Could harnessing institutional investment fix our broken rental market?

The UK’s private rental sector (PRS) is facing two severe crises: plummeting a ordability and an ageing housing stock that is unprepared for a net-zero future.

Housing in the UK, especially in high-demand areas such as London, has always been expensive. A ordability issues have worsened in the context of post-Covid, post-Brexit and mid-Ukraine turmoil. As is the case for the wider economy, house price inflation is being driven by shortages of supply.

Whilst most other sectors of the economy were put into an induced coma during the pandemic, the housing market exploded.

The temporary SDLT reduction designed to combat the impacts of Covid on the housing market acted as a catalyst, but this was not the only cause of house price growth.

Clare Harper Director IMMO

Demand was boosted by a glut of people wanting to upsize. Thanks to historically low interest rates and higher savings as a result of repeated lockdowns, many were also more able to a ord to buy their own homes.

On the supply side, new housing was curtailed by planning backlogs from lockdown alongside labour and material shortages and inflationary pressures spiralling out of Brexit and Covid. Construction material prices rose by over 20% per year over recent years (The Construction Leadership Council).

Buoyant demand combined with stagnant supply means an ever growing shortage of housing in general, and a ordable, quality homes in the places people want and need to live, in particular.

Housing shortages and rising prices are not phenomena confined to the UK. House prices in most major economies soared even as their economies flatlined as a result of lockdown restrictions.

The unique challenge faced in the UK is one of quality, which has direct and painful consequences for renters.

The government’s latest English Housing Survey revealed that over one fifth of PRS homes are deemed ‘non-decent’ and contain ‘Category 1’ hazards including mould growth, asbestos, and lead poisoning. Our poor quality rental housing is estimated to cost the NHS £340m a year - just £10m short of what Brexiteers claimed we would get from leaving the European Union. Clearly something needs to be done.

The age of Britain’s housing also means it is deeply energy ine cient, which will make this winter even harder for many.

The Future Buildings Standard will ensure homes built from this year are more energy-e cient. However, 80 percent of the UK’s housing stock in 2050 already exists, so this only solves a small part of the problem. Minimum Energy E ciency Standards seek to tackle the e ciency of the rest. A key question is, who pays?

In the UK rental market, demand keeps growing with demographic changes and the rise of ‘Generation Rent’, who cannot or do not want to purchase their own home. Meanwhile, supply is shrinking due to a landlord exodus. Many smaller ‘mom and pop’ see the 168 laws and regulations governing residential property and its management, including Minimum Energy E ciency Standards, alongside rising interest rates and the impacts of Section 24 on their tax bills, and are re-evaluating. Plenty are selling up.

The ‘landlord exodus’ is resulting in major shortages of quality, a ordable rental housing in the places people want and need to live.

The a ordability problem is worst in big cities as life normalises, driving private rents higher and higher - in London, they are up 17.8% in a year. As a result, lower-income renters can now expect to pay up to 40 percent of their income to live in an averagely-priced rental home. This is far beyond the oftenused definition of a ordability of 30% of household income.

With the UK having experienced no real wage growth since 2008, and people’s incomes already being stretched by the cost of everyday goods shooting up, this situation is clearly unsustainable.

The quality and energy e ciency problem is dispersed throughout the UK.

Part of the problem is that underinvestment, and herein lies the opportunity for patient institutional investors.

The most sustainable building is the one already built, so a mass retrofitting campaign is needed if we are to ever meet our net zero targets.

Upgrading homes from an EPC D to B rating results in over 50% less emissions, representing two ton(ne)s of CO2 per year per house.

Clearly there is a role for the government to play here. However, given the scale of the challenge - estimates for the cost of retrofitting the UK’s housing stock sit between £300 and £500bn - policy-makers need to look for alternative sources of finance outside of public spending.

Passing the bill onto consumers is not a politically viable choice, especially with household budgets already squeezed.

There is a third way: harnessing the weight of institutional capital looking to enter the UK residential market. By transforming the ownership in the rental market, which remains dominated by non-professional landlords (82% of landlords owned fewer than 5 rental properties in 2021 - English Private Landlord Survey 2021), we can improve the quality of our housing while meeting the government’s ambitious sustainability goals.

To do this at scale, it’s essential to use technology to e ciently identify, acquire and then accurately predict the cost of retrofitting existing homes.

Fundamentally, investors want steady, long-term income streams that provide bond-like returns to help match their liabilities.

By aggregating portfolios of individual rental properties and targeting where the depth of demand is greatest - the midmarket - it is possible to provide institutions with a reliable alternative to fixed-income investments such as sovereign bonds while delivering more sustainable, higher quality homes for rent.

We recently announced plans to use £1 billion of institutional investment allocated to us by some of the world’s largest pension funds and insurers to do exactly this to over 3,000 homes across the UK.

The Department for Levelling Up, Housing and Communities estimates the average cost to upgrade a privately rented property to an EPC C rating in the UK to be around £7,650, meaning our plans could save UK homeowners, landlords and taxpayers a collective £25 million. This is only the start: the eventual saving could be far greater.

We are not alone in recognising the huge opportunity that lies in fixing broken rental markets. Investment managers such as MARK and Moorfield are targeting pre-existing rental homes as part of their residential strategies.

The benefits of a more institutionalised rental market do not end with better insulated, more a ordable homes.

A thriving, functional rental market also allows the UK to build a more transient workforce that is capable of plugging skills gaps where necessary by providing assurances to skilled labour that they will always have a great home and community to live in, no matter where they relocate.

Since the 1980s, rapidly growing equity markets and the fact that households have increasingly shifted from direct stock ownership to holdings via asset managers, mean that institutional investors have had the financial capabilities to enact real, long-term changes.

In the same way that they improved transparency and accountability across the corporate world, institutions are now well-placed to transform the PRS sector into one that is capable of tackling housing shortages, plummeting a ordability and climate change.