Memorandum from The British Land Company
PLC (SRH 26)
ENCOURAGING THE PRIVATE RENTED SECTOR
AN INSTITUTIONAL PERSPECTIVE
EXECUTIVE SUMMARY
The Private Rented Sector (PRS) is generally
fragmented, introspective and alienated from the public housing
sector. A larger institutional element, in the form of major private
and public property companies and banks, investing in residential
stock to let, could dramatically improve housing quantity and
quality. A PRS which was well regarded and active would provide
better standards of tenant service and greater collaboration with
Registered Social Landlords. A well managed PRS would be beneficial
to the economy and provide a diversified financial product returning
a combination of house price growth and net income. This would
be of significant benefit to individuals and institutions with
the widest range of investment budgets. For the individual this
would help to create a disconnect between the need always to purchase
a property and the ability to benefit from house price growth.
There is currently significant interest in large-scale
institutional investment in the residential market. However, in
order to encourage the PRS, a number of challenges for institutions
investing in residential property need to be addressed. Fiscal
incentives and a reduction in regulation in certain areas are
required. Institutions within the sector also need to work together
to address the image problem of the PRS so that, with their longer
term and larger scale perspective, they can encourage environmental
sustainability and the development of communities.
It is possible that institutional residential
investors could form an independent, self-regulating body to tackle
the above issues. The fiscal incentives and regulation reductions
suggested herein would provide both a "stick" and a
"carrot" to members, removing the administrative burden
on central government and local authorities. These benefits could
be available to members, with the body internally monitoring to
agreed standards and enforcing a well publicised tenants' charter.
The body would have a variety of remedies for non-compliance of
members, with persistent offenders having the significant stick
of the removal of the fiscal incentives and reintroduction into
the normal regulatory framework.
The appropriate body should have standards of
membership and proof of compliance, in return for the benefits
set out herein. However, expensive, time-consuming or administratively
onerous regulation could be unpopular, particularly in the context
of a significant period of time where little legislation since
the Housing Act 1988 has provided an encouragement to large-scale
institutional investment. This can be avoided by close consultation
with the industry, in particular via a body such as the British
Property Federation (BPF), whose efforts to encourage the private
rented sector we wholeheartedly endorse.
British Land is Europe's largest quoted property
company measured by assets. It invests in modem commercial properties
principally in the London Office and Retail Sectors. The portfolio
is valued at £19.4 billion of which £15.2 billion is
directly owned. Over the last 5 years, British Land has acquired
a portfolio of residential units. In February 2006 British Land
transferred the 1,500 houses and flats in this portfolio to Insight
Investment, for approximately £300 million. British Land
remains significantly involved in the asset management of the
portfolio.
1. THE OPPORTUNITY
1.1 For Government
1.1.1 Addressing the housing short-fall:
There is currently a need for a step change in the provision of
appropriate housing stock. At the same time there is significant
interest in institutional investment in the residential sector.
Encouragement of the PRS could help to address the shortfall between
the required output identified in the Barker Report and current
levels of housing output.
1.1.2 There is no reason why this sector
of the market should not be profitable for institutions if the
restraints detailed herein are removed. Given the availability
of funds for this asset class, this could lead to a significant
change in the rate of delivery of housing stock.
1.1.3 A well managed PRS would help to support
some of the more vulnerable people in society; those caught between
the home-owning and the state-supported sectors. It is estimated
that 47% of rental demand from the PRS comes from this "intermediate"
market. By investment in indirect residential property investment
vehicles (as set out in 1.1.5-1.17 below) or by the provision
of shared ownership schemes, many would have a greater chance
of a home of their own.
1.1.4 Furthermore, a PRS building stock
for long-term investment would increase the quality of housing
delivered. The focus during the development process would shift
from being turnover-based to the creation of long-term communities
and sustainable homes which generate long-term, as well as short-term,
profit.
1.1.5 Strengthening the economy: The widespread
growth of investment products that allow small capital sums to
be invested in a vehicle which tracks or outperforms the House
Price Index (HPT) would revolutionise the way we look at what,
for most people, is their most valuable asset: their home.
