Redmayne Bentley Publications Podcast July 2024

We are pleased to present the audio version of our Summer 2024 edition of the 1875.


 
Welcome to the audible version of Redmayne Bentley’s 1875 publication. In the summer 2024 edition of 1875 we take a closer look at some of the key policies of our new Labour government and explore two companies operating within the UK’s build-to-rent sector.

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. There is an extra risk of losing money when shares are bought in some smaller companies. Redmayne Bentley has taken steps to ensure the accuracy of the information provided. 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.
 
Transcript
The Second Half, was written by Alastair Power, Investment Research Manager

Passing through the mid-point of 2024, we’re several weeks into both the second half of the year and a new government. Financial markets were muted in the aftermath of 4th July, with limited movement following confirmation of a Labour majority, indicating the result being fully priced-in. Perhaps the outcome was easily forecastable or financial markets remain more interested in the direction of both inflation and interest rates.

The former have been steadily trending lower through the year, with the recent Consumer Price Index (CPI) for June coming in at 2.0%. Lower goods inflation contributed to the decline, with the largest downward contribution coming from clothing and footwear. Services inflation, however, remains a thorn in the side of the Bank of England at 5.7%, unchanged from the previous month and potentially quashing hopes of a cut to interest rates at the August meeting.

While financial markets eye interest rate cuts, our new government’s focus is firmly on driving economic growth, a challenging task considering the current level of interest rates and lack of  fiscal wiggle room. Chancellor Rachel Reeves is just weeks into her new job and wasted no time in commenting on having inherited “the worst set of circumstances since the Second World War” during her first speech. Housing and clean energy are key focal points outlined in the party’s manifesto, with the government aiming to reform planning policies to facilitate the building of 1.5 million homes and make Britain a clean energy superpower by 2030. Both are bold targets, with high levels of execution risk attached. Our Topic of the Month article explores this further, commenting on the key policies of the new Labour government, while our Stock Focus article narrows in on the key issue of housing, more specifically the UK’s build-to-rent market.

In comparison, the UK’s election was a rather muted affair. In France, voters shunned the right-wing in the second round, leaving left-wing parties struggling to form a government at the time of writing. Meanwhile, the US elections took a turn with President Biden announcing his decision not to run for a second term in office, leaving Vice President Harris bidding for the Democratic nomination. Geopolitics remains a cause of concern for a potential second Trump term, with recent comments on Taiwan sending share prices of semiconductor chip manufacturers lower. Set to be held on 5^th November, election day will soon be upon the US populace.

There’s still plenty to unfold in the latter half of the year, but as with the first, inflation, interest rates, and political developments are likely to be key features in the news headlines.
 
Ruth Harris, Investment Research Analyst, considers the UK Build-to-Rent Market.

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 consumer 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 two to four 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 five 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.
 
Greg Lodge, Performance and Risk Analyst wrote Key Policies of the New Government.

After 14 years of Conservative rule, the pendulum has now swung the other way. For the first time since 2005 the Labour party has won a general election, and by a landslide at that. While this represents a significant political realignment, few can say they were genuinely surprised by the result. Polling had consistently indicated a substantial Labour lead for some time and, until the respective seats were declared in the early hours after the polls closed, the main question was simply how big Labour’s majority would be. By mid-morning, it was clear that Labour leader Sir Keir Starmer had a secure majority of 412 seats and was free to start implementing his party’s manifesto. Let’s examine some of these key policies and what impact they might have.

Starmer and former Prime Minister Liz Truss don’t have very much in common, but one preoccupation they do share is the perennial issue of the UK’s lacklustre GDP growth. The 2008-09 financial crisis and ensuing recession cast a long shadow which persists to this day. GDP shrunk by more than 6% over the period and took five years to recover to the size it was pre-crisis. The rate of growth is yet to recover, and this is causing a knock-on effect on productivity, wage growth and living standards. Weak GDP growth translates to lower tax revenue for the Government. With strained public services and an ageing population increasingly in need of health and social care, this presents a real problem. Increasing tax and spending is one solution but is likely to be unpopular with voters. Instead, a better plan would be to improve the UK’s growth prospects, although this is easier said than done. Truss’ intended approach of substantial tax cuts fell apart mere days after their unveiling at the now infamous mini budget.

