Buy to rent sector should continue to flourish despite uncertainty - Lyndsey O’Connor

Whilst some of those active in the real estate market may feel unsettled by current geopolitical events and rumblings of a forthcoming recession, there’s a compelling argument that the Build-to-Rent (BTR) asset class could be set to flourish, despite or even because of such challenges.

Key factors underpin this assessment, foremost that the UK is still grappling with an acute housing shortage. The UK government hasn’t reached its annual target of 300,000 new homes, with the number built from 1991-2021 less than the number of homes constructed from 1961-1991. Yet the UK population has dramatically increased (by 9 million) in recent decades.

In addition to this housing shortage, recent data suggests the cost of a typical UK home is now 7.1 times average earnings. What’s more, increasing interest rates has for some increased their mortgage costs at a time of rising household costs. Collectively, these factors may influence some in the UK population to adopt the rental model that dominates in continental countries like France and Germany.

As a key legal advisor for many of the most active BTR operators, it’s notable that Shoosmiths hasn’t seen any slowdown in the UK-wide BTR market. Consequently, while some real estate sectors have faced economic headwinds caused by the likes of the Covid pandemic, the key factors underpinning the BTR sector suggests it will continue to thrive.

Lyndsey O’Connor is a real estate partner, Shoosmiths

That said, a buoyant BTR sector presents its own challenges.

The market has attracted many new entrants with funding available which is driving greater competition. To successfully bid for and secure residential sites, some operators have to submit very healthy offers, occasionally markedly in excess of current market value.

On forward purchase transactions (where a developer vendor builds out the site following the sale - vendors are becoming loath to commit to a fixed price sum for construction due to what has been described as “hyperinflation” impacting the construction sector.

Consequently, vendors are either delaying committing to contract until matters are aligned - such that the build can commence immediately - or they are seeking terms in build contracts whereby the construction sum can be increased by inflation.

In the former case, agreeing any such uplift can be significant. As there are often delays with securing planning permission beyond the timescales estimated by either the vendor or purchaser, the time lag between agreeing costs and starting the build can be lengthy meaning building materials and cost of labour may have increased substantially.

From an investor purchaser perspective and faced with rising interest costs, there can be a need to financially reappraise if bids offered for a planned build or acquisition remain viable.

Investors will also need to consider if rising living costs and a potential recession will adversely impact on rental rates. However, given the rising demand for BTR and current limited supply, a scenario of falling rents is unlikely to materialise quickly.

Of course, there are opportunities too. Should the economy take a dip, there may be more sites made available for BTR development that may otherwise have been utilised for other real estate projects. In addition, consumers may, driven by rising costs, be forced away from home ownership in favour of the relatively greater flexibility offered by the rental sector, even if only in the short term.

Undoubtedly, in order to fully capitalise on a BTR opportunity, operators need to carefully differentiate themselves from the competition in order to secure key sites and attract occupiers. Many of the most successful BTR operators are keenly aware of their competition and recognise that branding and market position are crucial factors to achieve both a successful development pipeline and an attractive occupier proposition to ensure newly built properties remain fully rented.

Moreover, operators recognise that maintaining positive relationships with vendors, negotiating constructively and being able to complete projects to required timescales are all salient factors that can assist with winning bids for properties over competitors, even when similar bids are offered.

In summary, there are challenges for the BTR market. However, even in the face of wider economic uncertainty, it’s a sector - still relatively new in the UK and particularly Scotland - that should continue to flourish. In my opinion, those operators who can turn the challenges into opportunities and continue to differentiate themselves from competitors will thrive.

Lyndsey O’Connor is a real estate partner, Shoosmiths