1.1.6 By investing homeowner's equity in
a diversified fund, rather than directly in a single property,
the decision on where to locate, in many circumstances, could
then be based on use value rather than investment value. Disconnecting
the need for a property purchase from the ability to invest in
house price growth could develop mobility of labour, lead to a
more diversified investment base for most individuals, and encourage
increasing professionalism within the residential industry.
1.1.7 In the sector of the market where
people have some equity but not enough to purchase, in one stroke
this would remove the rift between those who have the ability
to benefit from house price growth and those who do not. Many
who presently feel they have "missed the boat" of the
housing market would be given a new chance.
1.1.8 Raising Standards by greater PRS and
RSL collaboration: At present there is little collaboration between
the PRS and RSLs (Registered Social Landlords), although this
is increasing. By working more closely together the PRS and RSLs
could enhance standards of long-term tenant care and environmental
performance. By working together the PRS and RSLs could develop
houses more profitably and more accurately meet local needs, and
develop the long-term income streams from shared ownership that
could be attractive to both institutions and stakeholders.
1.1.9 A joined-up approach to development
would encourage viable, mixed communities from development inception,
within the context of long-term joint investment and management.
Issues such as security and long-term management could be designed
in within all areas of a scheme, as could ways to facilitate property
management and reduce social tensions.
1.1.10 A Comparison with Buy-to-Let: At
present buy-to-let forms the majority of the PRS. However, most
individual investors have an undiversified investment product
and are vulnerable to local market fluctuations, general economic
downturn and the impact of one bad tenant. Although some buy-to-let
investors offer a good service, many lack professional expertise.
Therefore the volatility of this sector is destabilising to both
an individual's finances and the wider housing market, particularly
in specific areas such as city centres.
1.1.11 As many perceive capital gains slowing
over the next few years, recent entrants to the buy-to-let market
with high levels of gearing could encounter difficulties. It is
also more challenging for local authorities to enforce environmental,
best practice and condition standards within a market composed
of a large number of small landlords.
1.1.12 Larger institutions can more easily
redirect proportions of investment, diversify investment between
higher numbers of units in a variety of locations and may find
it easier to hold stock for the long-term over short-term difficult
periods. An institutional investment sector would enhance standards
of best practice, and enforcement of standards is easier as the
number of residential investors reduces.
1.2 For Institutions
1.2.1 Demand for the product: There is increased
demand for HPI-based investment products from both individuals
and institutions. This is due to both a growing recognition of
the long-term investment characteristics of residential property,
which has a high correlation with RPI, and its value in comparison
to alternative investment products. Institutions are looking to
diversify commercial property portfolios and residential may,
in the future, provide a viable alternative.
1.2.2 Ability to manage properly: There
are increasing numbers of residential management specialists which
leads to greater confidence in the ability to properly manage
large numbers of residential units. This has been facilitated
by both the development of high quality property management software
and the improvement of the quality of staff and education in the
residential sector. This is a key requirement for institutional
investors.
1.2.3 Informed investment decisions: In
recent years there has been a significant increase in research
information in the sector. This allows more informed investment
decisions. In addition, on the measurement of performance, the
provision of both the Residential IPD benchmark and various other
capital growth indicators, allow investors to track performance
and monitor different elements of the portfolio. With increased
data and analysis at their disposal, institutions can move towards
de-risking investment decisions, thus increasing the probability
of success.
2. THE CHALLENGE
FOR THE
INSTITUTIONS
2.1 Despite the high levels of interest,
there is currently reluctance by many institutions to invest in
residential property on a larger scale, due to difficulties in
two main areas: management inefficiencies and fiscal restraints.
2.2 Management Issues: Residential property
investment suffers from high management costs due to the large
number of small units; a problem exacerbated by increased regulation.
The example of the variety of approaches to enforcing the Houses
in Multiple Occupation (HMO) legislation by different local authorities
has significant implications for large portfolios with units spread
on a nationwide basis. High profile investors take their reputation
as landlords very seriously and although the need for careful
monitoring of HMO stock is very much recognised, the current approach
by local authorities is unstructured, inefficient for any large-scale
investor, and often fails to catch the true culprits.
