16 February 2017

Blog: Hearts and Minds: Grainger and PRS

by Scott Fulton | 16 February 2017

When the economic history of the UK in the early 21st Century is written, the evolution of the housing market is likely to play a significant role. Home ownership was the dominant feature of the market in the latter half of the last Century. The “Right to Buy” programme, mortgage deregulation and regular bouts of real house price inflation (HPI) combined to make a UK house more than just a home. In a very real sense, your house was and is a critical component of your net worth.

However, the financial crisis of 2009 and its aftermath may have irrevocably changed this position. While public policy managed to avoid negative equity and higher repossessions, specific demand-side initiatives such as “help to buy” bolstered demand while supply was limited by issues such as the scarcity of development finance for SME builders and the rigid planning system. The result has been significant house price inflation at a time of low real wage growth. We are now faced with a generation who simply cannot afford to buy a home.

The “Housing White Paper” published by the Department of Communities and Local Government (DCLG) on 7th February recognises this trend. As Kurt Mueller, Corporate Affairs Director at Grainger PLC*, commented, “for the first time in my experience, Government policy appears focused on the supply-side of the equation”. The White Paper is seeking to bridge the gap between the current housing stock and that required by demographics through a variety of sources. Inevitably, this focus has resulted in consideration of the Private Rental Sector (PRS).

Economically, this makes sense. The issue facing Government is how to increase the supply of homes without destabilising the market. Supply and demand theory implies that any increase in the former could have a detrimental impact on pricing at a time when market confidence is fragile. Further, the current provision of new homes may be curtailed if a drive for volume results in cost inflation and, therefore, margin erosion. The obvious alternative is to develop a PRS whose pricing is unrelated to the owned homes and whose build programmes are more efficient than single family housing.

Historically seen as the poor relative of the home owning market, the PRS has been dominated by a large number of private landlords who own a small number of individual properties. It has developed in this way through the availability of “buy to let” mortgages, a prolonged period of low yields within alternative investments and the impact of “Pension Freedom” which provided for access to pension funds at age 55. At one stage in 2015, buy to let mortgages accounted for 20.0% of all funds advanced; the fastest growing segment of the UK housing market at that time. The risk that this lent to the wider housing market was recognised in a series of measures designed to limit this growth; notably the revision of tax treatments and the imposition of a 3.0% surcharge, through stamp duty (SDLT), on second homes.

The White Paper provides more detail on the Government’s strategy for this market. It has been clear that it would like to see the development of an institutional rental market which is capable of providing much needed new homes in a sustainable fashion. As it comments, “We want to … attract major institutional investment in new large-scale housing which is purpose-built for market rent.” The direction of travel is for the creation of a significant PRS estate, purpose-built, professionally managed and backed by institutional funds.

There are still considerable hurdles to achieving this aim. National planning guidelines do not yet accommodate private rental to the same extent as homes to own. Local authorities are yet to fully embrace the concept of private rental within local plans. The provision of large scale PRS development is hindered by the availability of funds. Finally, there remains the issue of reversing decades of a preference for home ownership.

All that said there is now a genuine sense that we are approaching a paradigm shift. Kurt Mueller believes that “the framework outlined by the White Paper clearly addresses some of the key issues facing PRS. We can now see public policy looking to install the private rental sector within national and local planning strategy. There is more clarity on the issue of the proportion of affordable or discounted market rent (DMR) properties required. Local authorities have been given more latitude in determining the sale of land. Finally, we are witnessing strong growth in institutional funds’ demand for residential rental assets. Overall, we believe that the White Paper is a major step forward in the development of the PRS in the UK.”

Mueller concedes that there is more to be done but highlights that the White Paper is an operational document which informs the debate, not the end result. Financially, there is scope for the Budget on 8th March 2017 to offer more granularity and, potentially, incentives for the continued evolution of PRS. Specifically, Grainger has highlighted previously the impact of the 3.0% surcharge on the institutional PRS investment market. Designed to cool the “buy to let” market, the absence of an exemption for institutional landlords (owning 15 or more properties for example) appears ripe for reconsideration. Additionally, The Treasury could return to the issue of the creation of an institutional investment class, focused on unitised PRS funds, where investors could gain access to the yields offered by rental without having to buy a house. This appeared to be a natural development from the abolition of compulsory annuitisation in 2014 (“Pension Freedom”) but has stalled following the changes after the Referendum vote.

While comment around the White Paper focused on private home developers’ land banks and the lack of any further eye catching demand-side initiatives, Grainger believes that its publication provides further evidence of a sea change in Government thinking. The development of an institutional PRS in the UK is no longer a question of “if” and the “when” now looks closer than ever before. This may not sell newspapers which have become accustomed to reporting house prices and “housing crisis”. It is an answer to the supply issue currently facing the UK housing market.

*Capital Access Group acts as an advisor to Grainger PLC

Capital Access Group will be hosting a seminar on 6th March 2017 for interested investors at which Grainger PLC and Galliford Try PLC will present their views on the UK housing market following the White Paper.

Please contact CAG to attend this seminar.