around ten times larger than the UK Index over this
timeframe. Given that the US population is circa five times that of the UK, the UK
Index is significantly under represented. This suggests that there is an opportunity for
institutions to increase their exposure to the UK residential sector.
A further factor to consider is the historic performance of the UK Index. Analysis of
the UK and US indices shows that from 1982 to 2014, the UK Index had average
returns of 13.9% per annum, whilst over the same period the US Index has delivered
9.5% per annum. Over this period, the UK outperformed the US in 22 of the 33 years4.
2014
2013
62.2
2012
54.9
2011
Market
value
(£ bn)
70
60
50
38.2
35.7
50.2
2010
45.6
2009
2008
2007
32.4
40
30
Source: Investment Property Databank (IPD)/National Council of Real Estate Investment Fiduciaries (NCREIF) as at July 2015.
5.8
4.8
4.1
3.9
3.1
2.7
2.6
3.0
20
2.4
4.2
0.3
4.9
0.4
6.0
0.5
6.7
0.7
8.3
0.8
10.8
0.9
12.9
1.3
14.6
1.8
15.9
1.8
17.6
2.0
23.6
2.2
UK IPD Residential Index Value
45.8
2006
43.7
2005
2004
2003
2002
2001
2000
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1999
US NCREIF Apartment Index Value
Figure 4
NCREIF and UK IPD Index values
Both indices have seen rapid expansion
10
IPD UK Residential
IPD All UK Property
Equities (FTSE All Share)
Gilts
Core Funds
Value Add Funds
3 Year
15 Year
5 Year
10 Year
%
10.7%
10.0
5.2%
6.4%
6.3%
3.8%
3.0%
6.4%
8.0
7.9%
8.1%
6.6%
6.4%
4.4%
7.4%
10.0%
11.0%
12.0
8.9%
11.13%
9.9%
11.8%
7.9%
11.9%
14.0
13.4%
12.6%
16.0
11.0%
6.0
4.0
2.0
Sources: IPD, Macrobond and IRE as of December 2014, latest available data. Total
return, annualised, in sterling. Core and Value Fund data from INREV. Past performance
is not a guide to future returns.
Size and growth of the UK PRS market
Relative to the IPD All UK Property Index, the UK PRS market is materially larger.
The estimated value of the PRS is about £1.16tn compared to £187bn in the IPD All
Property Index (Figure 6). The bulk of this market is held by private investors who have
a small number of units, typically on a buy-to-let basis. Based on the 2015 Investment
Property Forum (IPF) survey of 47 UK institutional investors, 38 of the investors owned
a total of £15.4bn in the UK PRS with an average holding value of circa £428m at the
time of the survey in May 2015.
FTSE All
Share Index
UK PRS
IPD All UK
Property
IPD UK
Retail
IPD UK
Office
IPD UK
Industrial
Figure 6
UK’s largest real estate market sector
Student
Housing 6
UK residential has been a long-term
outperformer against traditional commercial
real estate in the UK (office, retail) and
has outperformed gilts and the IPD All UK
Property Index over all periods measured
and UK equities over longer periods
(5/10/15 years) (see Figure 5).
Figure 5
UK residential – a long-term outperformer
Serviced
Apartments 6
And what about performance against
other real estate sectors?
An investment in residential is an investment
not only into a property market that is
recognised globally, but also into a strategic
market sector, which has been less volatile
than other more “traditional” real estate5.
£1,964
Market
size
(£ bn)
£2,400
£2,000
£1,160
£1,600
£1,200
£800
£14
£20
£30
£51
£82
£187
£400
Source: DCLG, IPD, Savills, IRE as of June 2015.
The level of institutional transactions in UK PRS, for the 12 months to the end of Q4
2015, amounted to circa £6bn7. This activity is from a wide variety of investors, with
76% of these transactions being made by cross-border investors.
IRE believes that the UK PRS has sufficient scale, transparency and return profiles to
be of potential interest to institutional investors. According to the 2014-2015 English
Housing Survey, the number of households in UK PRS properties fell by 100,000 to
19.0% of all UK households (see Figure 7), making it the second largest tenure in the
UK next to owner occupation (63.6%). Over the last 10 years, the number of households
renting in the UK has risen by 38.5%, whilst the number of owner occupiers fell by 11.1%.
This fast growing tenure is seen by many households as the sector of choice.
Case study: The London PRS market
In IRE’s view, London, with its strong economic growth and its position as a global
leading financial centre is uniquely positioned for growth. While other regions in the
UK have established PRS markets, London and the South East have the largest PRS
markets and greatest supply/demand imbalance.
