Institutional investors sniff around tax-shelter housing

Copyright: David Lawson – appeared Property Week May 1998
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Fund managers are forever labelled as sheep, swarming after  anyone who breaks from the flock. Not when it comes to residential investment. A pack of randy dogs come more to mind.  They know there is a bitch on heat somewhere:  the air is heavy with the scent of opportunity as computers spit out figures showing potential returns better than commercial property. But they just can't find her.

 In the meantime, the pack rushes about, sniffing and snuffling, with  the  occasional yelp from behind the bushes as  macho types make experimental encounters.  One female called HIT flaunted shamelessly but received so little attention that she died a virgin. The RICS has booked an appointment with Housing Minister Hilary Armstrong to beg relaxation of rules on what these housing investment trusts can buy. Otherwise, they will forever be consigned to history as the hit that missed.

  A new squeeze called BES has emerged to tempt the pack, however. Rented homes are coming on the market via business expansion schemes reaching the end of their five-year tax holiday. Chesterton has sold 1800 in the last year alone for  banks and building societies which bundled repossessions into BESs.  Residential division head Andrew Wells says he expected a two-year campaign to dispose of  the Bradford & Bingley tranche of 1400. Demand was so heavy, it took only half this time.

 A few institutions rushed in - and then rushed out again. 'We have been outbid by 20% a number of times,' Nick Mansley of Norwich Union. BES could be another false scent for big UK institutions. Specialists like Pemberstone, which buys and breaks up   portfolios, will  always be able to beat  fund managers  demanding premium yields to tackle what they still see as a risk play.

  Even bigger competitors could be waiting to pounce. FPD Savills has bounced back from its HIT fiasco by helping Amresco pick up  900 homes for 30m pounds in two BES deals. More are in the pipeline. This little-known name is the UK arm of another of those property-hungry financial groups crossing the Atlantic. Just to give a hint of its strength, total assets soared from 2.6bn dollars to 3.6bn dollars in the first three months of this year.

  It is also about to launch a real estate investment trust. The underlying mood of the market is that REITs will come bounding into the UK without the traditional UK prejudices against residential property. Amresco is being tipped as an advance party. And what will they find to buy? Wells says  just two lenders, the Royal Bank of Scotland and Abbey National, have 3,500 BES properties they must 'lump and dump' fairly soon. A ragbag of other financial groups will top this up further as investors clamour for an exit.

  But there will be a queue of competitors. Pemberstone MD Andrew Bruckland anticipates he will be bidding  for trading stock for a couple of years before the company concentrates on becoming  a mainstream landlord. Another BES specialist, City North, has just floated and is expecting to expand rapidly from the current 40m pound asset base. London & Henley is also waiting in the wings and there are at least half a dozen private funds being put together by various intermediaries.  Suddenly, this pool begins to look a tad small.

 Informal  soundings in the US about what REIT investors might consider also threw up a problem 'One asked if we could provide 3,000 homes. That is about three times our annual output,' he says.

  It is ironic that  lack of stock rather than lack of interest could become the stumbling block to both major investment by both REITs and institutions. Fund managers have made a quantum leap from outright hostility  to mild interest in housing. 'It took a year to believe the new government was serious about allowing a free market,' says Nick Jopling, head of the Residential Investment & management Group.

  Norwich Union and ING are dipping toes in the water and the Prudential has put a working paper before its  board. Making the figures add up can be a problem when gross yields of 10%-plus net down perilously close to the cut-off of around 6% because of management charges. But even where they work, there is a fear that this could be tiny market unless someone comes up with enough stock to satisfy potential investors.

  Buying new property off-plan is an option long  advocated by  David Goldstone, chairman of developer Regalian. But he has received not a single query from an institution.  Several vulture funds are being created  to fill the gap left by Far-east investors, however,  and ING has done some small deals with builders. A major offer involving 90,000 sq ft of West End apartments is currently in the pipeline.

  Pemberstone is already in this market. 'Clustering makes for much more efficient management than scattered BES portfolios,' says Bruckland. But REITS and UK institutions could have their work cut out trawling through the market to accumulate the critical mass which would make residential investment more than a fringe interest.

 Goldstone suggests a shortcut: a pooling of stock by several volume builders.  That has one major flaw. 'Builders don't need to sell in bulk at discounts when they can easily get full market price,' says Jonathan Vandermolen of investment specialist Blenheim Bishop. In other words, the market would need to fall to kick-start this trend. But investors would then lose the bonus of capital growth which is still an essential element to make yields worthwhile.

  Another possibility could be the kind of limited partnerships becoming popular in commercial property, says Jopling.  Pooling resources this way would not provide the tax advantages of HITs but at least offer the arms-length management fund managers demand -  plus a degree of liquidity.

   Even then, the market may still not yield what investors demand.  Peter Peirera Gray of the Prudential, a fund manager with a rare openness about interest in residential investment, is also sceptical of figures tossed around about a potential multi-billion-pound residential market. Once honed down to the right location, the right price and the right management, this could leave  a lot of big players on a small playing field.

  But at least the market has progressed. Searching for stock to satisfy hungry investors is a lot more hopeful than the outright hostility to residential investment that has been the norm for so many years.