Ruth Harris, Investment Research Analyst
This article was taken from the Summer 2024 issue of The 1875. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications
You may have seen an influx of stylish new apartments or professionally managed homes in your area. These developments often advertise a suite of luxury amenities such as; rooftop lounges, shared workspaces, on-site 24-hour maintenance, communal gardens, concierge services, and a calendar of resident events. Many are even pet-friendly, with good local schools and convenient transport links. You might think that such standards would come with a hefty price tag, however an increasing number of people across the UK are living in similar professionally managed accommodation thanks to the rise of build-to-rent providers. These companies develop and build properties specifically designed for renters, and then manage the portfolio to collect rent as opposed to selling to another landlord.
As inflation eats into household budgets and interest rates remain high, many are struggling to get on the property ladder. House prices relative to earnings have reached a height that hasn’t been seen since 1876, when only a wealthy minority were able to own a home. These trends are pushing more young people into renting for longer, and supply is struggling to keep up with demand.
There’s a clear gap in the market, and a keen appetite for rental homes. The private rental sector supplies over three quarters of UK rental accommodation while, remarkably, institutional holders make up less than 5% of the private rental sector. The rest is held by buy-to-let investors, often individuals purchasing and renting out completed properties for the passive income and potential for capital gain. This group of private landlords are themselves under pressure from changing regulations and rising debt costs.
Build-to-rent is a small but exciting area of the institutional market which has seen remarkable growth over the last few years. The subsector currently represents just 2% of the private rental sector. The model is significantly more popular in the USA, where build-to-rent investors own 37% of the market.
Grainger plc is one of the companies looking to make the most of this opportunity. As the largest UK-listed residential landlord, Grainger manages an operational residential portfolio of £3.4bn. This covers 11,000 homes, with an additional 5,000 in development which are set to add £1.5bn to operational assets. Grainger offers professionally managed, high-quality apartments, typically with a suite of extra amenities. The portfolio has a strong urban focus, with investments in 14 of England’s largest cities. Tenants include students, recent graduates, professionals, young families, and down-sizers.
The platform is delivering strong growth, with net rental income up 11% in 2023 and a corresponding 11% increase in dividends per share. While the dividend growth is encouraging, the total yield remains low at 2.7%. There’s scope to continue growing rents, with customer affordability at 28%, well below the Government’s guide of 35% of net income. The company is on track for conversion to a Real Estate Investment Trust (REIT) in October 2025.
REITs give investors exposure to a portfolio of properties through a publicly traded and highly liquid instrument. According to regulation, REITs must generate at least 75% of gross income from; rent, interest on property mortgages, or real estate sales. In addition, they must pay a minimum of 90% of taxable income in the form of shareholder dividends each year. This can make REITs an attractive option for investors looking for income, but with potentially lower capital growth.
PRS REIT plc is a REIT with 5,308 completed homes, as of March 2024, and a further 268 underway. While Grainger focuses on developing built-to-rent apartments in urban centres, PRS REIT manages the UK’s largest portfolio of build-to-rent Single Family Housing across 72 sites, marketed under the Simple Life brand. Typically these homes will be high quality, spacious developments, with 2 to 4 bedrooms, a secure garden, and good transport links to a nearby city. Many developments offer resident events, on-site maintenance teams, and dedicated shops and cafes.
PRS REIT aims to provide an attractive level of income to investors, as well as the prospect of income and capital growth. Management is anticipating around 5,600 completed homes in the portfolio by summer 2025, with an anticipated rental value of £64m per annum. Like Grainger, PRS REIT is seeing strong rental growth on stabilised sites, up 11% in 2023. Despite the strong operational performance and a dividend yield of 5.1%, PRS REIT is trading at a significant 38% discount to net asset value.
While both PRS REIT and Grainger have had a run of impressive growth, is this sustainable? Analysts are divided. While the underlying supply and demand dynamics may seem like a good investment opportunity, there remains significant regulatory difficulty facing housebuilders. Savills reported a mixed outlook for the build-to-rent sector as the number of new constructions started falls below the number finished. While the build-to-rent construction pipeline remains strong, falling planning applications suggests growth in new developments may be set to reduce. Both PRS REIT and Grainger may see rental growth slow under affordability pressures.
There is some cause for optimism. The long run structural undersupply of housing in the UK remains, and it’s a key issue on the agenda for the new Government. The party has pledged to build 1.5 million new homes over the next 5 years, with housebuilding targets for local councils and relaxed planning regulations. While the limited capacity and a tight labour market may make this particularly challenging, a more supportive environment for quality housebuilding could be good news for the build-to-rent sector.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.