UK residential investment Assessing the market fundamentals supporting the UK Build-to-Rent sector

UK residential investment Assessing the market fundamentals supporting the UK Build-to-Rent sector The document is intended for Professional Clients only in Continental Europe, Dubai and the UK; for Qualified Investors in Switzerland; for Institutional Investors in the United States, Australia and Singapore; and for Professional Investors only in Hong Kong and in Japan as defined under the Financial Instruments and Exchange Law of Japan. In Canada, this document is intended only for accredited investors as defined under National Instrument 45 106. It is not intended for and should not be distributed to, or relied upon, by the public or retail investors. Please do not redistribute this document. Despite the UK voting for Brexit on 23 June 2016, the underlying market fundamentals that have been driving the potential opportunities in the UK Buildto-Rent sector (also known as the Private Rented Sector) continue to remain sound, in Invesco Real Estate s view. The case for investing in the UK Build-to-Rent ( BtR ) sector is underpinned by a number of key factors, which include the supply/demand imbalance in UK housing; the population growth forecasts for the UK (which is impacted by immigration); the change in household tenure driven by affordability and choice; and the growing institutional demand for the investment opportunity. This paper looks at these market fundamentals, which continue to drive the potential investment opportunity in this sector, while assessing the implications of the Brexit vote and how it may impact the UK s BtR sector. John German, Senior Director, Residential Investments, Invesco Real Estate Focus on market fundamentals, not market sentiment Invesco Real Estate (IRE) believes that BtR remains an investment opportunity with positive attributes that have not changed following the Brexit vote. In our view, it is the market fundamentals underlying the sector, as opposed to market sentiment, which is driving the opportunities for institutional investors. These fundamentals include: UK housing supply/demand imbalance There is no reason to believe this imbalance will change as a result of Brexit; in fact, IRE believes it could increase. The share prices of listed house builders dropped significantly following the Brexit vote which, if sustained, could make it difficult for these builders to create new supply. UK population growth The UK has among the highest population growth in Europe and London is roughly double that of the rest of the UK. Approximately 35% of London s population are not nationals, of which only 10% are from the EU27 1. Brexit is unlikely to have a significant impact on London s population growth or demographics. Falling home ownership and an increase in the rental sector The uncertainty caused by Brexit is likely to increase demand for the rental market as some potential buyers hold off until there is greater certainty. Growing institutional demand The UK residential market is made up of a diverse universe of sub-sectors of which the Private Rented Sector ( PRS ), which IRE believes currently offers some potentially attractive opportunities for institutions, has an estimated value of 1.16tn 2. 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 institutional investors, 38 of these owned c. 15.4bn in the UK PRS with an average holding of c. 428m at the time of the survey in May 2015. IRE believes that the UK PRS continues to have sufficient scale, transparency and return profiles to be of potential interest to institutional investors. 01 Assessing the market fundamentals

Looking at the fundamentals more closely: UK Residential market: the scales of opportunity Today, the UK is facing a demand and supply imbalance in its housing market (Figure 1). 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 198,000) 3, owner occupation has become less affordable, making many people turn to the rental market. The greatest pressure on affordability is in Greater London, which potentially provides the strongest opportunity for institutional investors. However, current uncertainty post the Brexit vote may create investment opportunities. The market uncertainty may impact on pricing over the coming quarters and IRE is keeping an open mind as to investment opportunities in what remains a fundamentally sound real estate sector, in our view. UK housing supply/demand imbalance Looking at the UK housing market, the supply/demand projections for both the United Kingdom and Greater London, suggests that there will be an under supply of new housing, both in the capital and nationally (Figure 2). Figure 1 Scales of opportunity The supply/demand imbalance in the UK Residential market 100,000 too few new houses built each year Supply There will be a 1.1m deficit by 2020 198k Average house price +4% p.a. Population growth amongst 24-34 year olds 34 Average age of first time buyer Demand More people now rent than own increasing by 0.2% pa* Out of a 1.16tn market less than 5% is institutionally owned Sources: Moody s analytics, Department for Communities and Local Government (DCLG), 1981 to 2015. Latest available data as of 31 March 2016. Figure 2 New homes delivery shortfall 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 New homes built Household formation Cumulative shortfall 2015E Household/units 2020E Since the Brexit announcement, UK house builders and bank stocks have seen amongst the largest falls in values. Our viewpoint is that the fall in house builders shares is being driven down by the fact that there may be a slowdown in house price growth in the UK and this could have a negative impact on house builder profits. This suggests that many house builders will seek to re-trench as they did following the Global Financial Crisis, which will likely lead to a slowdown in housing construction and a reduction in the amount of speculative development that they undertake. Cumulative under-supply expected to be c.1.1 million homes by 2020 1,124,949 666,582 572,517 1,200,000 1,000,000 800,000 600,000 400,000 200,000 The overall impact of a reduction in new construction will be to further increase the pressure on UK housing supply and so the under supply, as shown above, will not be reduced and indeed may increase. Source: DCLG, Welsh Assembly Government, National Records of Scotland, NISRA and DCLG. Latest data available, June 2016. E = estimate. IRE has seen that both listed and unlisted house builders have already reacted to the slowdown in the London housing market and also recognised the importance of the BtR market opportunity by offering projects for BtR investors. The reduction in construction of for sale product is likely to see more BtR opportunities being offered as house builders seek to maintain cashflow. 02 Assessing the market fundamentals

