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Rental adjustment
Housebuilder – July 2009

Is it time for housebuilders to take a serious look at getting involved in the private rented sector? With initiatives under way to boost new build for rent and to shake off the Rachman and Rigsby reputation, Mark Smulian looks at the opportunities

Private rent has long been the tenure that few chose if they could afford not to, but it could soon be a new source of customers for housebuilders. Apart from the very top end of the market, the insecurity, lack of control over one's home and inability to gain from rising property prices has made renting unattractive to most people. But does the current famine of mortgage finance mean that private rent is an idea whose time has come?

There are some serious hurdles to jump, but the Homes and Communities Agency is confident that its attempts to attract large investors to private rent will succeed because people who can no longer easily secure a mortgage still need to live somewhere, and renting is the only obvious alternative. The HCA's analysis is that residential property has traditionally offered capital growth, not income, and so was of little use to pension funds in need of regular cash. It wants to foster, though not own, an investment vehicle that would attract money from funds and other large investors to buy homes from builders, which could be pre-sold to remove some development risk. By mid June 64, investors had responded to the HCA's invitation for expressions of interest - someone, clearly, thinks the idea is a runner.

public perception

Private rent's worst problem is public perception. The sector's reputation never really recovered from the scandal caused by the notorious London slum landlord Peter Rachman almost 50 years ago, and has tended to be used by young people waiting to buy, or those who can access neither a mortgage nor social housing. Various government attempts to increase the use of private rent have come to grief on two simple stumbling blocks - why pay a landlord if you could afford a mortgage, and so buy an appreciating asset; and if you could rent from a social landlord why chance your luck with the legions of private individuals who dominate private rent?

HCA chief executive Sir Bob Kerslake explains that he hopes to succeed where others failed because: "This is very different from the Rachman era. We are talking about a private rent sector backed by institutional investors to get them engaged in building properties that will be managed to a very high standard." He explains: "The scale is potentially very large because institutions have historically not invested in residential property, they have put their money into commercial, and this is a new opportunity. There are institutions with hundreds of millions to invest. "People who would previously have bought might now be attracted to a high quality rented option backed by institutions and managed by a reputable manager that also gives them flexibility while they are moving jobs."

He sees the HCA not as an investor in its own right but as a catalyst for "helping this sector to fulfil its potential, possibly by sharing risk in the early phases". Sir Bob also sees a role for the agency in helping to renegotiate planning gain deals. "For example, one might have a good [mixed tenure] scheme that cannot go ahead because of lack of sales," he says. "That means nothing on the site goes ahead because the sale element cannot be built, but if we can get private rent in there it could work. It could make sites stack up." The agency could also help to renegotiate demands for infrastructure where needed. Investors and builders attracted by the HCA initiative will doubtless be reputable, but any prospective tenant will want their home's manager to be honest and competent. There are companies in this category, but in a sector dominated by private individuals there has never been a critical mass for property management firms to grow.

Sir Bob says: "It's possible that some registered social landlords will want to play a role here. "Also, companies that manage property in continental Europe may come over here. There are plenty of them but it's not been viable for them as private rent has been dominated by very small landlords." Nick Jopling, head of residential at property firm CB Richard Ellis, thinks there is a ready market for private rent and that the HCA will find the investors. "Pension funds have to produce returns for their members that are linked to wages and the sector that most closely correlates to wages is residential," he explains. "Property values have fallen by 25% or more so this is a sensible point to consider entry to the market with young people burdened with student debt and the difficulty of getting mortgages, you are looking at an opportunity."

The most obvious opening for builders is to work in effect as contractors to private rent bodies backed by major investors, collaborating on design and sharing risk. One firm likely to be interested is the UK's largest private residential landlord Grainger. Its corporate affairs director Dave Butler says: "Building as a contractor to investors in the HCA scheme is something housebuilders could do. You could see builders and investors working together to de-risk such developments and I'd see interest in building long term strategic relationships with housebuilders so there is less risk upfront." Butler says he would welcome builders' input into design of homes for rent. "The role of private rent is slightly different when it becomes a tenure of choice rather than necessity," he says. "I'd be wary of saying that we need more blocks of city centre flats for single people. I think there will be a shift to mixed communities."

There is another approach though. One of few builders to stick its neck out and commit to building homes specifically to retain ownership for long-term rental is Intro Homes, the private sales division of John Laing Partnership Housing. This is a management buyout from the original Laing empire, and being privately owned gives the company an incentive to enter this market says sales and land director Steve Doherty.

"If you look at private company wealth in any field there is usually rental income there, and it's a core strategy of many private businesses to have investment income," he says. "By doing that we are also doing society a favour, you have got people who cannot buy and we provide a place they can rent for a few years." Intro is testing the waters with a 25 home scheme at Stevenage where Doherty says it expects heavy demand given the town's convenience for London commuters. Intro also has some experience of renting out homes that it cannot sell, rather than selling them now by discounting heavily. "Companies that are driven by volume might find this doesn't work for them because the stock market demands quick returns, but we are taking a delayed big profit rather than one now where we practically give it away," he says. "If we sold now we might get 200,000 and in a few years 250,000 and we get the rent in the meantime.

We're a private company so we can do that." Butler is slightly sceptical that Intro's approach would become common. "The problem with housebuilders building for rent is that their objective is to build, sell and move on and building to rent needs different skills and a different cash flow model," he says. McInerney Homes has considered and rejected these approaches, as sales director Stephen Grant explains: "Private rent does not fit with our business model because of the build cost. We looked at it, but we have quite good sales and if we did private rent a lot of money would be tied up in the build cost before we got a return."

United House md Colin Dixon says he has "avoided the option of renting out homes because we can't sell them, and in fact we are selling quite healthily since Christmas at discounts of 15% or slightly above that price." He adds though: "I'm quite happy to work as a contractor to investors in private rent and I think people will see residential as a good investment. "It is very much the European model to rent, and we have an unusually high proportion of owner occupied households. "In the past young people would get a mortgage as soon as possible but now they may decide they cannot get one, or cannot afford it, and so will rent instead and I can see that growing though I don't think we would develop rented property in our own right." Galliford Try though would also be "very comfortable working as a contractor housebuilder to these institutions just as we do for clients in social housing", says its md for affordable housing and regeneration Stephen Teagle.

initiatives

Anything that pushes housebuilding rather than pulls it is particularly welcome, all the initiatives to date have been pulling housing along as ways to shift unsold stock, this brings in something new." Sir Bob intends to spend the summer working with property consultant DTZ to comb through the 64 bids and encourage those interested to "come together to create investment propositions with scale". The HCA has also begun to identify the stalled housing schemes it sees as "ripe for investment". Building as a contractor for rental market investors - let alone getting involved directly in this market - may not be to every housebuilder's taste, but for some it could offer a welcome new source of business in tough times.