Recognising that improving GDP is vital to reverse declining living standards and boost public services, Labour has made its plans for growth a central theme of its manifesto. Billing itself as “the party of wealth creation” it marked a significant departure in tone from the Corbyn-era. The manifesto states that the UK’s most successful sectors, including financial services, research institutions and creative industries, will be supported through a pro-business industrial policy. Details on what this approach will look like are light, but it does mention the establishment of an Industrial Policy Council which will be available to provide specialist advice. Corporation Tax will also be capped at its current level of 25% and the planning system will be reformed to encourage infrastructure development.

Clean energy is also a focus of the new government; the manifesto goes so far as to state “clean energy by 2030 is Labour’s second mission.” While this could be attributed to ideological reasons, or as part of an offering to voters concerned by climate change, there are sound reasons why this could be an opportunity for growth. In 1991, clean energy accounted for only 2% of the UK’s electricity generation. By 2023, wind power alone contributed nearly 30%. The use of coal, historically the UK’s chief source of energy, has fallen to 1%. The establishment of vast offshore windfarms in recent years has played a large part in this quiet energy revolution.

With this in mind, Labour is keen to capitalise on what it sees as a home-grown success story. The new government seeks to double onshore wind power by 2030, ending a de facto ban which had been in place since 2015 and which Chancellor Rachel Reeves described as “absurd”. The Government has also announced that it is considering designating large windfarm projects as nationally significant infrastructure, which would bring them under the remit of energy secretary Ed Miliband and reduce the influence of local councils on the planning process. The Government has stated that its Green Prosperity Plan will create 650,000 jobs by 2030.

While wind energy forms a large part of the Green Prosperity Plan, other factors are in play. It also aims to triple solar power and invest in carbon capture, while maintaining a strategic reserve of gas power stations, which still contribute a large portion of the UK’s energy generation. New oil and gas exploration licenses will not be issued, however, and windfall taxes may be levied on the profits of oil and gas companies. Nuclear power looks to benefit from the new administration. The manifesto states that construction of the Hinkley Point C reactor will be completed, and that the lifetime of existing plants will be extended. The nine operational nuclear reactors around the UK contribute a steady 20% of electricity generation, although nearly all are due to be decommissioned over the next decade. Deferring the intended closure of older nuclear plants has become a common policy across several other European countries, due to the costs of new projects and the price of natural gas following Russia’s invasion of Ukraine.

The new government will also introduce a raft of policies aimed at reforming housing in the UK. Affordability has become increasingly strained in recent years as property prices and rents have surged. To this end, Labour has pledged to reintroduce housebuilding targets, with the aim of building 1.5 million new homes over the course of the current parliament. The current plans are to prioritise brownfield land – land that was previously developed but is no longer occupied, and ‘grey belt’ land, which is previously developed land sitting within the green belt. For first-time buyers, a mortgage guarantee scheme will be introduced, similar to the Help to Buy scheme which closed in 2023. Section 21 notices, or ‘no-fault’ evictions whereby tenants can be evicted with two months’ notice with no reason given, will be banned. This is a resurrection of the ‘renters reform’ bill which had not passed when Parliament concluded in the run-up to the election.

As Starmer and his party set out the political tone for the next five years, they will be well aware of the scope of the tasks ahead. Re-energising the economy to promote growth while balancing the needs of an ageing population and crumbling infrastructure will not be easy. Starmer’s comfortable majority may provide him with some momentum and goodwill, but the electorate will want to see visible and meaningful improvements to public life and their personal finances if Labour is to repeat its victory for a second time.
 
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