Sector - the rise of Generation Rent Ownership of purpose built and professionally managed residential property developments Investment Case KPMG Investment Advisory Real Assets Research August 2018
Executive summary KPMG Investment Advisory View What is it? What are the advantages? We view PRS as an attractive opportunity for generating net returns of Gilts+2-4% p.a. primarily through stable contractual income. Large and growing supply-demand imbalances in the UK residential property market coupled with high housing prices are the main drivers of the opportunity. Investment involves a heavy reliance on manager skill, political risks and some geographical concentration. Ownership of residential property developments to cater for long-term rental tenants. Developments are purpose built, professionally managed and designed to take advantage of economies of scale. Approaches range from either high end accommodation targeted at young professionals to more affordable housing with an increased social aspect. Returns are driven primarily by rental income and expected rental increases. Attractive Yield and Income Focus - Contractual income distributed during both the construction and operational phases is expected to form a significant proportion of total returns. Long Term Opportunity Market supply and demand imbalance expected to remain for sometime. Diversification Historically low correlation of returns relative to both commercial property and traditional asset classes. Clients should only consider allocations if they are comfortable with the level of risk, illiquidity and transaction costs in the asset class. Target net returns: Gilts + 2-4% p.a. Fund structure: Open ended or closed ended. Indicative fees: 1%p.a. (AMC), no performance fees. How does it fit in? Cashflow Driven Strategy Given the risk/return profile, and strong income focus, PRS is a suitable building block for CDI. Commercial Property Complement or Replacement The diversification benefits provided by PRS, combined with the muted outlook for balanced commercial property, make it an attractive substitute for traditional property exposure. ESG Some funds have a strong social focus which provides alignment with clients looking for investments with a positive ESG impact. Reduction Many asset classes are currently trading at relatively high valuations. PRS could be a risk reduction trade if investors can afford the illiquidity. What are the key risks? Excessive Vacancy - Uncertainty around resident take-up of developments is a risk. Vacancy rates could increase depending on market cycle. Political/Regulatory Reliance on free market rental pricing which could change via government policy. Additionally, external political shocks such as Brexit could have a negative impact. Construction - Assets are not immediately operational with time taken to deploy capital and develop sites, carrying the risk of potential time and cost overrun or constructor default. Illiquidity Assets cannot be easily sold on the secondary market, however, offer greater liquidity than many private markets.
Private Rented Sector What is it? Ownership of residential property developments to cater for long-term rental tenants. Returns are driven primarily by current rental income and future expected rental increases. Investor access via pooled investment funds, typical characteristics are: Structure: Open ended AuM: c. 500m - 1b Geographical focus: Large UK cities with London and South East bias Asset Concentration: 30-50 assets Leverage: 0-30% ESG: Focus on positive social impact Case Study Location Purchase Price 71.4m Units Development Future potential Zone 4 in East London 206 Units made up of one, two and three bed lots Constructed for purpose by private developer Designated as a new housing zone and situated in major regeneration area Close to mainline train station Transport links 6 minutes journey time to Canary Wharf 16 minutes to City of London Geographic Allocation of Example Fund Onsite manager to enhance customer offering Amenities Landscaped gardens Residents lounge Onsite gym Net yield 3.8% p.a. income during construction 5% p.a. during operation 14% 8% 27% Greater London South East North West South West Rental growth assumption 3.8% p.a. 52% 3
The market opportunity Large and growing supply-demand imbalances in the UK residential market coupled with high housing prices are the main drivers of the opportunity. Strong UK population growth, a rising proportion of private renters, low quality private rental stock and a historical lack of institutional investment provides further market support. This has created a void in the market that asset managers are well positioned to take advantage of, with institutional investors such as pension schemes able to invest. Increasing government pressure on private buy to let landlords (e.g. increased taxes on second homes) is reducing the amount of private stock available. Residential rental market has begun to institutionalise in recent years. There is significant scope for a continuation of this given the total market size and the UK lagging the US and Europe in this respect. House prices are elevated driven by a large and growing supply/demand imbalance First time buyer affordability at an all time low. Demand for Institutional Ownership Often young adults have experienced high quality student accommodation and expect a similar standard after university. Commonly the private buy to let market stock is not up to standard, with quality lacking. More people are renting, and for longer, with a reduction in the negative connotations historically associated with renting. Robust UK population growth, 5th strongest in Europe, particularly amongst 24-35 year olds who often rent. These trends are expected to continue. 4
Key risks There are a number of risks that clients should be familiar with and gain comfort from before considering an investment into the asset class. Key risks are: Excessive vacancy Political/regulatory risk Constructor default or overrun Uncertainty around resident take-up is a risk as developments are not pre-let and with rental contracts typically 1-3 years. Tenant diversification helps to manage this risk, as does the inclusion of appealing building amenities e.g. onsite gym, and concierge and laundry services Excessive Vacancy Political/ regulatory risk There is a reliance on free market rental pricing and a lack of a competitive product which could change via government policy. Additionally, external political shocks, such as Brexit, could have a negative impact. Within the UK, portfolios are increasingly diversified away from the South East and by tenant in order to help manage these risks. Illiquidity of assets Developing assets includes the risk of constructor default, project overruns, and unexpected increases in costs, amongst others. Construction Typically, projects have planning permission granted with construction overrun contracted away from investors to constructors. Contracts allow for the constructor replacement should a default occur. Illiquidity Underlying assets cannot be easily sold and there is potential for liquidity to be restricted, and capital values impaired, in times of market stress. PRS is more liquid than commercial property with managers able to sell individual units if required. This is reflected in more generous fund terms than many other private markets. Leverage Most developments are in London and the South East resulting in a microeconomic risk related to this area. There are an increasing number of developments in regional UK cities and increasingly diversified portfolios. Geographic Concentration Some investments are levered in order to enhance returns. Leverage is prudent and only applied once the assets are operating. 5
Stuart Pawson Head of Real Assets Investment Advisory Tel: +44 0121 232 3502 stuart.pawson@kpmg.co.uk Andrew Singh Executive Consultant Investment Advisory Tel: +44 0131 451 7749 andrew.singh@kpmg.co.uk David Barlow Consultant Investment Advisory Tel: +44 0141 300 5634 david.barlow@kpmg.co.uk kpmg.com/uk The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. The KPMG name and logo are registered trademarks or trademarks of KPMG International. CREATE: CRT101132A