Population growth The UK has one of the fastest growing populations in Europe (Figure 3). This has contributed to the shortage of housing in the UK as outlined previously. From 1990 to 2015, the UK population grew by 7.82m (12.1%) but in London the growth was 1.82m (21.2%) over the same period. Forecasts to 2031 suggest the UK will grow by 6.60m (9.2%) and 1.22m (12.4%) in London over the same period. Over the last 11 years, the UK population (including non-uk nationals) has risen from 58.9m to 63.4m, an increase of 4.5m (7.03%) as shown in Figure 4 opposite. In Greater London, EU27 nationals account for c.10% of the population, but it should be noted that nationals from the Rest of the World account for c.26% of the London population (Figure 5). In addition, the EU27 nationals only account for 4.3% of the UK population whilst those from the Rest of the World account for 8.1%. This 4.3% of the UK population accounts for c.2.1m. Of this about 800,000 are from Poland, 358,000 from Ireland and 300,000 from Germany. It has been suggested that all EU citizens living and working in the UK may have acquired rights to stay under the 1969 Vienna Convention. At present the only suggestions of population/job movements have been in the financial sectors. It has been suggested that up to 100,000 jobs across the UK may move, but this has not yet been confirmed and may occur gradually, if at all. In our view, the impact of inward migration is important for the UK, but in the event that border controls are introduced, the c.5.1m nationals from the Rest of the World will not be impacted (based on current policy suggestions) and the possibility of a Norwegian or Swiss style trade agreement could mean full freedom on inward migration from the EU. Figure 3 UK population growth One of the fastest growing in Europe 90 57.2 91 92 93 94 95 96 97 98 Source: DCLG, Welsh Assembly Government, National Records of Scotland, NISRA and DCLG. Latest data available, June 2016. E = estimate. Figure 4 UK population growth Breakdown of nationals 2004 58.9 2005 2006 59.3 59.7 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 21E 2007 2008 2009 2010 2011 2012 2013 2014 60.3 60.7 61.2 Source: DCLG, Welsh Assembly Government, National Records of Scotland, NISRA and DCLG. Latest data available, June 2016. E = estimate. 61.7 UK EU27 62.2 62.7 65.1 67.8 31E 71.7 80 75 70 65 60 55 Asia Rest of the World 62.9 63.4 000 s 66 64 62 60 58 56 54 52 50 If this is the case then the population growth should be broadly be in line with the forecasts as shown above and the pressure will continue on the UK housing market. The prospect of finance jobs moving from the UK still remains, but the strategy of targeting locations which attract more mainstream workers means that this is not expected to impact the target investments. Figure 5 UK population growth Non-UK nationals Total North East North West Yorks & Humber East Midlands West Midlands East London 35.7 South East South West England Wales % EU Nationals % Rest of the World Scotland Northen Ireland % 40 30 12.4 4.8 8.0 8.4 9.4 10.9 10.4 11.5 7.7 13.7 5.3 6.6 5.9 20 10 Source: DCLG, Welsh Assembly Government, National Records of Scotland, NISRA and DCLG. Latest data available, June 2016. E = estimate. 03 Assessing the market fundamentals

Homeownership affordability The UK has historically been a market dominated by homeownership. According to the Nationwide Building Society as of March 2016, since 2007, average house prices across the UK have risen by 5.5% relative to the 2007 peak. The continued growth over the last eight years has led to affordability constraints amongst those who are looking to buy their own home. The house price to earnings ratio (the ratio of house prices to mean gross earnings) suggests that in London to buy the average house, the average earner will pay over 10 times their annual gross earnings (over 100% above the long-run average) and across the UK the same measure suggests the multiple is over five times (about 45% above the long-run average), see Figure 6. Figure 6 Is owner occupation affordable? London London average UK UK average House price to earnings ratio 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 London: 100% above the long run average UK: 45% above the long run average 12 10 8 6 4 2 The combination of renting as a lifestyle choice and the growing affordability constraints have meant that many wouldbe buyers are moving into the rental sector as they cannot afford to buy. Within London from 2003/4 to 2013/14 the percentage of those renting rose from 13.6% of all households to 29.6%. Over the same period those renting in England rose from 8.7% to 17.5% of all households 4. Source: Nationwide as of March 2016. Figure 7 UK housing tenure UK housing tenure 25-34 year olds 04-05 05-06 06-07 07-08 08-09 09-10 10-11 11-12 12-13 13-14 Owner occupied Social rented Private rented 14-15 2025F % In considering the preferred target tenant base for the BtR sector, the 25 to 35 year olds, the change in ownership has been even more marked. Over the same period, the number of households renting rose from 21.4% to 46% as shown in the graph below. PWC also undertook a forecast of the tenure in this age group as at 2025. This suggested that 66% of all 25 to 35 year olds would be in the rental sector at that date (see Figure 7). 58.6% 20.0% 21.4% 34% 20% 46% 21% 13% 66% 100 80 60 40 20 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. 04 Assessing the market fundamentals

