In the last issue of All Magazine, my colleague Emma Hart discussed the importance of research in designing a build to rent (BTR) scheme. In this issue, I will be discussing the challenges faced by investors and developers in producing a viable scheme.
BTR or private sale?
BTR will significantly de-risk the development as investors prefer to forward fund the scheme, which effectively means that 100% of the units are sold prior to construction commencing. The ‘for sale’ option carries much more risk as it exposes the developer to market fluctuations during the development period.
So where is the catch?
As a reward for forward funding and de-risking the development, most investors will expect a discount to the aggregate full open market sales value. From our experience this is circa 5-15%. However, there are a number of other considerations that need to align to make the scheme suitable for investment:
- Establish the full Estimated Rental Value (ERV).
- Prepare a bespoke management budget which will be used to discount the ERV to the anticipated Net Operating Income (NOI).
- Finally, apply a Net Initial Yield (NIY) multiplier to that NOI to produce a Gross Development Value (GDV).
- Review the GDV against equivalent individual unit sales values to see how it sits as a discount and against a cashflow analysis to benchmark the potential investment return.
The management budget is a key value driver as every % gained or lost on the NOI can add or subtract hundreds of thousands of pounds from the GDV on larger schemes.
How can BTR compete with a private for sale development appraisal if a discount is required?
- Developers require a lower level of profit on cost due to the development being forward funded and 100% sold on practical completion.
- As long as sufficient shared resident amenity has been provided, then smaller, but well-designed apartments can be considered. This will create more units in the same net sales area.
- There is potential to negotiate the costs incurred to the date of exchange to be reimbursed to the developer within month one of the development cash flow.
- Often, investors require a lower rate of return throughout the construction phase when compared to bank finance.
- A fixed price build contract is agreed with a strong contractor offering protection of profit.
- Possibility of lower or no requirement for affordable housing.
Bricks and mortar and tier 1 contractors
If it wasn’t complicated enough to satisfy the investors’ requirements, then throw in the construction variables and you have a Rubik’s cube of a conundrum.
Our view is that a BTR investment is most robust in the ‘upper-mid’ tier where a significant element of the rental demand is situated. This means creating a high-quality scheme, but not at market leading rents. Working with contractors to keep build costs under control is vital. Part of this process is to explore innovative build techniques, such as off-site and modular construction.
Investors are predominantly risk adverse financial institutions. The choice of contractor is, therefore, very important and until recently most investors would insist on so called ‘tier 1’ contractors. However, the collapse of Carillion has brought this in to question. Considerations must include the balance sheet, track record, experience in the sector and current order book.
It all sounds complicated, so why do it?
There is a chronic shortage of housing in the UK and the BTR sector is gathering significant support from Government, local authorities and investors as a vital component of the solution. The low risk factors of agreeing a forward funding model with an institutional investor are attractive to a different type of developer, as well as to traditional house builders. These developers often have experience of developing commercial property, which has similar investment drivers to BTR product and understand the importance of high quality professional documentation.
Where are the best locations for BTR to work?
BTR works best in locations where open market sales values range between £300-£700 per sq ft. Any lower and it is difficult to build the scheme cheap enough, any higher and the rents don’t go high enough to offer required yields.
If you have a site capable of accommodating 100+ units, in a good location and benefitting from a healthy rental market, good employment, transport and infrastructure, then you have the foundations of a BTR development.
Allsop’s expertise covers all aspects of the BTR sector. Our services include research & consultancy, analysis & viability, development, management, valuation and investment.