2.3 Another example would be the difficulty
in renting accommodation to housing benefit tenants. Here, delays
in the application process and the payment of rent in arrears
rather than advance, like the rest of the market, acts as a disincentive
to landlords to provide accommodation to those in this sector.
2.4 In addition to regulatory challenges,
holding residential property is expensive. Void costs need to
be accepted, ongoing maintenance obligations need to be met, reactive
repairs need to be completed quickly and management costs are
high. Most residential investors accept between a 30% to 40% discount
to the gross rent they receive on these costs. This is a significant
disincentive to many potential institutional investors.
2.5 Support Large Scale Investment: Institutional
investors have the ability to support large-scale projects and
with this ability comes a greater responsibility to encourage
community-wide initiatives. In particular, one of the greatest
determinants of success in investing for the long-term in family
housing is the quality of local education. Institutions understand
that investment which understands the inter-relationship between
education and housing can bring significant, long-term economic,
as well as social, benefits.
2.6 Fiscal Issues: The issues stated above
are exacerbated by an uncompromising fiscal regime. VAT is payable
on most costs and losses are difficult to offset.
2.7 Furthermore, for institutional investors,
there is a tax inequality on purchase costs when they pay stamp
duty on the aggregate of the units purchased, rather than the
purchase price of individual units normally paid by an individual
buy-to-let investor. This leads to difficulties in buying blocks,
which are an easier product to manage well as a single entity.
3. INSTITUTIONAL
SELF REGULATION
3.1 A possible way forward
3.1.1 A self-regulating body: If the opportunity
for both Government and institutions is acknowledged, and the
current difficulties causing institutional reluctance to enter
this market agreed, a new approach is likely to be needed. Consideration
should be given to the creation of an independent, self-regulating
body to represent institutional landlords and enforce standards.
This would be paid for and set up by the industry and accountable
to Government for ensuring agreed standards are met.
3.1.2 How the self-regulating body might
work: There are various self-accreditation schemes for landlords
currently available and these are often set up on a local or regional
basis. Some schemes are voluntary, and with the compulsory schemes
a major problem is often enforcement. In our opinion the key to
effective enforcement is the strength of the stick and carrot
within the set up. It is the proposal of this paper to provide
a strong set of incentives to institutional investors to encourage
membership and ensure standards are adhered to. The threat of
removal of these incentives would give significant teeth to those
enforcing the standards, and remove the burden of enforcement
from local authorities.
3.1.3 In practice, membership of the body
would obligate an institution or corporate investor to ensure
tenants are provided with clear standards of tenant care and an
available course of action for landlord non-performance. If an
inadequate response was received after an opportunity for the
institution to remedy, a formal notice to remedy would be provided
by the regulator and further noncompliance would lead to the removal
of benefits. The regulator could assess if any complaint was fair
and reasonable. The regulator could also enforce standards where
non-performance may not be highlighted by tenant complaint.
3.2 What the Institutions could offer: A proposed
minimum standard for membership of the self regulating body is
set out below
3.2.1 A minimum standard for property condition.
A commitment to an agreed standard of property condition could
raise the general standard of rented accommodation. With the help
of zero stamp duty in certain areas, the PRS could also assist
regeneration and encourage communities by improving the condition
of poor quality areas. It is in the interests of private landlords,
particularly high profile institutional landlords, to maintain
property condition and, with greater ability to purchase blocks,
the overall quality of an area and a community can be improved.
3.2.2 A minimum standard for management.
This would include a commitment to provide 24 hour help lines
available to all tenants, a service smaller buy to let investors
are often not able to provide. In addition to a clarification
of tenants' rights under the membership of the regulatory body
there could also be a commitment to provide a clear explanation
of all documents and tenants' rights at the commencement of the
tenancy, something that is often lacking in private renting.
