The pandemic has significantly disrupted real estate on a global scale, and all UK sectors have been affected. However, the residential investment sector – specifically build-to-rent (BTR) – has proven resilient in the face of COVID-19.
This is largely underpinned by strong underlying demographic and social trends, as well as housing supply and affordability constraints. Despite ongoing uncertainty, investment in the BTR sector increased in 2020 and reached a record high of £3.5bn. But why has there been growing investment in such uncertain times?
For one thing, operational performance has remained relatively robust, with stable rent collection rates of between 95% and 98% since April 2020.
This in part reflects the way operators reacted swiftly at the start of the pandemic, working closely with tenants and establishing hardship processes or payment plans where needed. In addition, the typical BTR tenant demographic and professions were generally less impacted by COVID-19. Compared to reported rent collection rates for the commercial sectors, which have been severely affected by ongoing lockdowns, the steady cash flow from BTR strongly appeals to investors.
Occupancy levels, however, have seen more fluctuation, with a drop-off after the first lockdown. This varied according to the specific scheme and location, with regional centres performing better. London was more severely affected, with many students, international residents and young professionals vacating the city.
Furthermore, areas where demand relies on local office markets that have been shut or at reduced capacity have suffered more. This, combined with the collapse of the short-term rental market, has contributed to an increase in supply and a challenging environment for occupancy and leasing up of new schemes.
Despite tough conditions, occupancy levels are slowly recovering. While at the time of writing, these are not yet back to pre-pandemic levels, we at CBRE envisage further improvement. It is also encouraging that demand from the student market looks set to return, with 2021–22 UCAS undergraduate applications up by 8% year on year.
In response to falling occupancy levels, operators have adopted dynamic pricing strategies and rent-free periods as incentives. Flexible lease terms have also become more important, with some operators now offering short-term lets from as little as three months, reassuring tenants that they can operate flexibly if their situation changes.
Investors have taken different approaches; while some have focused on increasing occupancy levels by reducing rents, others have sought to maintain rents rather than occupancy. There is clearly a fine balance to be achieved between maximising and sustaining income and occupancy. Therefore, investors are constantly reviewing and adapting to local market dynamics.
There has undoubtedly been pressure on rents in city-centre locations, especially London, given the short-term imbalances in demand and supply. As a result, the ability to negotiate at renewals has been diminished, and incentives such as rent-free periods have reduced overall headline rents.
CBRE's current forecasts predict rental growth will be slightly negative at -0.2% for the UK in 2021, with a rebound in 2022. However, BTR may perform better than the wider rental market.
BTR operators have adapted to changing day-to-day requirements by significantly increasing cleaning provision, adopting virtual leasing and enabling contactless move-ins to keep staff and residents safe. Even with restrictions easing, these initiatives have become part of the norm.
BTR amenities are also adapting, being one of the key differentiators between this sector and the rest of the market. However, with most amenities such as gym space being closed during lockdown, operators have had to think of creative ways to offer services safely. The focus is now on incorporating flexible, multi-use space into developments that can easily adapt to changing needs, including working from home, with one of the key trends being the provision of co-working space.
Furthermore, health, well-being and a sense of community have been priorities throughout the pandemic. Operators have provided online platforms for residents to engage in book clubs, quiz nights, cooking classes and fitness initiatives.
Building a positive perception is also likely to be beneficial in the long run to encourage brand loyalty, which will attract and retain tenants and show the way professional management can add value in BTR compared with the wider rental market.
Undoubtedly, the pandemic has caused investors to reassess their decisions, and continued BTR investment has been growing as a result of a flight to quality, with investors attracted by low volatility and stable income streams during the downturn.
This has been demonstrated by BTR bucking the general trend of other real-estate sectors in 2020 and recording the highest investment total of £3.5bn, 15% higher than the previous peak in 2018 of £3.1bn.