Rental growth still expected A recent study for the National Association of Estate Agents and the Association of Residential Letting Agents (April 2016) by the Centre for Economics and Business Research stated that The impact of a Brexit on the rental market would be minimal in the first 2-3 years following the referendum. Rental prices are primarily determined by the supply of and demand for rental property and the impact of Brexit on both would be insignificant in the short term. In the case of a Brexit we expect year-on-year growth in the private rental market of 5.9% in 2016, 3.4% in 2017 and 4.4% in 2018. IRE s investment strategy In light of the Brexit vote, IRE s strategy for BtR investments remains unchanged: Taking no direct planning risk and de-risking the development period; Focusing on supply constrained locations; Focusing on strong rental markets; Diversified mainstream markets with good local infrastructure; and Purpose built for rental. In our view, the immediate and short-term impact of the EU referendum result is expected to be widespread uncertainty amongst buyers and sellers across the housing market. We believe buyers will adopt a wait-and-see approach to assess the short-term impact on financial markets, the economy at large and the outlook for personal finances. This may result in deferring buying decisions on a move into rental premises. Despite this, the reality is that the fundamentals of the housing market remain unchanged with record low mortgage rates and a wide imbalance between supply and demand. The UK doesn t have a problem with housing demand; the more important question is how many buyers and sellers feel confident to participate in the market in the near term? Current suggestions are that there may be a slowdown in the rise in UK house prices and in some markets (London in particular) values may stall. IRE s preferred target markets of zones 3-6 ( 300-600 per sq. ft.) in London, South East commuter towns and strong gateway cities with diversified employment bases are more resilient to a slowdown and are not likely to be heavily impacted even if there are a number of staffing reductions in the financial and business services sectors in London. The opportunity for institutional investors 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. 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 5 ; Its low correlation with other UK real estate sectors 6 ; 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 7 ; 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 and storage, for example); and Facilitate exit, if required. However, at this stage, it will be difficult to quantify actual impacts on rental outlook given the uncertainty currently faced around the moving parts of the UK s extrication from the EU. What is certain is that the short term is going to contain many bumps in the road, as we have seen from early FX rates and shifts in the stock market. 05 Assessing the market fundamentals

Contact us Simon Redman Managing Director Client Portfolio Management Telephone: +44 (0) 207 543 3584 Email: simon.redman@invesco.com Robert Stolfo Managing Director Client Portfolio Management Telephone: +49 89 20 60 61 17 Email: Robert.stolfo@invesco.com Andrew Hills Senior Director Client Portfolio Management Telephone: +44 (0) 207 543 3561 Email: Andrew.hills@invesco.com Sebastien Daguenet Associate Director Client Portfolio Management Telephone: +33 1 56 62 43 29 Email: Sebastien.daguenet@invesco.com Important information The document is intended for Professional Clients only in Continental Europe, Dubai and the UK; for Qualified Investors in Switzerland; for Institutional Investors in the United States, Australia and Singapore; and for Professional Investors only in Hong Kong and in Japan as defined under the Financial Instruments and Exchange Law of Japan. In Canada, this document is intended only for accredited investors as defined under National Instrument 45 106. It is not intended for and should not be distributed to, or relied upon, by the public or retail investors. Please do not redistribute this document. 1 Oxford Economics, Q4 2013. Annual Population Survey, ONS as of January 2014. 2 Department for Communities and Local Government (DCLG), June 2015. Latest available data. 3 Nationwide, March 2016 4 2003-04 to 2007-08 English House Condition Survey; 2008-09 onwards: English Housing Survey, full household sample. Data as at October 2014. Latest available data. 5 MSCI, Macrobond, INREV and IRE as of March 2016, latest available data, 2001-2015. 6 MSCI and Macrobond as of December 2015, latest available data, 14 years to December 2015 (2001-2015). 7 MSCI, Macrobond, INREV and IRE as of March 2016, latest available data (2001-2015). Where Invesco Real Estate has expressed views and opinions, these are based on current market conditions and these may change without notice. Past performance is not a guide to future returns. The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. The value of property is generally a matter of an independent valuer s opinion. Property and land can be difficult to sell, so investors may not be able to sell such investments when they want to. Forecasts are not reliable indicators of future performance. This document does not form part of any prospectus. It contains general information only and does not take into account individual objectives, taxation position or individual financial needs. It does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Nor does it constitute an offer or solicitation by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation. 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