BTR new entrants align megatrends and social value with interest rate hedge

A swathe of new entrants have flocked to the build-to-rent (BTS) sector since the onset of the pandemic, as more institutional capital aligns major investment bets with long-term megatrends and societal value.  But rather than the new players creating a crowded field, the new capital will provide opportunities for scale and specialisation for long-term BTR developers and operators.

The UK’s build-to-rent (BTS) is on the verge of a rapid expansion over the coming decade. It is supported by the nation’s decades-long housing shortage, rising household income, a growing preference for renting for longer and the pandemic-fuelled popularity of service and community-oriented living.  New entrants are eying a piece of the market while seeking alternative profit centres to insulate against the prospect of slowing demand in core business lines.

Consider the most notable new players in recent months; Lloyds Bank, a traditional clearing bank, and John Lewis, one of the UK’s oldest department stores. In July, Lloyds Bank announced its entry into the private rental market, aiming to buy more than 1,000 residential properties by the end of next year. To bolster its inexperience in tenant management, Lloyds has partnered with Barratt Developments and will work on a site-by-site basis. Lloyds’ pivot is sensible. The banking sector has endured more than a decade of low-interest rates, which has affected loan profitability for the whole industry. This is part of the BTR sector’s core investment appeal; growth prospects are aligned to low-interest rates and therefore provides a hedge against continued rates. By comparison, John Lewis announced larger-scale plans to move into the residential property market in the second quarter by building 10,000 homes for rental over the next few years. The headwinds faced by high street retailers are widely understood; the conversation of retail space to demand-supported BTR must be compelling; the sector offers a hedge against e-commerce megatrends, disrupting high street retail.

For both companies and many others BTR new entrants soon to follow, the BTR reinvention is a diversification play. The investment thesis aligns long-term structural megatrends (e.g., demographics, sustainability and technology) with significant societal challenges (e.g., the UK’s decades-long housing shortage). But more than that, the foray into the BTR sector creates a new risk-averse business model anchored by corporate ESG requirements and social value – both of which are long-term cornerstone priorities for institutional investors. This is, perhaps, clear regarding ESG requirements but less so in what is meant by social value. The role of ESG in investment decision-making is already ubiquitous across all real estate investments. ESG is now a prerequisite for raising investor capital, meeting increased regulation and, not least, residents’ expectations. By contrast, the purpose of creating social value resonates more specifically with the BTR sector.

Creating social value

BTR can create social value in at least two ways. First, at the national policy level, in the delivery of modern housing stock across the UK’s cities and towns to address the national supply shortage and replace legacy housing stock, ill-suited to contemporary requirements. Second, by improving the daily lives of residents and keeping pace with their changing needs. As we emerge from lockdown, priorities have shifted, with a greater emphasis on public health and well-being, as well as work-life balance and convenience. Examples of integrated retail, leisure, food and services within BTR schemes include health and beauty centres, gyms, yoga, medical clinics, health food stores, nurseries, language schools, and cafes and restaurants. These ‘real estate as a service’ features run alongside transportation links, proximity to open green spaces, sustainable design, and affordable rents. These features improve residents’ quality of life and contribute to a broader urban regeneration, often in historic locations. Grainger, L&G, M&G and Hines, are all examples of long-term BTR developers and operators which have successfully aligned corporate ESG requirements and social value in their BTR investment strategies.

At the investment level, BTR offers high risk-adjusted returns relative to other asset classes. Investors expect rental growth will be supported by rising household income and stable demand outstripping falling supply as institutional landlords replace buy-to-rent owners over the long term. BTR also offers new entrants an opportunity to cross-sell products from its core business and, in some cases, revitalise demand.  While Lloyds will try to sell home insurance and rental deposit loans, John Lewis is expected to build BTR schemes in redeveloped department store car parks and above Waitrose supermarkets or next to distribution centres. John Lewis can efficiently cross-sell furniture, homeware and groceries.

No doubt, more new entrants will flock to the BTR sector over the coming years, but this trend need not concern existing players. It will represent opportunities for strategic partnerships and a greater development scale as the new capital, and BTR expertise align. In particular, US private equity capital is expected to increase its sector presence. Over time,  niches are also likely, such as the increased provision of single-family and single-occupant BTR units, suburban schemes and co-living.

To some extent, the pandemic has prompted a re-evaluation of what people want from where they live. It has reinforced the trend towards locality, work-life balance, demand for green spaces and gardens, and convenience. These spaces help to encourage resident socialising and community integration. Understanding of these requirements is shaping new entrants’ business models, which flows through to scheme design. BTR demand will increase in the years ahead, while in the near term, the removal of lockdown restrictions, together with the continued vaccine roll-out and easing of travel restrictions, will likely see a flurry of activity as 2021 concludes. Some even suggest the UK could be on the brink of a second consecutive record year for transaction volumes. Watch this space.

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