In London, for example, population increased by 14% (1 million) over the last decade,
double the rate of change of the rest of the UK. The Greater London Authority (GLA)
forecasts this growth will continue at the same pace, rising in 2021 to 9.2m and up to
9.8 million by 20318. Coupled with this, the size of households has decreased due to
changes in family situations and growth in the number of households in London – circa
250,000 per decade since 1981. Research suggests that London PRS is dominated by
smaller units of one-to-two bedroom flats (see Figure 8).
But supply of new homes has not matched this demand. A recent study by the GLA
shows that London suffers from an extreme shortage of housing. Completions have
averaged 24,500 over the last 10 years, against a projected requirement of 42,000
which has created an in-built shortfall of 175,000 homes today. Based on 30,000 new
homes being built annually from 2014 to 2018, the annual shortfall based upon the
maximum number of units required under the London Plan (spatial development plan)
will be about 32,000 homes p.a., which equates to a further 160,000 homes and a total
forecasted shortfall of 335,000 homes by 2018.
Figure 7
Housing tenure
2025f
14-15
13-14
Private Rented
12-13
11-12
09-10
08-09
07-08
Owner Occupied
Social Rented
06-07
05-06
04-05
03-04
UK housing tenure
%
100
21%
34%
80
13%
20%
58.6%
46%
20.0%
90
70
60
50
66%
40
30
20
21.4%
10
Source: 2003-04 to 2007-08: English House Condition Survey; 2008-09 to 2014-15:
English Housing Survey, full household sample. Data as of February 2016.
2025: PWC. f = forecast.
Figure 8
Unit sizes
Five bed
or more
Four bed
Three bed
Two bed
One bed
London’s PRS market: smaller units dominate
Total properties: 850,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
GLA – Housing in London 2014. Latest available data.
Invesco Real Estate’s residential experience
In 2014 IRE completed its first UK residential transaction on behalf of a UK Local
Authority Pension Fund in Hayes, Greater London. The particular attributes of this PRS
property are:
– Purpose-designed PRS block;
– 118 flats, 96 car spaces and 7 commercial units;
–No development or construction risk due to fixed price contract;
–5A1 credit rated developer supplying a Parent Company Guarantee;
–Good location – Suburban Greater London with excellent transport links;
–Generously-sized apartments designed for professional sharers; and
–The building is to be operated under a branded property management platform.
Investment in residential property has formed a key part of IRE’s global business
since 1983. IRE has invested circa US$16bn in 370 direct residential investments
globally across the US, Asia-Pacific and, more recently, concluded its first residential
acquisitions in Europe with six investments in the UK and Germany for c.US$300m9.
Institutional investment in PRS is in its infancy in the UK, which is why IRE believes there
is potential for the PRS market to become highly institutionalised.
Why consider and how to access the UK PRS market
Our research shows that despite rented residential being the fastest growing tenure
and has historically been the highest performing real estate asset class in the UK (see
Figure 5), today under 5% of the UK PRS is owned by institutions10.
We believe this provides potentially attractive opportunities for institutional investors
as it has the potential to act as a diversifier in a balanced real estate or mixed-use
portfolio due to:
– Its track record as the best performing, largest UK real estate sector;
– Its low correlation with other UK real estate sectors11;
– The current supply not meeting housing demand, creating an increasing under supply;
– UK population growth being one of the highest in the EU, creating demand;
– Demand for rental product increasing;
– Historic relative stability of income and capital values(see Figure 5); and
– Its development potential.
We believe that the demand and supply imbalance present in today’s UK housing
market has the potential to lead to positive outperformance and, as such, provides
an opportunity for investment. UK residential, however, does require in our view,
specialist expertise to access and assess opportunities that have the potential to deliver
attractive returns over the longer term.
IRE’s strategy is to continue to:
– Invest in an identified pipeline and acquire further sites in focused locations;
– Aim to create capital value by investing in locations with potential future
demand growth;
– Aim to increase NOI through cost management, maximising rental income and
economies of scale;
– Aim to further increase NOI through additional services (internet, cleaning,
storage...); and
– Facilitate exit, if required.
Our key investment criteria include:
– A recognised location;
– Proven rental market;
– Large scale (more than 100 units); and
– Quality building specification.
Sources
Department for Communities and Local Government (DCLG), June 2015.
Latest available data
2
Nationwide, January 2016
3
English Housing Survey Headline Report 2013/14
4
IPD/NCREIF, July 2015. Total returns in sterling
5
IPD, 20 years to end of 2013. Latest data available 6
Estimated total value of markets based on volume of stock available as of
December 2014
7
Real Capital Analytics, January 2015
8
Oxford Economics, Q4 2013. Latest data available
9
Data as at 30 September 2015
10
2016 ARLA, DCLG, July 2015
11
Total return: IPD and Datastream, 14 years to December 2014. Latest available data
1
Contact us
Important information
Stephen Messenger
Institutional Sales Manager
Telephone 020 7543 3551
[email protected]
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Past performance is not a guide to future returns. Forecasts are not reliable indicators
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