Residential investment begins to attract institutions

Copyright: David Lawson– first appeared Property Week June 1999

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The residential investment sector has reached a critical moment which could make or break prospects for the future, according to study to be published next week.

   A sea change in attitude means most institutions are testing the market or considering investing. 'Demand and supply conditions also suggest that a true takeoff in the market could be imminent,' says Richard Best, director of the Joseph Rowntree Foundation, which commissioned the report.

  But significant barriers remain. And there is a dire warning that if fund managers turn away now, it is  unlikely they will  look at the sector again for some time. Private renting will remain stultified, growing only marginally in spite of the surge of interest among new private landlords, according to the study authors, professors Tony Crook and Peter Kemp.

 'Neither current nor likely future levels of debt funding and equity investment are likely to transform the private rented sector,' they say.

  The picture looks brighter than a similar study five years ago when banks and institutions showed no interest in housing. Among the 27 funds and property companies polled this time, four  insurance companies had invested and two pension funds were thinking about it.

 But the amounts involved are still modest and the jury remains out on whether a significant change will happen unless investment restraints are lifted.   Fund mangers continue to put forward the same demands.

 They want changes to support  tax-transparent investment vehicles. Bigger property companies are necessary to offer equity stakes of  50m pounds or more. The sector needs performance benchmarks to justify investment which still demands a premium over other assets. And better standards of management are crucial.

  Ironically, housing investment trusts are not part of this future. These were trumpeted as the great hope for a true investment market and  studied by almost everyone in the  the period between the two studies. But they failed to take off, crippled by restrictions on size and lack of tax transparency. Instead, they left a  bad taste.

 'It's a dead subject,' one investor told Crook and Kemp. 'It's got to be a new thing. It can't be HIT II,' added the managing director of a property company.

  Much of the funds' information was gleaned from the only scheme which came close to fruition, the  FPD Savills HIT. This was criticised for  high set-up fees, a management team without the right track record, overcomplication and bad timing.

 Instead of tweaking HITs, new vehicles are suggested by the study called tax exempt residential letting schemes (Terls). These would  be less restrictive and give funds the equivalent return to direct investment .

  Another harsh lesson from the years of studying - and rejecting - HITs casts a dark shadow over  the capabilities of a  property industry which is forever nagging funds to become more involved.  Institutions were shocked at the poor standards of management they were offered. Before coming  back to the table, they demand an industry-wide code of practice setting out minimum standards.

  'This would improve the image of the sector, give confidence to tenants and, most important, provide confidence to the institutions that their reputations would not be sullied by association with poor standards,' say Crook and Kemp.

  Some institutions are so critical of property management firms that they sub-contract to housing associations instead. Others looking at potential investment said they would follow the same path because associations had a 'more professional outlook', are more concerned with proper long-term management and have more credibility and financial strength.

 Others were less dismissive, pointing out how the RICS and the Association of Residential Letting Agents had made improvements. But the code of practice is still a priority.

 Improvements have also been made in the dearth of performance information which funds consider essential to judge investments. Best points out that the University of York's Rents and Yields Index, supported by the JRF for its first three years, now fills this gap.

Private Investors

 The success of business expansion schemes in attracting new investors and the more recent surge of interest among  private landlords is often held up as an indicator that the sector is surging forward even without the full support of institutions. But Crook and Kemp put this in perspective.

  Expanding the rented  market by a mere 2% - or 400,000 homes at an average of 55,000 pounds each - would require funding of 22bn pounds. This is seven times the amount invested by private individuals in BES schemes between 1988 and 1993.

 'Growing the sector requires more property companies and greater involvement by financial institutions as well as the continued investment by private individuals,' says the study.

 It also throws doubt on those BES homes as a source of supply for institutions, pointing out that many homes are the wrong type, in the wrong place or badly managed.

Financial Institutions and Private Rented Housing, by Tony Crook and Peter Kemp. Available from the Joseph Rowntree Trust