While there has been a slow start to 2021, with investment volumes down year on year by around 20% to £770m, overall investor appetite remains strong, with £1.5bn under offer as at the end of the first quarter. Investors continue to look beyond the current impact of COVID-19, and recognise that access to opportunities and deploying capital remain the barriers to investment.
As such, we forecast investment volumes to total £3.5-£4bn by the end of 2021, which could represent another record-breaking year. We also continue to forecast that residential will outperform other real-estate sectors over our five-year forecast horizon.
Encouragingly, asset pricing has remained robust throughout the pandemic, and CBRE's benchmark yields remain largely stable and unchanged through 2020 and into 2021. Moreover, transactional evidence shows there is potential for downward pressure on prime regional yields in 2021. This shows prime regional locations are continuing to prove popular with investors and yield profiles are compressing.
There also remains a significant opportunity for the BTR sector to increase its share in regional cities and towns, and this will include the provision of more suburban houses that families can call home.
The pandemic has prompted a change in outlook about where we live and work. Factors such as working from home, the desire for more indoor and outdoor space, a decrease in commuting and a greater focus on affordability are resulting in a shift in demand from city-centre flats to houses in suburban locations.
As such, COVID-19 has accelerated the investment of capital in single-family housing (SFH) – also known as suburban BTR – an emerging market focusing on professionally managed rental housing in suburban locations aimed at young families, which has gained significant traction over the past 12 to 18 months. This does not only represent established, institutional BTR players entering the market but also more diverse capital, including interest from private equity and banks.
From an investors' point of view, the case is compelling. There is opportunity to scale by forming strategic partnerships with housebuilders that construct at volume and pace, reducing development timeframes.
Operationally, SFH offers similarly stable income streams as BTR; however, operating costs are lower as a result of less churn, lower voids and no amenity space or common parts to manage. Additionally, risk associated with lease up is minimised as developers hand over houses in phases, allowing investors generate income more quickly.
From the supply side, SFH could be beneficial for master developers to accelerate delivery on large strategic sites, de-risking and helping to deal with planning obligations by broadening tenure options. The early introduction of SFH in a development could assist in establishing successful placemaking, which can ultimately lead to increased sales value and also drive private sales premiums created through establishing placemaking.
Since CBRE sold the Gatehouse Bank PLC portfolio to Goldman Sachs-Pitmore earlier this year, a portfolio comprising more than 900 operational single-family houses across the North West of England, the market has gathered considerable momentum. We expect this trend to continue in 2021, especially as investors seek to diversify capital further. However, the biggest hurdle to investment is supply and access to opportunities of scale.
COVID-19 has also accelerated environmental, social and governance (ESG) initiatives in BTR. ESG has been moving up the agenda and demonstrating sustainability credentials is now at the forefront of investment criteria.
The link between sustainability and value in BTR is developing, however, there is a clear perception that buildings that do not meet certain environmental standards will be adversely affected in the medium to long term. As such, investors are futureproofing buildings to ensure continued liquidity of investments and to mitigate long-term risks.
Consequently, there has been a shift away from gas heating in BTR schemes towards electricity and renewable heating systems such as heat pumps to meet net-zero targets. Investors are also giving more consideration to the whole building life cycle, including the construction process, by using sustainable building materials and moving towards more efficient modern methods of construction such as modular, which generate less waste.
Likewise, residents are becoming more conscious of the impact they have, and the environment they live in. While developers can create sustainable buildings with smart technology in place, much of the responsibility for the buildings' overall energy consumption lies with tenants. There is therefore an opportunity for BTR operators to educate and shape tenant behaviours by providing the means to transition to a sustainable lifestyle.
As net-zero carbon and environmental legislation deadlines approach, it is crucial that BTR portfolios have ESG strategies in place so that investors are confident for the long term.
The BTR sector has not been completely unscathed by the pandemic, but it has proven resilient in the face of a significant challenge, outperforming other asset classes. We expect this to continue throughout 2021, along with the rise in investment in SFH, with ESG credentials high on both agendas.
Related competencies include: Housing management and policy, Investment management, Leasing and letting, Property management, Sustainability