The London Pension Fund Authority is providing 85 per cent of the financing for a new development of high-quality homes in East London, in what is a relatively new means for institutional investors such as pension funds to get involved in building projects for long-term rents in the private sector.
LPFA is part of a consortium that will create 200 homes and 11,000 square feet of non-residential floor space at Pontoon Dock – a 0.69 hectare site within the Royal Docks in the London Borough of Newham. It will include 137 private rented sector homes, 42 earmarked under the affordable rent programme and 31 under the shared ownership scheme.
Susan Martin, chief executive of LPFA, said: “We are delighted to have been selected as the majority financial backer for this project. Investing directly in the redevelopment of the Pontoon Dock site will not only deliver essential housing for London, but will also provide LPFA with the attractive, liability matching, long-term returns we need to provide for our pensioners.”
Around 2m Londoners are currently renting, according to the LPFA, equivalent to about one in four people in the capital. Yet there are few purpose-built rented schemes in the capital compared with major cities in Europe and the US, but this is starting to change. As institutional investors start to see the benefits of liability-matching with rental income that is generally rising at least in line with inflation, it is an area that is set to grow more quickly than commercial lets.
The UK’s private rented sector has more than doubled in size in the past 14 years, according to a report into this area by property specialists Knight Frank, and institutional investors from the UK and abroad are getting involved.
Grainne Gilmore, who wrote the Knight Frank report, said: “The idea of institutional investment in the rented sector to more closely mirror the tenure trends of other countries such as the US and Germany has been around for some time. But there has been significant progress in this area over the last year or two.
“Although moving to a market where institutionally managed rental blocks become much more common will necessarily take some time, it seems as if the market is now on the cusp of moving towards this goal. Investment will not only be targeted at existing blocks, but also development opportunities and buildings which have the opportunity for change of use.”
When you consider the returns available to institutional investors, it is little surprise that pension funds are finding this area more appealing. The Knight Frank data shows that residential rental blocks in London, Birmingham, Manchester, Bristol, Leeds and Glasgow returned an average of 6.4 per cent in 2013, with average initial gross yields of 6.6 per cent in Q4 2013. Across the entire rental market covered by Knight Frank’s new Private Rented Sector Index, the typical return was 2.9 per cent.
Around 10m people – about one-sixth of the UK population – live in rented accommodation, and there was a 134 per cent rise in the number of dwellings in the private rented sector between 1991 and 2011, according to Knight Frank’s data. While the tightening of lending criteria has clearly played a part in the increase in rental accommodation, much of the rise happened before the financial crisis, suggesting factors such as rising house prices and the plethora of buy-to-let mortgages available just before the crash has helped fuel house prices and rental demand, at least in part.
Perhaps surprisingly, around half of those renting are classified as being ‘high-income’, according to Knight Frank, with a third of these also having children, suggesting it is a real alternative to home ownership – which is akin to the situation in other European countries such as Germany.
This demand for rental property has resulted in higher rental income, which has whetted the appetites of the big institutional investors.
Ms Gilmore added: “Rental growth tracked earnings growth, and outpaced inflation up until the financial crisis – and as the economy recovers after the financial crisis, this trend is likely to continue making it an attractive option for institutions looking for long-term income plays.
“There has also been a push by policymakers to encourage investment in the private rented sector, which, after all, will help boost housing supply which is so lacking in the UK. As part of this initiative, the government last year set up the Private Rented Sector Taskforce, a group of property specialists who are working to bring together investors, developers, housing associations, local authorities and policymakers to establish institutional investment as a going concern in the UK.”
The Taskforce has identified a pool of more than £10bn that institutions want to put into the private rented sector, which could lead to around 50,000 more units coming into the sector. Overseas institutions have already started to move into the UK’s private rental space, perhaps as a result of the model already being established overseas. For example, Ivanhoe Cambridge, a Canadian pension fund, has been investing in existing residential blocks through their partners, Residential Land, for some time, said Ms Gilmore, and this trend is set to widen.
She added: “The interest of overseas wealth funds in the private rented sector has been well demonstrated, not least by the move by the Abu Dhabi Investment Authority late last year to invest £300m into Fizzy Living, a specialist private rented sector operator.
“Essential Living, a developer and operator of rented homes with a pipeline of over 1,500 rental properties across Greater London, is backed by $200m (£125m) of equity from M3 Capital Partners, who manage US institutional funds, again underlining the global interest in the UK private rented sector.
“There has been further exploration in ‘build to rent’ across the industry. Rather than purely building units for sale, developers, backed by institutions, are increasingly looking at developing residential blocks designed specifically for the rental market.
“Some of the first to become involved were Qatari Diar and Delancey, who, after redeveloping the East Village, the former Olympic Village, opted to rent out the units. While the Olympic park delivered existing scale, achieving this level of scale elsewhere in the UK is tricky. For institutions to become key players, they need high levels of stock – preferably blocks of rental units or units clustered together, rather than properties pepper-potted around a city or region.”
This, perhaps, is why funding a new block of 200 properties is particularly appealing to the LPFA – having ongoing rental income that should either keep pace with or exceed inflation will help to ensure its pension fund keeps pace with its pensioners’ payments.
A spokesman for LPFA said: “There have been a number of underlying investment beliefs and guiding principles which have shaped the evolution of the LPFA’s fund structure and will continue to do so in the future.
“First, an understanding of the cashflows the investment portfolio needs to generate to meet our liabilities is central to determining our choice of investments. Second, given the duration of our liabilities, we must be responsible long-term investors. Where prudent and affordable, the unrewarded risks associated with our liabilities should be hedged to increase the long-term sustainability of pension promises.
“We also wish to encourage environmental, social and corporate governance best practice in the companies in which we invest, as we believe this will deliver the best long-term returns. Within these guiding principles, if an investment also has a positive social impact, so much the better.
“We are delighted to have been selected as the preferred finance provider for Pontoon Dock because we believe it meets all of our investment criteria as set out above. It will not only deliver essential housing for London, but will also provide LPFA with the attractive, liability-matching, long-term returns we need to provide for our pensioners.”
Institutional investors working within the rental sector in other countries has resulted in a more professional level of property management, and this could ultimately raise standards across the board in the UK. Only time will tell.
Alison Steed is a freelance journalist
Key Points
The London Pension Fund Authority is providing 85 per cent of the financing for a new development of high-quality homes in East London.
Around 10m people live in rented accommodation, and there was a 134 per cent rise in the number of dwellings in the private rented sector between 1991 and 2011.
A pool of more than £10bn has been identified that institutions want to put into the private rented sector, which could lead to about 50,000 more units coming into the sector.
