The Daily Telegraph - Business
The property market is expected to remain buoyant even after the stamp duty holiday comes to an end
Investors have been bullish on the sector but they may head for the door as the threat of inflation increases, writes ‘The ability to reset rents more regularly will prove attractive’
Despite a string of lockdowns and Britain’s departure from the EU, the past year has produced a notable rise in one European import to the UK housing market: purpose-built rental blocks.
The properties have been springing up across Britain as investors and construction companies ride the wave of millennials who cannot afford to buy but want a more luxurious place to live than the average rental property.
More than 80,000 build-to-rent dwellings have been constructed since 2010, with another 80,000 planned, according to the British Property Federation.
The sector has proved popular among large investment banks looking to diversify from their traditional diet of office blocks and department stores for property income.
Figures published by BPF show that almost 7,000 new build-to-rent applications won planning permission in the first three months of this year – a quarterly record.
Institutional investors and pension funds including Legal and General Investment Management, Goldman Sachs and Aberdeen Standard have all poured money into the sector in recent years.
However, investors are increasingly concerned about how the build-to-rent market will react to a post-pandemic economic boom and spiralling inflation.
On the one hand, the sector may present something of a hedge against inflation, especially if wages escalate.
One investor says the sector is suitable “for long-term investors that want to manage inflation risk. Rents track wage inflation: as customers’ earning power grows, so does their affordability, allowing rents to grow sustainably”.
Mervyn Howard, executive chairman of investment manager Apache Capital Partners, also believes build-to-rent is a potential winner in a fight against inflation, rather than a victim.
“While real estate as an industry generally is seen as a good hedge against inflation, the ability to reset rents more regularly in residential will prove particularly attractive as you can better capture rental growth as leases are typically renewed on an annual basis compared to a five-yearly-rent view common in commercial property,” he says.
On the flip side, rising material costs in the construction sector present a threat to margins.
While most investors are still publicly bullish, the price of building materials has already jumped 8pc in a year, challenging the parameters some firms regard as a severe downside scenario.
Furthermore, if a landlord has not agreed to rent rises over the course of the tenancy, they could be left exposed to the threat of inflation.
Despite build-to-rent’s strong performance over the previous year, the double-edged sword of inflation – rising costs due to Brexit-related supply issues and a predicted boom in post-pandemic demand – presents a unique challenge to the industry.
Unlike the volume housebuilders that can target “red wall” areas and easily achieve margins of more than 20pc, build-to-rent investments work off lower yields. The area with the largest pipeline is London, where construction costs are higher.
The initial impact of inflation in construction is already being felt, according to Mark Reynolds, chief executive of construction company Mace Group.
He says: “Inevitably a significant increase in inflation and the cost of construction materials will have an impact on the sector, drive up costs and cause some delays.
“So far the impact has been largely limited to the domestic market, but we are beginning to see both housebuilders and major contractors being affected.”
One institutional investor says he will be avoiding the sector in the near future due to difficulties in obtaining planning permission and low rents outside the capital.
While retail and logistics are regarded as good investment opportunities as Covid fades, the low margins of build-to-rent mean some investors are considering leaving the sector behind as optimism about a post-pandemic revival increases. One executive suggests that build to rent could be abandoned by risktakers, but remain suitable for investors seeking a safer bet.
He says: “Build-to-rent is not a sector that will knock the lights out when it comes to returns, compared to other more speculative asset classes. The sector will never be appropriate for the profit-hungry short-term investors, looking to make a quick buck.
“The sector doesn’t make huge returns because it is relatively low risk and low volatility. Just look at the sector’s performance over the past year: a safe haven among some eye-watering losses elsewhere in the commercial property market.” Prospects for build-to-rent may depend on the level of inflation over coming years, and whether costs specifically in the construction sector stay elevated. Howard, whose company recently launched a £1.6bn suburban build-to-rent venture developing single-family homes for rent, says: “It is too early to tell whether the massive fiscal stimulus unleashed by governments in response to the coronavirus pandemic will lead to a more inflationary environment in the short to medium term, with central banks appearing to take a relaxed view for now.
However, it is clear the spectre of high or even moderate inflation – something that many Britons won’t have experienced in their lifetimes
– is concerning investors and markets.”
Meanwhile, Ian Fletcher of the British Property Federation is relatively relaxed about the prospect of inflation and any likely impact on the sector.
“We have a monetary policy regime that targets inflation growth, so overall inflation will not significantly erode the attractiveness of the sector if the monetary policy committee is doing its job,” he says.
“In the short term, construction inflation may erode developer margins, but that is likely to be a temporary phenomenon, driven by temporary factors such as Brexit and the pandemic and it will affect all sectors.”
Irrespective of the Bank’s movements in the coming months, it remains unclear whether build to rent is a passing fad or a permanent fixture in the UK’s housing mix. While there has been no shortage of investors in recent years, many are starting to wobble.
‘It is not a sector that will knock the lights out in returns’
The number of build-to-rent dwellings that have been constructed since 2010, with the same amount in the pipeline