A new entrant to the UK Housing Sector

You would need to have been living under a rock to have missed the arrival of Legal & General on the UK Housing scene. From a position of no involvement in housing, L & G are now set to become one of its biggest players. How has this come about? Because of the housing crisis.

L & G (and others) see the current UK housing market as an opportunity. With a backdrop of strong demand, rising prices and an existing set of housebuilders which are unwilling or unable to ramp up production to meet the demand, this looks like a market that is ripe for disruption.

Instead of going down the normal route for a new entrant to the market, and playing the same game as the uincumbents, L & G are going for broke. They have invested in the largest factory in the UK, bought a Cross-Laminated Timber production line, and just in case you missed the point, are setting up a plant to manufacture CLT to guarantee their source of supply. They are doing nothing by halves.

The plan is to produce and supply 5,000 homes per year, or more from the factory, and to supply all of it using CLT. Thereby adding the same output to the industry as ten additional Barratt divisions, or a Redrow to the housing industry.

They don’t intend to compete directly with the housebuilders, because they are not going to be selling a comparable product at a comparable price. Mostly they will be developing to own and rent their own housing stock.

The interesting elements of this is because much it will remain in their ownership, it is open to investment. The U.K. Housing industry has not been open to investment since we decided that we had to own our own properties. Now that we have accepted that this is both unwise at some stages of our lives, and impossible for many people, there is a clear and undeniable need for long term home rental. A pension fund looks at long term home rental and sees something that it can invest in.

The housebuilders have shareholders too, but their focus is on paying out dividends each year rather than owning assets thta appreciate. Although housebuilders do won assets in the form of land, and it does appreciate, it doesn’t have nearly as much value when traded as it does when it has homes built on it. This makes the housebuilders a poor investment risk compared to rental property. Rental property accrues value and brings in an income every year, so there are two opportunities to make a profit, both in the short term and in the long term.

In Germany, a large proportion of housing supply has pension fund backing. In the UK it is almost non-existent due to our historical distaste for renting. This is all going to change and there is a lot of headroom to grow into for investors.

Another impact from the pension fund is that they care about the long term, their business model means that they have to. If you are paying out pensions to thousands of people every year, you have to be confident that the money will be there for them. This means that they care about what homes are built from, how well it will last, and how sustainable they are, because it matters a great deal to them and to the people who are paying into their pension funds. Who would invest in an oil company now? Or a coal mine? But housing in the UK, with strong demand set to continue into the foreseeable future? That looks like a safe bet.

Private Rental Sector – a Naturally Sustainable Approach

In a recent discussion with clients in the PRS sector a number of issues came up for discussion where the private rental market takes a different approach to the speculative housing market and the affordable housing market. These five issues are key to the success or failure of the private rental sector and at the same time seem to me to naturally point towards the design of more sustainable buildings than an equivalent project in the speculative or affordable housing sectors.

1. A PRS landlord is interested in the long term quality of the building: Private rental is a real market, if tenants don’t like it they can leave. Most modern tenancies are short and if the landlord treats people badly, or if a better offer shows up nearby, the tenant will leave. This ensures that PRS landlords will be kept on their toes for the duration of their ownership of the building. The building becomes a live asset, not a sunk cost. This will encourage landlords to maintain their buildings, keep their energy plant well maintained, and to ensure that services are running smoothly. Badly run buildings will lose their tenants more quickly than a well run one. PRS landlords will naturally tend towards better quality design that appeals to the current market. Low energy and high quality buildings will be more attractive to the market.

2. A PRS landlord is interested in the long term performance of the building: The success and failure of private rented buildings at a large scale, is maintaining a margin between operating costs and the rental income. If there is no margin, there is no business. This drives the design of private rented buildings to be efficient in their running and maintenance. The desire to cut out waste is essential to running any sustainable business, so the natural behaviour of PRS management will tend towards a more sustainable business model. The building will be designed to use space efficiently, and to be built with little or no waste.

3. A PRS landlord is interested in the comfort and wellbeing of the resident: Resident comfort and satisfaction will be more important to a PRS landlord than to any other landlord, as this is a key reason for people to stay or to leave. A building that is poorly designed or constructed will have less appeal to residents than a well designed and well constructed one. A building that overheats or is difficult to heat, or where residents can hear their neighbours conversations or music will have a quicker ‘churn’ of tenants. This is more likely to lead landlords who procure a PRS building to ensure that it is well-designed for the residents comfort in the long term.

4. A PRS landlord is interested in the lifecycle cost of the building: The operational cost of a PRS asset will as important to a landlord as its capital cost. In a speculative building the capital cost is everything as the speculative developer has no involvement in the long-term running of the building. This will naturally lead to a more sustainable decision-making process where a balanced discussion can be had as to whether it is better to build using better materials, (in the sense of durability, ease of maintenance,) or whether to use a cheaper material and have to replace it or repair it more often. In a speculative development something that looks good at the beginning is always favoured over something that costs more but will look good in the longer term. It is normal for a PRS client to consider the life-cycle cost of materials and services, and unheard of for a speculative developer to do so.

5. The PRS landlord cares about the long term usefulness and appeal of the building: A PRS landlord has a difficult task as a client to forecast what the market will be like in the future. Will tenants prefer more space, better light, faster broadband? What will future tenants crave that current tenants don’t care about. This means that the PRS landlord must naturally keep an eye on trends for the future rather than living off the trends from the past. A good example is car parking. A speculative developer will insist on including a lot of parking spaces as history says that parking spaces sell homes. In an urban environment this is increasingly not the case, and a PRS landlord will be aware of this and won’t want to take up more valuable space with cars than absolutely necessary.

It is interesting to me that all of these considerations apply to the affordable housing sector too, but because the affordable tenant doesn’t have much choice and rarely wants to leave, these considerations don’t apply as much as one might think. There is a shortage of affordable housing for rent, so the chances of a tenant leaving are less, and tenant concerns are less high up the list of priorities than they could be.

Similarly, the speculative housing sector is dominated by demand, so there is little competition in a specific areas and purchasers have few options. There is no need for speculative developers to consider these issues as the private sale market isn’t working in the interests of the purchaser.

It will be interesting to see how the housing supply chain in the UK rises to the challenge of the institutionally invested private rental building. The standards will be different, the approach will be different, and anyone who approaches it in the same way as a normal speculative housing project will be missing the point, and missing an opportunity to create a long-term, high quality sustainable asset.