3.2.3 A centralised fund: A contribution
towards a centralised fund to publicise standards and raise the
profile of the private institutional sector. This would help address
the concern of Government of the reputation risk of supporting
the institutional residential sector. The body would develop a
strong brand, with the equivalent of a kite mark, of benefit to
both the members in terms of adding value, and to Government in
that the body would have a strong incentive to keep the reputation
of the brand untarnished.
3.2.4 Self assessment: At present a raft
of measures require assessment and enforcement by Government at
the local level. Additionally the burden of proof of compliance
causes significant inefficiencies to holders of large numbers
of residential property, whist rarely accurately targeting those
who do not comply.
3.2.5 It is proposed that the responsibility
of proof of compliance in a number of areas is transferred to
the regulatory body. These areas would include adherence to HIP
standards on environmental efficiency, tenant deposit schemes,
risk assessments using the Housing Health and Safety Ratings System
and compliance with Empty Dwelling Management Orders. Furthermore
institutional landlords would be able to provide an additional
commitment to not hold units vacant, ensuring full use of the
available housing, reducing the problem of investors holding vacant
units for long periods of time purely for capital growth.
3.2.6 Encouragement in shared ownership:
Self assessment could work for both institutions and the shared
ownership stakeholders. For the institutions shared ownership
should provide a higher net income as management is reduced, voids
are eradicated and the maintenance cost is shared with the tenant
and reduced due to the ownership by the tenant of a stake.
3.2.7 The incentives set out below could
direct significant funds to this area, with diversified elements
of shared ownership forming a significant proportion of institutions
funds, but current structures are problematic. However, small
units of shared ownership are illiquid and inflexible and therefore
investment in this area can only come on a scale that the institutions
(and a small number of high net worth individuals) can provide.
At present, the structures often found in the shared ownership
market make this unattractive to institutions and Government incentives
need to be stronger and provide long-term certainty.
3.3 The stick and carrot
3.3.1 Fiscal Incentives: The fiscal incentives
required by the institutions are well covered elsewhere, in particular
in the BPF document "Letting in the Future". These could
include VAT mitigation on residential expenditure, roll-over relief
from capital gains, removal of CGT on buy-to-let investors selling
to kite-marked institutions, the use of the Landlord Energy Savings
Allowance for mitigation of corporation (rather than just income)
tax and the reduction of stamp duty to be based on average value
of units purchased, rather than on aggregate value.
3.3.2 In addition, further specific tax
incentives for shared ownership could be agreed, as well as the
possibility that blocks in certain areas for long-term rent could
be stamp duty exempt, or free of COT on disposal.
3.3.3 Regulation Reduction: It is proposed
that agreed areas of regulatory burden are identified and internally
assessed by the body to appropriate standards. This would need
to be with an understanding that, from an institutional perspective,
many of these requirements are second nature and therefore areas
of over-regulation should be reduced.
4. CONCLUSION
4.1 Summary: This paper sets out both the
advantages to Government and institutions of a resurgent private
rental sector. The interest from the institutions exists, but
needs to be directed and encouraged. This paper attempts to identify
the barriers to greater institutional involvement and summarises
these in two key areas: fiscal disadvantage and regulatory overburden.
It is possible that a self regulating-body for institutions investing
large-scale in residential property and benefiting from decreased
regulation and fiscal changes, could provide the appropriate encouragement.
This would encourage institutional involvement in the sector at
the same time as reducing the burden of regulation on local authorities.
4.2 However, if the body suggested above
was over-administered, this body could be wholly unsuccessful.
Under this scenario the relevant legislation would merely act
as a further restraint on investment and reduce the likelihood
of increased development of good quality housing from this sector
of the market. This could, however, be avoided by a close dialogue
with current relevant industry regulators, which should include
the BPF.
4.3 A well regulated, thriving institutional
market, could develop and encourage housing stock on a significant
scale and provide a useful financial product that utilises the
likelihood of returning future house price growth for both institutions
and individuals. The potential of such a product has far-reaching
implications for the economy and individuals. The proposal in
this paper sets out a framework whereby this could be encouraged
and appropriately regulated.
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