Is scale now the key to cracking the buy to let market?

Although some portfolio and smaller buy-to-let investors have been disposing of their residential assets in a piecemeal fashion, there has recently been a new wave of corporate and institutional players keen to invest in the sector.

Despite some economic headwinds, there remains a healthy appetite for residential assets with investors looking for long-term growth and attracted by capital appreciation and rising rents. The squeeze on household finances combined with increasing interest rates driving up borrowing costs is making home ownership more challenging, boosting demand in the private rental sector. Furthermore, owning a property is not suitable for everyone and the private rental sector is playing an increasingly important role in fulfilling their accommodation needs. The long-term trend will favour much larger scale ownership with providers offering high-quality accommodation for private rent. Backing this transition are investors who are in it for the long haul for at least 20 or more years and are unperturbed by short-term challenges.

Why are people selling – and what kind of stock is it?

Driving sellers has been a combination of onerous tax changes, forthcoming tightening energy performance legislation and, in the case of family-owned properties, a wide range of succession issues. Private buy-to-let property owners have been hit by no longer being allowed to directly offset borrowing costs against rental income and 3% extra stamp duty. Adding to their woes is the future cost of upgrade and modernisation of existing properties under proposed legislation, requiring an EPC rating of at least a C for all newly rented property in 2025. An ageing private landlord demographic and a wish to avoid management hassles is also taking its toll. But now the greatest pressure will be increased borrowing costs, which will force many landlords to sell up. Many private family portfolios are being sold due to later generations not having the appetite to continue running the business, not helped in some cases by too many stakeholders involved, and other complexities. As a result, we have seen many family offices disposing of entire portfolios. Some flat and house portfolios for sale have been nationwide, from London to the regions of England and Wales, ranging in size from £5m to £50m. Amid the sales, certain trends are clear. Among these include “buy-back” schemes to turn homes into affordable or social housing. One of our recent examples is a major portfolio in Basildon, which we sold for £10m to a local authority pension fund. The portfolio was let to local authority tenants, so via the pension fund it effectively became new council housing. Meanwhile, there are instances such as that of the Merlin Portfolio, on behalf of a private family office, which was of mixed tenancy types located in rental hotspots across London and the South East and sold to an investment fund for £50m. Another portfolio trend we’re seeing and which is likely to increase will be unsold developer stock, examples of which we’ve handled across Greater London and the South East.

Who is buying and why?

Of course, the increased borrowing costs we’re experiencing right now that are forcing some to sell could in turn make it a very good time for others to buy, with yields almost certainly having to soften. On the demand side, investors are aiming for scale to reduce operating costs by reaching a critical mass in the size of their portfolio. On their ideal shopping list are freehold unbroken blocks and houses, located in close proximity to one another to enable efficient management. They are also looking for good yields or a discount on the vacant possession valuation (VPV) or, depending on location, a combination of both. Who are these investors active in the market? Specialist Real Estate Investment Trusts (REITs), local authorities, and large property companies, as well as some family offices. In the case of local authorities, attracting them to the sector is an urgent need to replace council housing stock sold off under the right to buy legislation. And then, for others, it is a buoyant private rental market. Demand is far exceeding supply with strong returns while rental income from short-hold tenancies can be raised thus reducing the impact of inflation. In addition, thanks to some of these diverse locations, the ability to sell off piecemeal into the owner occupier market in the future adds another layer of security to the investment. More recently is the increase in foreign buyers deploying cash to secure property, with such investors benefitting from the weakening pound.

What next for the sector?

More private landlords will sell off their portfolios for many years to come. Some of the individual assets will be absorbed piecemeal into the owner occupier market once or if vacant possession can be obtained. But in the short term thanks to interest rate rises, inevitably some investors will be seeking better returns and will be redeploying their capital in the north where capital values are lower and yields are higher. Those investors sitting on cash will be tempted by greater potential returns in the south where a significant discount to the vacant possession value will be the main lure because of much lower yields and higher capital values but better long term future growth prospects. In the short term a softening of yields is inevitable, but long term residential investment should hold up better than other sectors and remain very investable as rental growth and demand far outstrips supply in many areas. Scale will be the key to success.