All investments carry some level of risk, as 75 per cent of adverts on the London Underground are obligated to remind you.

Some of that risk is unavoidable, at least for investments within the UK. Brexit uncertainty and rising interest rates will leave their mark on all asset classes in one way or another.

Some risk is inherent to property and development. Construction and planning risk are common to all kinds of development, regardless of use class.

Here, we’ve chosen to focus on three flavours of risk specific to the BTR sector: namely, planning, letting rates, and regulation.

Planning

There’s a risk that BTR schemes will take longer to get planning consent because local planning authorities don’t have experience with them. That risk will decrease over time as we gather evidence of how BTR developments work and as investors and developers get better at communicating the sector’s advantages and benefits.

The planning system has already evolved considerably to accommodate BTR. But we think there’s still more to be done to help the sector flourish. For the first time, national planning policy recognises ‘Build to Rent’ and, in fact, requires local authorities to allocate sites for privately rented homes. However, as before, Affordable housing remains a sticking point.

Changes to the National Planning Policy Framework and associated Practice Guidance will help with this. In particular, Affordable Private Rent (Discount Market Rent in London, just to keep things simple) has begun to deliver an Affordable tenure that provides the control and security that BTR investors need over their building, management, and income.

There are challenges ahead, however. While the Draft New London Plan advocates “a positive approach to the Build to Rent sector”, it imposes a blanket 35% Affordable housing threshold and a new concept of London Living Rents. Rather than mitigating the recognised viability constraints of BTR compared to development ‘for sale’, this could do the opposite.

London BTR developments also face the threat of late stage reviews. The structure of these reviews allows developers to fix their profit, passing on risk to the investors who acquire the asset. There’s also inconsistency in how reviews are imposed, with some boroughs even seeking to include rental income within the review stage valuation. This puts BTR at an even greater disadvantage to ‘for sale’ development than before.

Letting Rates

BTR schemes can release large numbers of rental homes onto the market at once. Generally, that means you have an initial letting period as the scheme fills up, during which it won’t generate its full potential income. It’s in the interests of investors to keep this period as brief as possible.

There’s a few ways investors can mitigate the risk of a lengthy letting up period. They can register potential tenants before the scheme reaches completion. But the short-term nature of residential tenancies precludes the kind of lengthy pre-let agreements we see on commercial developments.

They can phase the development, releasing blocks of homes to the market in chunks as they’re completed. This is simple if the scheme comprises houses or several smaller blocks: larger schemes such as East Village released as few as 15 homes to the rental market at a time to avoid overwhelming the market. But phasing may not be an option on large, individual blocks of apartments.

And they can price schemes so they’re affordable to the deepest part of the market. Letting evidence suggests that tenants are willing to pay a higher rent for the higher level of service and convenience in BTR homes. But increasing rental values substantially restricts the pool of potential tenants. Restrict that pool too far, and schemes will struggle to let.

Regulation

Housing now sits near the top of the political agenda, raising the risk that Government could introduce new regulations to the rental market.

We’ve seen a range of initiatives from across the political spectrum aimed at improving the private rental market. To date, these changes have largely benefited the institutional landlord. Plans to abolish tenants’ letting fees will align the rest of the market with what is now common practice in the BTR sector.

The Conservatives pledged to explore ways to encourage longer tenancies, while Labour has called for three-year tenancies as standard. That’s not a problem for long-term investors seeking a secure income stream, who are generally happy to offer longer tenancies with tenant-only breaks. And policies aimed at restricting amateur Buy to Let investors leave a gap in the market for professional landlords.

Perhaps the greatest potential risk is of rent regulation. One look at the regulated rental markets of Germany and the US will confirm that BTR investors are comfortable with modest caps on rent inflation. They provide greater certainty of income while reducing perceived risk.

We have yet to see detailed proposals in the UK from either major party. Labour has proposed rent unions and an inflationary cap on rent increases within tenancies, while the Conservative party has repeatedly ruled out support for any form of rent control.

The fastest way to decrease regulatory uncertainty would be for Government to publish policy setting out how it intends to oversee the rental market. Until we have that clarity, the threat of stricter measures remains.

TALKING HEADS – What the industry experts think

Rental growth

“There is a process of evolution which comes from direct experience of BTR. When our next generation of purpose-built, truly built to rent homes come through, we’d expect to see a design premium emerging in the rent. That will grow as the market becomes more familiar with the offering.” Angus Dodd, Quintain

“The upshot of building at scale is that we are creating new neighbourhoods with amenity to back it up, albeit ones that sit within the existing urban fabric. In doing that we seek to add a regeneration uplift as the quality of the area improves. Beyond that, any performance adjustment comes from a compelling resident proposition and operational efficiency.” Rick de Blaby, Get Living

Gross to net

“Pushing up rents but underinvesting in your asset might improve your leakage in the short term, but it will harm your investment in the long run. Schemes or businesses that don’t have regard to these factors could easily become unstuck.” Angus Dodd, Quintain

“We find you need an operating income of at least £2 million a year to justify having staff on site full time. Once you get beyond that point, there’s opportunities to scale up without significantly increasing costs.” Alex Greaves, M&G

“There are areas where we could cut costs in the short term: landscaping, the retail side, the events team, and so on. But all these things form part of our wider proposition and brand: if we weaken that, it weakens our ability to attract and retain residents.” Rick de Blaby, Get Living

Regulation

Rather than regulation, the BTR sector needs support from Government if it is to maximise housing supply. That support should recognise the social value created by BTR schemes over the Buy to Let market, such as the greater flexibility and security for residents. Dan Batterton, L&G

“It’s important both the physical product and the tenancies you offer match what your residents need. We offer longer leases, but most of our current demand is for one-year tenancies. We may find in later phases, where we’re building larger, family homes, longer tenancies become more popular.” Angus Dodd, Quintain

Who’s missing?

“Student housing developers build a similar kind of product, they have experience of providing the amenity space and services we’re trying to develop, and they’ve got a track record in using modern construction methods. You’d think BTR would be a natural step for them.” Alex Greaves, M&G

“There’s a lot of players active in the market now who want to build a pipeline, show that the concept works, and exit. I think the biggest buyers of that kind of stock will be pension funds.” Dan Batterton, L&G

“BTR is a long-term business where the best returns are derived from patience, operational skill, and long-term commitment. This means it’s better suited to long-term, patient investors. Rick de Blaby, Get Living

“I’m surprised by the number of people who think they can make BTR work. The investment that’s required in recruitment, training, and IT infrastructure to establish a BTR operating platform is huge. Not a lot of companies have the size or the conviction to make that investment.” Angus Dodd, Quintain